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DODD-FRANK ACT REFORMS THE REGULATION AND TAXATION OF SURPLUS LINES INSURANCE

Since the preparation of this article, the National Association of Insurance Commissioners ("NAIC") Surplus Lines Implementation Task Force ("Task Force") amended and approved the Nonadmitted Insurance Multi-State Agreement ("NIMA") on December 8, 2010 in order to implement state-based solutions for addressing the surplus lines reform contained in the Dodd-Frank Act. The NAIC Joint Executive Committee unanimously adopted NIMA at the Plenary Meeting on December 16, 2010. The analysis of the issues raised in designing these state-based solutions contained below will provide a template of the issues that will continue to be discussed throughout NIMA's implementation.

Tucked within the 849 pages of the recently-enacted Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank Act")1 are the 8 pages comprising the Nonadmitted and Reinsurance Reform Act of 2010 ("NRRA").2  Although a minor part of the Dodd-Frank Act by page count and apparently unrelated to Wall Street reform or consumer protection, the NRRA has important ramifications for surplus lines brokers and the standards for allocating premium taxes to states. This article will describe the major provisions of the nonadmitted insurance sections of the NRRA, the steps the National Association of Insurance Commissioners ("NAIC") has taken to promote an "interstate compact" as envisioned under the NRRA, and unsettled questions that remain with respect to the implementation of the nonadmitted insurance provisions of the NRRA.

I. Description of Nonadmitted Reinsurance Provisions Within the NRRA

The NRRA has an effective date of July 21, 2011. The provisions do not apply to risk retention groups. The sections relating to nonadmitted insurance can be divided into six categories, as follows:

Home State Exclusivity for Premium Taxation and Allocation of Taxation

Section 521 provides that no state other than the home state of an insured may require any premium tax payment for nonadmitted insurance. Home state is defined in Section 527. For natural persons, the home state is that person's principal residence. For all other persons, if any part of the risk in the insurance contract is located in that state, the home state is the principal place of business, and if not, then the home state is the state to which the greatest percentage of tax premium for the insurance contract is allocated. For affiliated groups, the same analysis is applied to the member of the affiliated group with the largest percentage of premium attributed to it in order to determine the home state of the insured.

Section 521 also authorizes states to enter into a compact or otherwise establish procedures to allocate among the states the premium taxes paid to the home state. Congress intends that each state shall adopt uniform requirements that provide for the reporting, payment, collection, and allocation of premium taxes for nonadmitted insurance. The NRRA provides that the NAIC may submit a report describing any agreement reached among the states for the allocation of premium tax. The home state may require its brokers to produce a Tax Allocation Report that details that portion of nonadmitted insurance premiums attributable to properties, risks or exposures located in each state.

Home State Regulation of Nonadmitted Insurance

Section 522 provides that only the insured's home state shall regulate nonadmitted insurance (including the licensing of insurance brokers selling nonadmitted insurance). Still, this provision is not to be construed to preempt any state law, rule, or regulation that restricts the placement of workers compensation insurance or excess insurance for self- funded workers compensation plans with a nonadmitted insurer.

National Insurance Producer Database

Section 523 encourages state participation in the NAIC national insurance producer database (or any other equivalent uniform national database) for the licensure of surplus line brokers and the renewal of these licenses. Beginning July 21, 2012, states that do not participate in this database are prohibited from collecting any fees relating to the licensure of surplus lines brokers.

Standards for Surplus Lines Eligibility

Section 524 prohibits states from imposing eligibility requirements on nonadmitted insurers that are domiciled in a U.S. jurisdiction, except in conformance with 5A(2) (relating to insurer authorization to write types of insurance) and 5C(2)(a) (relating to capital and surplus requirements) of the NAIC Non-Admitted Insurance Model Act (Model 870), unless the state has adopted nationwide uniform requirements, forms, and procedures in accordance with the NRRA. In addition, a state may not prohibit a surplus lines broker from placing nonadmitted insurance with, or procuring nonadmitted insurance from, a nonadmitted insurer domiciled outside of the United States that is listed in the Quarterly Listing of Alien Insurers maintained by the NAIC.

Streamlined Process for Commercial Purchasers

Section 525 streamlines the purchase process for large insureds. A surplus lines broker seeking to procure or place nonadmitted coverage for an exempt commercial purchaser shall not be required to make a due diligence search to determine whether the insurance could be obtained from admitted carriers if it has: (1) disclosed that the insurance might be available from an admitted carrier that might provide more protection with greater regulatory oversight; and (2) the exempt commercial purchaser has subsequently requested in writing that the broker procure the insurance from the nonadmitted insurer. As defined in Section 527, commercial purchaser means that the entity has employed or retained a qualified risk manager to negotiate insurance coverage, has paid in excess of $100,000 in property and casualty insurance premiums in aggregate on a nationwide basis over the previous 12 months, and, if a business, meets a certain threshold for net worth, annual revenues, or number of employees.3

GAO Study of Market

Section 526 requires the U.S. Comptroller General, in consultation with the NAIC, to prepare a report on the nonadmitted insurance market and to complete the report within 30 months after the NRRA's enactment. This report must address the effect of the Act on the size and market share of the nonadmitted market for coverage typically provided by the admitted market.

II. Development of the Interstate Compact by the NAIC

As noted above, the states may form an interstate compact to allocate taxes on multistate risks, preferably on or before July 11, 2011 (when the NRRA becomes effective). The NAIC's Executive Committee created the Surplus Lines Implementation Task Force (the "Task Force") for this purpose and with a charge to "develop and oversee implementation of state- based solutions addressing the surplus lines subtitle" of the NRRA.4  The Task Force first convened on August 30, 2010. Since this time, the Task Force has drafted Guiding Principles for Surplus Lines Reform Implementation, presented two discussion drafts of nonadmitted insurance compact legislation, and received written comments from 13 states in response to the two circulated drafts.

The initial draft considered by the Task Force was based on the Surplus Lines Insurance Multi-State Compliance Compact ("SLIMPACT").5 SLIMPACT was originally drafted by the Excess Line Association of New York ("ELANY"), the National Association of Professional Surplus Lines Offices ("NAPSLO"), state stamping offices and other organizations and has been circulated since 2007. Proponents of SLIMPACT argued that "there is no time left to study and defer consideration of SLIMPACT [since it] is the only viable, readily available solution which has any reasonable chance of passage and adoption by a sufficient number of states to address the NRRA provisions in the time provided."6

SLIMPACT envisioned the creation of a Nonadmitted Insurance Commission, a body politic that would set binding decisions for Participating States. The Commission would adopt mandatory Rules concerning the allocation of taxes and the development of a clearinghouse to process payments and could adopt optional Uniform Standards. The Task Force stripped the Nonadmitted Insurance Commission from its second draft, entitled the Nonadmitted Insurance Multi-State Agreement ("NIMA").7

Other features of SLIMPACT, however, were retained in Part IV of NIMA relating to collection and allocation procedures. Each compacting state designates one tax rate applying to all forms of non-admitted insurance regardless of class or coverage type and designates up to four uniform tax payment dates. For multistate risks, the broker enters information into allocation software, which determines the amount of premium tax payable to each state. The premium is reported to a nationwide clearinghouse using data from the allocation software. Using the data, the clearinghouse may credit or debit a state's depository account in order to account for the allocation.

Annex A of NIMA sets forth the method to determine tax allocation by type of insurance. For example, general liability and umbrella policies can be determined either by revenue receipts or payroll. Medical malpractice may be determined by revenue receipts, number of professionals, or bed count (for facilities). Property insurance will be determined by total insured values, which is computed in different ways according to the coverage type.

As of November 12, 2010, a final proposal has not been posted by the NAIC. After adopted, the final proposal, with amendments, will be sent to the full membership of the NAIC for consideration.

III. Open Questions

The main thrust of the NRRA was to create uniform standards for surplus lines broker licensure, surplus lines eligibility and large commercial purchasers, and also to simplify the parties with jurisdiction over surplus lines taxation and regulation. It is uncertain whether the NRRA will be effective in these goals. First, what if an insufficient number of states act to adopt an interstate compact before the July 21, 2010 deadline? Premium taxes would only be payable to the home state with no established method of allocation. This may benefit certain states that are the principal place of businesses but have a disproportionately low amount of risk contained in the state, including Delaware, Nevada and Wyoming, which would make it even more difficult to pass an interstate compact after this date.

Second, if NIMA is adopted, would the administrative burdens on surplus brokers be simplified by it and the NRRA? The NRRA permits the collection of tax allocation reports that detail the portion of nonadmitted insurance policy premiums attributable to properties, risks and exposures located in each State. Conceivably, insurance departments could make the filing of such Tax Allocation Reports so detailed as to not alleviate the administrative burden on brokers associated with placing multiline risks. In addition, the NAIC's movement to promote NIMA instead of SLIMPACT could result in the adoption of a bare bones tax allocation agreement. Such an agreement may leave many open gaps which states could fill with their own individualized requirements, frustrating the intent of uniformity and simplicity.

 

References

1. Public Law 111-203 (July 21, 2010), http://www.gpo.gov/fdsys/pkg/PLAW-111publ203/pdf/PLAW-111publ203.pdf.

2. NRRA, §§ 511-542.

3. Each person must meet at least one of the following: net worth in excess of $20,000,000, (ii) annual revenues in excess of $50,000,000, (iii) 500 full time equivalent employees for an individual or 1,000 affiliated employees for an affiliated group, (iv) budget expenditures of $30,000,000 or more (if a non profit or public entity), or (v) a population of 50,000 or more (if a municipality). § 527(5)(C).

4. Surplus Lines Implementation (EX) Task Force, http://www.naic.org/committees_ex_slitf.htm.

5. Surplus Lines Task Force, NAIC Summer National Meeting Summaries (June 15, 2009), http://www.naic.org/meetings0906/summary_c_surplus_lines.htm.  The initial draft is available at http://www.naic.org/documents/committees_ex_slitf_100927_draft_compact_legislation.pdf.

6. Letter from NAPSLO et al. to Commissioner Ario, Re: Non-Admitted and Reinsurance Reform Act of 2009 (NRRA) / Surplus Lines Insurance Multistate Compliance Compact (SLIMPACT) (July 26, 2010).

7. http://www.naic.org/documents/committees_ex_slitf_101103_nima.pdf.