Clock is Ticking on Surplus Lines Tax Reform

With Less Than a Year to Go, Can States Agree on Tax Sharing Plan?

The insurance industry called the passage of the Wall Street Reform & Consumer Protection Act on July 21, 2010, a “big win” thanks to provisions in the massive reform bill that would modernize regulation and taxation issues for surplus lines.

Title V, one portion of the 2,300-page legislation called the Nonadmitted & Reinsurance Reform Act, or NRRA, came as good news for an industry that has been pushing for surplus lines reforms for years.

Now that it’s official, state regulators and legislators have to figure out how to implement NRRA’s provisions – and in just a little more than nine months. The deadline for legislation enactment is July 21, 2011.

To get the job done, the National Association of Insurance Commissioners (NAIC) has set up a task force focused exclusively on how to implement the surplus lines reforms. The states have a big job ahead of them, according to industry insiders.

The timeline to implement the provisions is as “aggressive” as it gets, says Phil Ballinger, executive director of the Surplus Lines Stamping Office of Texas (SLSOT).

The NRRA addresses several issues on how the surplus lines industry does business – including uniform standards for insurer eligibility, regulation of nonadmitted insurance by an insured’s home state, participation in a national producer database, streamlined applications for commercial purchasers, and a study of the surplus lines industry – most of which must be implemented within the year deadline.

One of the most important and helpful provisions to surplus lines brokers could very well be the most complicated to implement. That’s the provision that deals with how reporting, payment and allocation of premium taxes will be handled post-July 2011.

While the legislation eases the tax reporting, payment and allocation burden for surplus lines brokers and the insurance industry, it could place additional burden on the states, at least in terms of how they will now divvy up premium taxes for surplus lines risks. This is the challenge the states and their insurance regulators face today.

How Tax Payments Change Under NRRA

Under the new NRRA, only the home state of an insured may require premium tax payment. This is one of the key advantages the reform legislation offers surplus lines brokers, says Alan Kaufman, CEO and president of wholesaler brokerage Burns & Wilcox. The legislation clears up confusion over where taxes for multi-state risks should be remitted. Now the taxes will be paid in one state rather than a number of states. But, according to Kaufman, while the ambiguity for brokers and their insureds about where taxes are to be paid on multi-state risks has been eliminated, the burden now shifts to states that must devise a plan for sharing all that premium tax revenue.

The legislation says that states must enter into a compact or establish other procedures to allocate any taxes paid directly to the insured’s home state that may be due to another state. For example, if an insured’s home state is Arkansas, then Arkansas would collect all premium taxes on that surplus lines risk. Then it would be up to Arkansas, and the other states where the risk also does business to agree on a plan as to how that home state would dole out any due tax to any other state where the insured has operations.

Thus far, states have not adopted any such plan or “compact” even though ideas, including the Surplus Lines Insurance Multi-State Compliance Compact, or SLIMPACT, have been in the works for some time.

Several years ago during open meetings held at NAIC national meetings, state regulators, tax officials, legislators, stamping offices, brokers and trade associations, took part in SLIMPACT’s creation. Then in 2007, the National Conference of Insurance Legislators (NCOIL) gave its support to the concept. However, it wasn’t until this past August, after the NRRA passed, that the NAIC began to take the matter seriously and examine the compact model and its possible use.

In August, the NAIC launched an Implementation Task Force to examine SLIMPACT and other possible solutions to the surplus lines premium tax allocation issues. Since then, the task force, headed by Commissioner James Donelon of Louisiana, has been meeting regularly to discuss SLIMPACT and other models, including the International Fuel Tax Agreement (IFTA), that might work for surplus lines premium taxes, SLSOT’s Ballinger says.

But the clock is ticking.

The task force plans to have a complete package recommendation to give to the NAIC’s leadership at the association’s fall meeting on Oct. 20 in Orlando, Fla. – an aggressive time table, Ballinger says. Whatever allocation plan the NAIC adopts, must also be adopted by state legislatures – which could also be a challenge given the short timeframe.

“What we will definitely see is, either by legislation, regulation, or by interpretation, the states will be changing their laws,” says Daniel Maher, executive director of the Excess Line Association of New York. When “you’re talking about getting in front of a lot of state legislatures, it’s a daunting task to accomplish in the time frame allowed.”

But Mike Humphries, spokesperson for NCOIL, said that while getting the states to change state laws on whatever tax concept is finally adopted under the tight deadline is ambitious, it’s not impossible. SLIMPACT is a concept that has been out for discussion for some time; it’s now new, Humphries says. “NCOIL legislators have known about it (SLIMPACT) for several years.” Even so, Humphries agreed that the 2011 deadline is “ambitious” at best.

Reaching Consensus

To help advance discussions, NCOIL legislators recently asked the NAIC to indicate which provisions in the SLIMPACT proposal that state regulators cannot support. NCOIL’s President Rep. Robert Damron (Ky.) said that NCOIL is “willing to work with the NAIC and others to modify SLIMPACT, if necessary, so that we can expedite guidance to the states.”

But while the surplus lines industry and NCOIL may have been discussing possible solutions to the tax allocation issue, such as SLIMPACT, for a long time, the NAIC did not begin addressing the issue until the NRRA actually became law, Maher says.

“I think they were late out of the box, but I think they’re trying the commissioners are trying to determine where they have consensus and because they were late out of the box, I think bringing consensus is a pretty tough issue,” Maher says.

Maher says how states decide to allocate taxes is one of the most difficult issues of NRRA to implement.

“We’re six weeks into this, and I don’t think consensus has emerged, but I think there’s been a good faith attempt to try to see whether SLIMPACT, the international fuels compact or agreement, or some other method to allocate and distribute taxes will essentially win a consensus,” Maher says.

Once NAIC adopts a model, states will have strong motivation to reach consensus too: money.

“The states, collectively, stand to lose millions of dollars in tax revenues if they don’t come to an agreement,” Maher says.

Today, some national brokers pay a portion of tax to every state. Maher says in 2009, New York processed $1.75 billion in total taxable surplus lines premium. However, a portion of the premium that New York did not taxt, some $1.34 billion, was taxed by other states.

SLSOT’s Ballinger said to date his office has processed $3.1 billion in total taxable surplus lines premium. However, some $683 million of that amount, or almost 22 percent, was premium allocable to other states.

“So, if the states leave a void and don’t do anything, in terms of adopting a tax allocation and sharing agreement, then it’s going to be whatever the home state law is,” Maher says. That means the states will start to lose revenues.

“I think that that’s why the NAIC is recommending that one thing the states do, at least on an interim basis, is amend their laws to charge tax on 100 percent of the premium until there is some kind of tax allocation agreement. That’s a recommendation or a guiding principle that has been issued by the NAIC task force.”

How realistic is the July 21, 2011? According to Maher, in setting the deadline the federal government may have been trying to instill a sense of urgency. And perhaps there’s no greater sense of urgency than the threat of losing millions in tax revenue.

Topics New York Agencies Legislation Excess Surplus Arkansas