NRRA Surplus Lines Requirements: The Devil is in the Details

Editor’s Note: This is the second installment of a two-part article on compliance with the Nonadmitted and Reinsurance Reform Act. Part one appeared in the West region of Insurance Journal’s February 21, 2011 issue.

When the Nonadmitted and Reinsurance Reform Act (NRRA), Subtitle B, Part I, Dodd-Frank Wall Street Reform and Consumer Protection Act, takes effect on July 21, 2011, it will represent a sea change for taxation and regulation of surplus lines insurance. Consequently it’s important to understand the ground rules for NRRA compliance.

Understanding a Home State

Under the NRRA, only the insured’s Home State may tax or regulate placement of a surplus lines insurance policy. “Home State” generally means the state of the “insured’s principal place of business.” The surplus lines broker need be licensed only in the Home State. For Affiliated Groups, the Home State is the state of the “principal place of business” of the “member of the affiliated group that has the largest percentage of premium attributed to it under such insurance contract.” Section 527(6)(B).

Unless preempted by the NRRA, the laws of the Home State control diligent search, surplus lines disclosures, forms and filing procedures, and taxation of surplus lines premium. Correct identification of the relevant “insured” at the outset is critical to identifying the correct Home State.

The NRRA, Section 527(6), defines Home State as:

1. In general, the state in which an insured maintains its principal place of business or, in the case of an individual, the individual’s principal residence; or if 100 percent of the insured risk is located out of the state referred to, the state to which the greatest percentage of the insured’s taxable premium for that insurance contract is allocated.
2. Affiliated Groups — If more than one insured from an affiliated group are named insureds on a single nonadmitted insurance contract, the term “home state” means the home state determined pursuant to subparagraph (A), of the member of the affiliated group that has the largest percentage of premium attributed to it under such insurance contract.

Allocated or attributed by who according to what allocation methodology is a question the NRRA of course does not address.

Single Insureds

The Home State is the state of the insured’s principal place of business for a commercial account or the state of the insured’s principal residence for individuals. Different rules apply for Affiliated Groups.

If any portion of the premium is allocable to the state of the insured’s principal place of business or residence, that state is the Home State. But if 100 percent of the premium is allocable to risks outside the state of the insured’s principal place of business or residence, the Home State will be “the State to which the greatest percentage of the insured’s taxable premium for that insurance contract is allocated.”

Affiliated Groups (Multiple Insureds)

The term “Affiliated Group” means “any group of entities that are all affiliated.” The term “Affiliate” means, “with respect to an insured, any entity that controls, is controlled by, or is under common control with the insured.” Where more than one member of the Affiliated Group is insured under a single surplus lines policy — i.e., two or more affiliated “entities” — the Home State is the “principal place of business” of the group member to which the “largest percentage of premium is allocated.”

For example:

• The ultimate corporate parent is domiciled in Delaware.
• The parent and five corporate subsidiaries including Subsidiary X are named insureds under the policy.
• The largest percentage of premium is properly allocable to Subsidiary X.
• Principal place of business for Subsidiary X is Iowa.

On these facts, Iowa is the Home State. The surplus lines broker must be licensed in Iowa and Iowa regulatory requirements apply. If the surplus lines broker mistakenly pays the surplus lines tax to Delaware, Iowa will demand payment and the broker could be faced with having to pay the tax twice.

For Affiliated Groups, it is important to appreciate that the Home State is defined by reference to the principal place of business of the relevant insured entity.

Surplus Lines Insurer Eligibility

The NRRA establishes uniform minimum capital and surplus eligibility requirements for foreign and alien nonadmitted insurers with whom surplus lines brokers may lawfully place risks.

Foreign nonadmitted insurers (i.e., domiciled in the U.S. but outside the Home State) may accept surplus lines business if they have capital and surplus of at least $15 million under the laws of their domiciliary state or meet minimum capital and surplus requirements of the Home State, whichever is greater. California recently increased the minimum capital and surplus requirements for nonadmitted insurers from $15 million to $45 million. Other states can be expected to follow.

The NRRA, Section 524(2), bars states from prohibiting surplus lines brokers from placing business with alien nonadmitted insurers (i.e., domiciled outside the U.S.) if they are listed on the NAIC’s Quarterly List of Alien Nonadmitted Insurers.

The fact that the Home State has approved a surplus insurer as financially sound and otherwise qualified to insure risks in the state (e.g., California’s LESLI), arguably eliminates or at least greatly reduces the surplus lines broker’s due diligence obligation relevant to insurer financial condition. The NAIC Quarterly Listing of Alien Nonadmitted Insurers is not such a state-approved list. Plan accordingly.

Be prepared to pay $250 to obtain a copy of the Quarterly List from the NAIC — it is not available for free.

The laws of the Home State govern diligent search requirements unless the insurance buyer is an Exempt Commercial Purchaser and therefore exempt from state diligent search requirements. However, the laws of many states also exempt “export list” coverages and “industrial insureds” from diligent search requirements.

Exempt Commercial Purchaser

An Exempt Commercial Purchaser is what one would expect: a substantial commercial ($20 million net worth, $50 million annual revenues, 500 full-time employees) or not-for-profit/public entity enterprise ($30 million annual budgeted expenditures), or a municipality (50,000 population). The Exempt Commercial Purchaser must employ or retain a qualified risk manager and have paid $100,000 of property and casualty premium in the immediately preceding 12 months.

Where the insurance buyer is an Exempt Commercial Purchaser, the surplus lines broker is relieved of all diligent search requirements if:

1. The broker procuring or placing the surplus lines insurance has disclosed to the exempt commercial purchaser that such insurance may or may not be available from the admitted market that may provide greater protection with more regulatory oversight; and
2. The exempt commercial purchaser has subsequently requested in writing the broker to procure or place such insurance from a nonadmitted insurer.

Congress apparently considered the sequencing important: first the broker disclosure, thereafter a request from the insured instructing the surplus lines broker to procure the insurance in the nonadmitted market. Unless the Home State has its own version of Exempt Commercial Purchaser or maintains an “export list” that exempts diligent search requirements, failure to comply with NRRA requirements could expose the surplus lines broker to possible fines or penalties for disregarding Home State diligent search rules.

Having the necessary NRRA disclosure and request forms available on July 21 could be a good idea.

Topics Carriers Agencies Legislation Excess Surplus Iowa