The Nonadmitted and Reinsurance Reform Act (NRRA), Subtitle B, Part I, Dodd-Frank Wall Street Reform and Consumer Protection Act, will usher in a new era of premium taxation and regulation for surplus lines insurance on July 21, 2011, a convenient Thursday shortly after the Fourth of July.
The NRRA preempts (i.e., overrides) inconsistent state laws to (a) establish a uniform system for taxation of surplus lines premium, (b) establish uniform capital and surplus eligibility standards for surplus lines insurers, and (c) streamline other aspects of surplus lines regulation.
The principal feature of the NRRA is the concept of “Home State.” Only the Home State may tax surplus lines premium and regulate the insurance transaction. Surplus lines brokers will remit surplus lines premium tax only to the Home State and need comply only with the Home State’s premium tax and regulatory requirements. The days of surplus lines brokers having to deal with conflicting state laws and premium tax allocation methods for multistate placements will soon be history.
The NRRA leaves to the states to work out arrangements for allocating premium taxes among themselves – if they are able to do so. The states are actively pursuing possible creation of an interstate compact, clearinghouse or other method to ensure that each receives its “appropriate” share of surplus lines premium tax, an ongoing process that presently does not appear destined for an early conclusion. The National Conference of Insurance Legislators (NCOIL), the Council of State Governments (CSG), and the National Conference of State Legislators (NCSL) also have asked Congress to delay NRRA implementation until July 21, 2012, which industry opposes.
With these balls firmly in mid-air, the reality is that the NRRA goes live at 12:01 A.M., Thursday, July 21, 2011, time zone of your choice. There is no transition period.
The NRRA has significant ramifications for surplus lines broker accounting and production management systems, staff training, forms, filing procedures, internal controls and vetting of market security.
Accounting – Consider a July 20, 2011, cutoff date so that on and after July 21, 2011, premium tax is paid only to the Home State. Trying to recover surplus lines premium tax paid to the wrong state can lead to hypertension.
Training – Surplus lines brokers and key staff need to be seriously familiar with the NRRA definition of Home State, especially as applied to Affiliated Groups.
Forms and Procedures – The NRRA requires a special disclosure to Exempt Commercial Purchasers, and a written request from the insurance buyer to procure the subject insurance from the nonadmitted market. Each insured should be required to confirm in writing its, his, or her principal place of business or residence (e.g., in the insurance application).
For multi-state risks, the NRRA eliminates the need to provide differing state surplus lines disclosures; only the Home State’s surplus lines disclosure form is required.
Do not destroy the other states’ forms. They will be needed when those states are the Home State for other transactions. So much for regulatory streamlining.
Regulatory Compliance – Are existing systems and procedures adequate to ensure correct identification of the Home State and compliance with Home State regulatory requirements? Beware: the definition of Home State offers traps for the unwary.
Security – NRRA preemption establishes uniform surplus lines insurer minimum capital and surplus eligibility requirements that are independent of state-approved eligibility lists such as California’s LESLI (List of Eligible Surplus Lines Insurers). For insurers that do not appear on the Home State’s approved list, surplus lines brokers may wish to consider augmenting their security measures.
Pending Legislation – To implement the NRRA’s Home State taxation system, most if not all states are considering legislation that will tax 100 percent of surplus lines premium when they are the Home State. (See “Multi-State Surplus Lines Tax: State Inaction Risks Loss of Surplus Lines Premium Tax Revenue,” Insurance Journal’s West Region Jan. 10, 2011 issue, page 20). Some pending state legislation (e.g., Washington) also includes provisions designed to implement other aspects of the NRRA.
Surplus lines brokers should be alert during 2011 to possible last-minute changes in Home State premium tax and other surplus lines laws, particularly any post- July 21 legislation that would tax 100 percent of surplus lines premium effective retroactively to July 21, 2011.
With appropriate planning, NRRA compliance should not be difficult.
- Correctly identify the Home State at the outset.
- Be licensed by the Home State.
- Determine whether the insured is an Exempt Commercial Purchaser, therefore exempt from diligent search requirements, and provide required NRRA disclosures. If the Section 525 disclosure and written request from the insured are overlooked, Home State diligent search requirements will apply.
- Verify surplus lines insurer capital and surplus eligibility.
- Comply with Home State surplus lines filing and premium tax requirements.
No filings need be made with any state but the Home State for a given surplus lines policy.
The devil is in the details. The term “Home State” generally means the state of the “insured’s principal place of business.” 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:
- In General – except as provided in subparagraph (b), the term “home State” means, with respect to an insured – (i) 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 (ii) if 100 percent of the insured risk is located out of the State referred to in clause (i), the State to which the greatest percentage of the insured’s taxable premium for that insurance contract is allocated.
- Affiliated Groups. – If more than 1 insured from an affiliated group are named insureds on a single non-admitted insurance contract, the term “home State” means the home State as 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.
Home State License
The surplus lines broker need be licensed only in the Home State. Section 522(b).
For Affiliated Groups, the Home State is 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).
Are you licensed in the Home State?
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. Section 527(6)(A)(i). Different rules apply for Affiliated Groups. Section 527(6)(B).
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. Section 527(6)(A)(i).
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.” 527(6)(A)(ii).
Affiliated Groups (Multiple Insureds)
The term “Affiliated Group” means “any group of entities that are all affiliated.” Section 527(3). The term “Affiliate” means, “with respect to an insured, any entity that controls, is controlled by, or is under common control with the insured.” Section 527(2).
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.”
- 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 will be faced with possibly having to pay the tax twice.
For Affiliated Groups, it is exceptionally important to appreciate that the Home State is defined by reference to the “entity” or “entities” insured – not the situs of the risks being insured.
Premium Tax Calculation
Most, if not all states, are in the process of updating their surplus lines premium tax laws by July 21, 2011, to tax 100 percent of surplus lines premium when they are the Home State.
If the Home State appears to tax less than 100 percent of the premium, that would be an excellent reason to check whether the Home State recently updated its premium tax laws. Otherwise the surplus lines broker risks under-collecting premium tax from the insured.
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) are eligible to 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 will increase the minimum capital and surplus requirements for nonadmitted insurers from $15 million to $45 million on Jan. 1, 2012. Other states can be expected to follow.
The NRRA, Section 524(2), bars the 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. Although the Quarterly List is effectively incorporated by reference into the NRRA, Section 524(2), it curiously is not publicly available free of charge. Perhaps a Freedom of Information Act request would pry loose a free copy.
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. Note, however, that 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). Section 527(5). 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. Id.
Where the insurance buyer is an Exempt Commercial Purchaser, the surplus lines broker is relieved of all diligent search requirements per Section 525 if:
- 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
- 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 strictly 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 would be a good idea.
Prior planning can save your summer vacation from NRRA exasperating disruption. Only six months remain. Be prepared.
Richard A. Brown is an insurance regulatory attorney based in San Francisco with decades of experience in surplus lines matters nationwide. E-mail: RAB@InsuRegulatory.com. Further information can be found on his Web site: www.InsuRegulatory.com.
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