Good Morning NRRA! Home State Scenarios for Affiliated Groups

By | July 21, 2011

Welcome to the magical mystery tour of Home State taxation and regulation under Nonadmitted Insurance and Reinsurance Reform Act of 2010 (NRRA). The NRRA went live at 12:01 a.m., July 21, 2011, in all time zones. You may have been sleeping.

Under the NRRA, only the Home State may tax or regulate surplus lines transactions. The Home State is generally the state of the insured’s “principal place of business.”

The National Association of Insurance Commissioners (NAIC) has crafted a unique definition of “principal place of business” for its Nonadmitted Insurance Multistate Agreement (NIMA).

This article illustrates how the Home State is determined for affiliated groups under one multistate factual scenario.

Grades will be distributed in the course of future premium audits. Surplus lines brokers whose business exclusively involves single-state risks may wish to suppress the urge to read further.

Others may wish to consider a triple espresso latte before continuing. Good morning, NRRA!

The Kumquat Scenario

The Kumquat Group, headquartered in Connecticut, is a hedge fund whose investments include a portfolio of four companies in the hospitality industry, each of which is a named insured on the same surplus lines policy.

1. Kumquat Hospitality Inc., the holding company for the Kumquat Hospitality Group, is headquartered in Connecticut with the same management as Kumquat Group.

2. Kumquat Inns Inc. acquired from Marriott Corp. five years ago, a mid-priced motel chain that consists of 300 properties with locations in all 50 states, is headquartered in Chicago and operated under the same management as when owned by Marriott.

3. Kumquat Hotels Inc., acquired from Hilton Corp. three years ago, consists of 25 luxury hotel properties located in 12 states, is headquartered in Maryland, and operated under the same management as when owned by Hilton.

4. Kumquat Residences Inc., a chain of 25 residence-inn type properties located in 17 states acquired from Starwood Corp. last year, is headquartered in New York and operated under the same management as when owned by Starwood.

Hertz Nerve Center

The most recent U.S. Supreme Court case, Friend v. Hertz (2010), interpreting “principal place of business” for federal “diversity of citizenship” jurisdiction purposes held that Hertz’ “principal place of business” was New Jersey because that was the state of its corporate headquarters or “nerve center,” where all of its high-level executives were housed and from which all worldwide business activities were directed and coordinated.

In the Hertz case, the principal place of business for each of the Kumquat Group hospitality portfolio companies would be:

1. Kumquat Hospitality Inc. — Connecticut;

2. Kumquat Inns Inc. — Illinois;

3. Kumquat Hotels Inc. — Maryland; and

4. Kumquat Residences Inc. — New York.

The risk manager for Kumquat Hospitality Inc. negotiates a surplus lines property cover under one policy. The premium for the property schedule is Kumquat Inns Inc. ($50 million); Kumquat Hotels Inc. ($75 million); and Kumquat Residences Inc. ($26 million).

Total premium is $151 million. No premium is allocable to Kumquat Hospitality Inc.

Kumquat Hotels Inc. has its corporate headquarters and “principal place of business” in Maryland, where its top executives reside, golf regularly at Burning Tree and Congressional, and make the day-to-day corporate decisions for the luxury hotel chain at the 19th hole.

No Kumquat Hotels Inc. exposures insured under the policy are located in Maryland.

For the policy overall, the largest percentage of premium is allocable to Colorado due to the concentration of luxury, residential inn, and mid-priced motel facilities in ski resort areas.

NRRA Home State

Section 527 of the NRRA provides:

(6) HOME STATE —

(A) 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.

(B) 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, 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.

Under the NRRA, Kumquat Hotels Inc., is the “member of the affiliated group that has the largest percentage of premium attributed to it under the insurance contract.” Total Premium is $151 million — Kumquat Inns Inc. (33.1 percent); Kumquat Hotels Inc. (49.7 percent) and Kumquat Residences Inc. (17.2 percent).

Under NRRA Section 527(6)(B), the principal place of business for Kumquat Hotels Inc., is Maryland, subject to 527(6)(A)(ii).

Because there are no Kumquat Hotels Inc., exposures in Maryland, “100 percent of the insured risk is located outside” the state where Kumquat Hotels Inc., has its principal place of business.

Under NRRA Section 527(6)(A)(ii), the Home State therefore is “the state to which the greatest percentage of the taxable premium for that insurance contract is allocated.”

The four largest luxury hotels insured under the contract are located in California and represent 7 percent of the premium. Texas has the next largest percentage of premium with three luxury hotels (5.8 percent).

California is the Home State under the NRRA.

California’s AB 315 and NIMA

The determination of Home State for affiliated groups under California’s AB 315 and NIMA is a function of how both identically define “principal place of business.” The NRRA does not attempt to define principal place of business.

Except for numbering the NIMA and AB 315 definitions of principal place of business are verbatim identical and produce the identical Home State result. References below are to the California Insurance Code as amended by AB 315.

§1760.1 (e)(2) “Principal place of business” means, with respect to subparagraph (A) of paragraph (1) determining the Home State of the insured,

(A) the state where the insured maintains its headquarters and where the insured’s high-level officers direct, control, and coordinate the business activities; or

(B) if the insured’s high-level officers direct, control, and coordinate the business activities in more than one state, the state in which the greatest percentage of the insured’s taxable premium for that insurance contract is allocated; or

(C) if the insured maintains its headquarters or the insured’s high-level officers direct, control, and coordinate the business activities outside any state, the state to which the greatest percentage of the insured’s taxable premium for that insurance contract is allocated.

Which principal place of business definition applies?

Maryland is the principal place of business state under 1760.1(e)(2)(A) because Kumquat Hotels Inc., is headquartered in Maryland. California is the Home State because it has the largest percentage of allocable premium and no premium is allocable to Maryland.

The insured’s senior management directs, controls, and coordinates its business activities in more than one state. The principal place of business state and Home State under 1760.1(e)(2)(B) are California because it is the “state to which the greatest percentage of the insured’s taxable premium” is allocable.

1760.1(e)(2)(C) is inapplicable.

But change the facts slightly…

If some amount of premium is allocable to Maryland, Maryland is the Home State under NRRA.

If the senior management of the insured with the greatest premium, Kumquat Hotels Inc., directs, controls, and coordinates its business activities in more than one state so that 1760.1(e)(2)(B) applies, California is the Home State under the AB 315/NIMA regardless of whether some portion of premium is allocable to Maryland.

Caveats

The NRRA and related state implementing legislation raise substantial Constitutional and state law legal issues of first impression yet to be clarified by the courts or through regulatory guidance.

The Kumquat Group Scenario is deliberately fact-sensitive to illustrate certain points. Slight changes in the facts can change the Home State result. For example, if Kumquat Hospitality Inc. is the only named insured under a policy that includes coverage for all subsidiaries and affiliates, is the correct Home State Connecticut, California, or Colorado?

Pending regulatory or judicial guidance about how to determine the correct Home State with certainty under AB 315 and similar NRRA state implementing legislation, surplus lines brokers have little alternative but to rely on the NRRA.

The NRRA is, after all, the law of the land. AB 315 and other state implementing legislation must conform to it.

The Kumquat Scenario hypothetical was originally conceived by Richard Bouhan, executive director, National Association of Professional Surplus Lines Offices (NAPSLO), in the course of my discussions with him about the NRRA and NIMA.

Brown is an attorney who regularly represents surplus lines brokers, insurers, and industry organizations in a variety of regulatory and other surplus lines matters. He has authored multiple articles about the NRRA and its implementation. E-mail: RAB@InsuRegulatory.com. Copies of his other NRRA articles are available at: www.InsuRegulatory.com.

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