Surplus lines reform deadline looms

The following article was published by Business Insurance on June 6, 2011:

 Surplus lines reform deadline looms

Patchwork likely as state legislatures differ on tax rules

WASHINGTON—Eager for an arrangement that will simplify paying premium taxes, the surplus lines market is divided over whether that will happen anytime soon and what form of allocation should prevail.

As the July 21 implementation date of the Nonadmitted and Reinsurance Reform Act approaches, state legislatures are addressing requirements within the federal law that call for them to devise a method to allocate surplus lines premium taxes.

While NRRA stipulates that only the home state of the policyholder can collect premium taxes starting July 21, it does not set a deadline for a premium allocation system to be in place.

Nationwide, gross surplus lines premiums written during 2009 totaled $32.26 billion and generated $1.12 billion in tax revenue for the states, according to the latest available Business Insurance survey data.

At the time, state tax rates ranged from 1% to 6%.

Deciding how to allocate surplus lines taxes has become a race against the clock as state legislative terms wind down and the NRRA implementation date looms.

“I think it will be difficult to get a tax allocation system between now and July because of the details involved” in getting states to agree on the workings of such a system, said Steven P. Stephan, director of government relations with the Kansas City, Mo.-based National Assn. of Professional Surplus Lines Offices Ltd. There are, however, “some folks who think a tax allocation system can be put in place” by the law’s effective date, he said.

Separate clearinghouse arrangements, or “compacts,” have emerged as mechanisms for states to handle surplus lines taxes. Some states have passed legislation to allow use of the Surplus Lines Insurance Multi-State Compliance Compact, which NAPSLO favors. The National Assn. of Insurance Commissioners is backing another clearinghouse approach, the Nonadmitted Insurance Multi-State Agreement.

The two differ in that SLIMPACT authorizes, among other things, a governing commission to establish allocation formulas, uniform payment methods, and reporting requirements for policyholders and surplus lines brokers. NIMA addresses the tax issues, but does not address uniformity issues covered by SLIMPACT, sources say.

States are not required to choose one or the other, and some may opt to come up with their own methods or simply pass laws authorizing creation of a system to handle the tax allocation.

Susan Nolan, executive director of the Troy, N.Y.-based National Conference of Insurance Legislators, says NCOIL backs SLIMPACT and there’s a good chance it will be in place by July 21.

Once 10 state governors or governors from states that represent at least 40% of the surplus lines market sign SLIMPACT legislation, a commission can be established that would develop a framework. As of late last week, eight governors had signed laws authorizing the compact.

“We’re pretty optimistic that we will have 10 states” before the law is implemented, Ms. Nolan said. Even if the number of signatures falls short, nothing prevents a state from approving SLIMPACT after July 21, she said.

As of late last week, SLIMPACT legislation had been signed in Indiana, Kansas, Kentucky, New Mexico, North Dakota, Ohio, Rhode Island and Vermont, according to NAPSLO. In one other state—Tennessee—SLIMPACT legislation had passed but had not yet been signed into law.

So far, only Nebraska has signed legislation authorizing NIMA as the only compact that can be used in the state, although another dozen states have legislation in the works that appears to be leaning toward the NIMA system, according to NAPSLO.

A mishmash of tax allocation approaches is inevitable, at least for the short term, as some states have so far ignored the NRRA mandate to develop a system.

Ms. Nolan conceded that it is unclear how states would reconcile differing allocation systems, but said she is confident that most will approve a compact by the NRRA implementation deadline and are likely to favor the SLIMPACT approach.

The NRRA’s provisions include several that appeal to the surplus lines market, sources say, such as one that allows brokers to place coverage in the surplus lines market for large risks without first conducting a diligent search for admitted market coverage as called for under current regulations. Such companies must employ a “qualified risk manager” to represent the policyholder in the transaction, among other requirements.

“Our view is that the ultimate implementation of the law will make the surplus lines space all the more appealing for corporate consumers as well as the industry and regulators,” said Joel Wood, senior vp of the Council of Insurance Agents & Brokers in Washington.

As for the tax issue, the first several months after the law is implemented could be “somewhat confusing because of the inability of the states to all join in a single mechanism” to collect and allocate premium taxes, Mr. Wood said.

Risk managers are pleased with the NRRA’s provisions because it means they can write one check to one state to pay taxes on surplus lines premiums, their policy terms will be governed solely by their home state and the diligent search requirement has been eliminated for large risks, said Jim McIntyre, Washington-based legal counsel for the Risk & Insurance Management Society Inc.

RIMS has provided input in developing the clearinghouse proposals, and the society’s members prefer the SLIMPACT approach because of its uniformity in processes and forms, Mr. McIntyre said.

Risk managers may, however, see some added costs once the clearinghouse approach is in place, he said.

“Somebody will have to pay for the clearinghouse operations,” Mr. McIntyre said. “I don’t think the states will do that; I think it will be passed along to policyholders.”

Risk managers are hopeful, though, that efficiencies gained by the new system will produce savings that will offset any new costs, he said.