Unnecessary SMART Act Distinctions Could RestrictE&S Market Access For Some Buyers
Inconsistent definitions of sophisticated buyers may leavesome in tough spot

By John P. Dearie, Jr.
and Lewis Fickett III

Distinctions between insurance buyers buried in the language ofthe proposed federal State Modernization and Transparency Act willcreate inconsistencies in their access to admitted and surpluslines markets, if draft language is adopted.

In August 2004, the House Financial Services Committee unveileda discussion draft of the SMART Act, on the heels of an ongoingdebate concerning the potential role of the federal government inthe regulation of insurance.

The 300-page insurance regulatory reform measure is designed tobe a compromise proposalone which would eliminate, or at leastgreatly reduce, state-to-state variances with respect to certainregulatory issues while avoiding the creation of a federalbureaucracy.

The draft legislation also preserves the states role ininsurance regulation, if only to apply laws mandated by Congress(or by a majority of the states).

The end product is a patchwork of 17 Titles requiring thestates' adoption within two or three years of various “model” lawsand regulations, covering a broad and, in some cases, incompatible,spectrum of insurance issues.

While the proposal at first blush appears to be a quick-and-easyvehicle to create harmonization of state insurance laws, there areinherent inconsistencies with such an approach, particularly in thetreatment of large commercial policyholders.

Specifically, Title VI of the SMART Act includes a definition of“exempt commercial policyholders” to describe an insured to whom anadmitted carrier may sell an insurance product exempt from rate andform review.

Title VI defines an “exempt commercial policyholder” as “atleast” any policyholder meeting unspecified criteria in any two ofthe following categories:

Net worth.

Revenues or sales.

Number of employees.

Employment of a risk manager to procure insurance.

Annual premiums paid.

Annual budget (if the entity is a non-profit or publicentity).

Population (if the entity is a municipality).

Only in the case of a population of 50,000 inhabitants doesTitle VI specify the threshold criterion to qualify for exemptcommercial policyholder status.

Alternatively, this section allows a state to use the definitionof “exempt commercial policyholder” from the National Associationof Insurance Commissioners Property and Casualty Commercial Rateand Policy Form Model Law as adopted at an undetermined futuredate.

Title VIII of the SMART Act, which deals with surplus lines andindependently procured insurance, defines a “sophisticatedcommercial purchaser” as an insured with which a surplus linesbroker may place insurance procured from a non-admitted insurer onan “automatic export” basisthat is, without the broker making adiligent search to determine the availability of the same coveragein the admitted market.

“Sophisticated commercial purchaser” is defined as an insuredhaving two of the following characteristics:

Net worth of $50 million.

Net revenues or sales of $100 million.

500 employees.

Procurement of life insurance through the use of a riskmanager.

Annual aggregate premiums of $500,000.

The status of being non-profit or a private entity having anannual budget or assets of $45 million, or a municipality having apopulation of 50,000 people.

If a majority of states adopt a standard for “sophisticatedcommercial purchaser,” then that standard shall apply to all statesin lieu of the SMART Acts default definition set forth above.

The SMART Acts bifurcated treatment of sophisticated buyersreflects the industry's divergent perspectives on commercial linesderegulation. Buyers and brokerage firms tend to view it as thederegulation of large sophisticated policyholders and the brokersrepresenting those buyers. To many admitted insurers, commerciallines deregulation simply means the elimination of rate and formfiling burdens to bring products to market faster and moreeffectively tailor them to the sophisticated customer's needs.

While these two views of deregulation are neither conflictingnor inconsistent, the use of two terms to represent the sameconcept is unnecessary and confusing. At the very least, Title VIand Title VIII should use the same defined term to representsophisticated buyers.

Also, Title VIII's inclusion of minimum thresholds forqualifying as a sophisticated commercial purchaser and Title VI'somission of corresponding thresholds for qualifying as an exemptcommercial policyholder suggests that Congress might be planning toallow only the largest group of buyers affected by admitted marketregulation to purchase surplus lines coverage on an automaticexport basis.

Moreover, a definition of “sophisticated commercial purchaser”adopted by a majority of states would trump the default definitionin Title VIII, and states could comply with Title VI by using thedefinition of “exempt commercial policyholder” in the NAIC Propertyand Casualty Rate and Policy Model Law.

The “majority rule” referred to in Title VIII and the NAIC modelreferred to in Title VI could differ from the default rules setforth in either title and, therefore, from each other. This couldfurther impede unrestricted access to markets for admittedcompanies selling deregulated products and surplus linesinsurersclearly a result contrary to the best interests of thesophisticated buyer.

In view of these inconsistencies, Congress would be well advisedto consider consolidating the definitions of “sophisticatedcommercial purchaser” and “exempt commercial policyholder” andestablishing one default mechanism for modifying that definition(similar to the “majority rule” approach used in Title VIII).

Such remedial measures would offer the dual benefit of levelingthe playing field for surplus lines insurers and admitted companiesselling deregulated products, and ultimately making theinsurance-buying process more efficient and accessible to riskmanagers and commercial lines purchasers nationwide.

John P. Dearie Jr. is a partner and Lewis Fickett is anassociate in the Insurance and Reinsurance Department of Edwards& Angell, LLP. They can be reached at: [email protected],and [email protected].

Reproduced from National Underwriter Property &Casualty/Risk & Benefits Management Edition, February 11, 2005.Copyright 2005 by The National Underwriter Company in the serialpublication. All rights reserved.Copyright in this article as anindependent work may be held by the author.