By the time this column is printed, surplus line insurers and brokers will have roughly 45 days to adjust to the biggest change to impact their business in generations. The Non-admitted and Reinsurance Reform Act (NRRA) will stand many long-held assumptions on their heads. Surplus line brokers, corporate risk managers and property-casualty insurance underwriters will see regulatory Darwinism in action beginning July 21, the day that the NRRA takes effect.
Tectonic shifts in the ways business gets done bring with them the attendant risks of falling behind the curve and facing new liability exposures. As Charles Darwin observed, "It is not the strongest of the species that survives, nor the most intelligent, but the one most responsive to change."
What exactly does NRRA do? A comprehensive answer would fill more than this entire magazine and still leave gaps because individual states may change some aspects of the NRRA through interstate compacts. Stay tuned to the September 2011 column for NRRA development, from its effective date through its first few weeks.
An NRRA Primer
NRRA substantially changes the following state-based regulatory systems for property and casualty lines of insurance and creates a new Federal Insurance Office:
- NRRA preempts conflicting state laws and regulations and places the power to regulate non-admitted P&C insurance placements solely in the hands of the policyholder’s "home state."
- Under the NRRA, an insured’s surplus lines broker needs to hold that license only in the policyholder’s home state. Note that businesses with operations in multiple states will still need to use locally licensed surplus line brokers for lines of coverage other than P&C, and the NRRA expressly does not apply to worker’s compensation insurance.
- NRRA preempts state-based due diligence requirements, some of which require that surplus lines brokers submit a risk to one or more admitted markets, and obtain rejections from them, before submitting the risk to non-admitted markets. Only the home state’s due diligence requirements still apply to P&C placements and those requirements are trumped if they are more restrictive than a new national standard that applies to "exempt commercial purchasers."
- NRRA allows that only the insured’s home state may impose and collect a surplus line tax on a P&C placement. Although several states have considered compacts that would allocate surplus line tax revenues among the states where the insured has covered operations, the prospects that the states will come together and enact a joint plan before July 21 appear slim. Much of the writing about the NRRA has focused on the tax issues—not surprising when states are curtailing public services due to budget shortfalls. For those in the industry, a more important question may be, "What are these new rules about non-admitted placements and how do I comply?"
- Once NRRA takes effect, non-admitted insurers will be subject to a single, uniform eligibility standard. A state may only impose eligibility requirements that conform with the Non-Admitted Insurance Model Act, or under a nationwide interstate compact, on U.S. domiciled non-admitted insurers. As to non-admitted insurers domiciled outside the U.S., no state may prohibit a surplus line broker from placing coverage with such an insurer that is on the National Assn. of Insurance Commissioners’ (NAIC) Quarterly Listing of Alien Insurers.
- NRRA strengthens the uniformity reinsurance credit for financial solvency determinations, and prohibits any state from refusing to give the cedent the same credit that its state of domicile allows. As of this writing, each of the 50 states plus the District of Columbia have financial solvency requirements that are accredited by the NAIC, and allow reinsurance to be taken as a credit by ceding insurers that are domiciled in that state.
- NRRA permits that only the ceding insurer’s state of domicile may impose legal restrictions or rules of interpretation on that insurer’s contracts with reinsurers.
- A separate part of the Dodd–Frank Wall Street Reform and Consumer Protection Act creates a Federal Insurance Office (FIO). Although the FIO does not supplant the states’ or NAIC’s roles, it does have very broad powers that seem certain to have great influence on the insurance industry in the years ahead.
Quite simply, the NRRA fundamentally changes how P&C insurance will be regulated, sold and taxed in the U.S.
No Place Like Home
"Home state," a key phrase in the above outline, requires some explanation. It is not necessarily a company’s state of incorporation—otherwise, Delaware would be looking forward to a huge surplus line tax windfall. Nor is the "home state" necessarily the state where the company has the largest percent of its operations, payroll, revenues or market share.
So where is home? NRRA uses the legal phrase "principal place of business" to determine a company’s home state (and "principal residence" for an individual). In common parlance, that means where the company has its headquarters, the place from which its highest-level leaders direct the company’s business. There is an exception: If 100 percent of the risk insured under a given P&C policy is outside the state where the company has its principal place of business, then the state with the greatest percentage of taxable premium for that policy is the home state solely as to that policy.
The risk manager and the surplus line broker will need to carefully assess the insured’s operations in determining which state is called "home." While the NRRA is still new and not yet interpreted by courts, it would be wise to hedge any opinions identifying an insured’s "home state."
Many corporations are part of affiliated groups, that is, a parent company or holding company with various levels of subsidiaries. NRRA recognizes this, treating the parent company’s home state as the home state of all affiliates.
That sounds simple enough, but it isn’t as simple as the rule of thumb, ownership of 50 percent of the subsidiary’s stock. Under the NRRA’s definitions, two corporations are "affiliated" if one "controls" the other or if both are under common "control." There are two alternative tests for control:
- The ability to vote 25 percent or more of any class of voting stock, including doing so through intermediaries, or
- Controlling in any way the election of a majority of the directors or trustees of the other entity.
Business combinations and interlocking ownerships may not be immediately obvious at the time when an insurance policy is placed. The surplus line broker is dependent on his or her client for such information, especially in privately owned companies. This situation calls for questions beyond those that appear in many P&C insurance applications. As always, the safest course is to confirm the answers to those questions with the applicant in writing.
For affiliated groups, the NRRA modifies the home state rule. Rather than looking to the home state of the ultimate corporate parent, the new law looks to the state where any member of the group has the largest percent of allocated premium under the given insurance policy. For example, if one member of the affiliated group of companies has its operations in State A and accounts for the largest percent of the premium for an employment practices liability insurance policy, State A is the home state of all the companies in the group for purposes of the EPLI policy. State B, where the parent company is headquartered and where decisions are made for the group, may be the home state for the companies with respect to their D&O liability policy. If another member of the group owns the largest percent of insured property in State C, that is where the home state will be for the property insurance policy, assuming that all the companies’ properties are covered under a single policy.
Anytime that a question is properly answered with, "It depends," there is room for creativity. Simply because members of an affiliated group can be jointly insured under a single policy doesn’t mean that they must be. Could there be advantages to writing a separate policy for one group member, leaving the others to be covered under a different policy? Although NRRA intends to simplify surplus line placements, that may not always be its effect.
Exemptions from Submission Requirements to Admitted Carriers
NRRA forbids all states, even the insured’s home state, from requiring due diligence submissions to admitted markets before resorting to surplus lines markets, if the insured is an "exempt commercial purchaser." Some states have similar terms defining sophisticated insureds, but the NRRA term supplants any contrary state law requirements.
Who is "exempt?" The NRRA sets three tests, all of which must be met:
- The company must have a "qualified risk manager," either employed or contracted. The statute requires more than a title on a business card—the NRRA spells out specific educational, experience, and certification standards.
- It must have paid nationwide P&C premiums greater than $100,000 in the preceding 12 months.
- The insured must meet at least one of these additional criteria:
a. Its net worth is greater than $20 million
b. Its annual revenues are above $50 million
c. It has more than 500 full-time or full-time-equivalent employees, or more than 1,000 in an affiliated group
d. It is a not-for-profit organization or public entity with annual, budgeted expenditures of at least $30 million
e. It is a municipality with a population greater than 50,000.
Those exemptions will include a great many commercial policyholders. Time will tell whether the NRRA exception to state diligent search requirements will swallow the rule.
In the September edition of American Agent & Broker we will take a closer look at the FIO and the early changes to the industry that occur after the NRRA’s July 21 effective date.
For now, education is the best preventive medicine for potential NRRA related errors and omissions. Please feel free to contact me if, in keeping with Darwin’s advice, you want to be "the one most responsive to change."
It is a municipality with a population greater than 50,000. It is a not-for-profit organization or public entity with annual, budgeted expenditures of at least $30 million It has more than 500 full-time or full-time-equivalent employees, or more than 1,000 in an affiliated group Its annual revenues are above $50 million Its net worth is greater than $20 million