We resumeour discussion on NRRA, left off from the June 2011 issue. Surplus line brokers found anewborn left on their doorstep on July 21, 2011, the day when theNonadmitted and Reinsurance Reform Act (NRRA) took effect.

Despite a 12-month gestation from the day NRRA was signed intolaw as part of the Dodd-Frank financial industry reforms to itseffective date, the states failed to use the grace period to reachuniform agreement on any of the proposed interstate compacts toallocate surplus line tax revenues, leaving brokers with a crazyquilt of state "conforming" laws and filing forms to decipher andtrack.

In fairness, many states had higher priorities on their agendas,such as balancing budgets in times of slashed revenues andincreased demands for services. Congress likewise had little timeto spare for insurance issues, being preoccupied with raising thedebt ceiling and nearly causing the first default by the U.S.Government on its obligations.

The surplus lines industry is left with an infant law to feedand care for. Messrs. Dodd and Frank, the law's putative parents,clearly did not provide for the details of its upbringing.Consider:

1. Home is where the head is? Several states' conforming lawselaborate on NRRA's definition of a corporate insured's "homestate," the threshold determination under NRRA as to which state'slaw apply. NRRA adopts a headquarters test, rather than looking tothe state of incorporation. That's an easy standard to apply to,for a company like Apple, but not all organizations have such welldefined nerve centers. California's NRRA statute provides that "ifthe insured's high-level officers direct, control and coordinatethe business activities in more than one state, the state in whichthe greatest percentage of the insured's taxable premium for thatinsurance contract is allocated" will be the home state. Allocatingpremium for multi-state property insurance is a cinch, butliability insurance isn't so simple. The test also leads to theprospect of multiple home states if, for example, a company that isdirected from two states has a predominance of its D&O premiumallocated to State A, but its EPLI premium is more heavily weightedtoward State B.
2. Paperwork. NRRA does not establish a national clearinghouse orsimilar mechanism to allocate premium taxes among states that havejoined either of the two competing, and inconsistent, multi-statecompacts for tax sharing. In the absence of a national system, somestates have developed their own forms and formulas for surplus linebrokers to report on how premiums are allocated, even where theresult under the NRRA is that only one state receives all of thepremium tax revenue. California's Assembly Bill 315, for example,requires surplus line brokers to provide data on tax allocations onmulti-state premiums beginning on March 1, 2012, though theCalifornia Commissioner of Insurance can decide to forego thereport. Thus, a "simplified" system under NRRA becomes moreburdensome and less predictable. It also outsources governmentdata-collection functions to the brokerage community.
3. Other loose ends. NRRA left at least as many issues unansweredas it answered. Though it established an exception for "exemptcommercial purchasers" to state-based requirements that brokerssubmit proposed insureds to multiple admitted carriers beforeresorting to the surplus lines market, NRRA did not expresslypreempt existing state rules that similarly exempted "industrialinsureds." The two terms are not synonymous, each having complexdefinitions. The result: Having determined the commercial insured'shome state, the broker must next determine whether the insuredmeets NRRA's test for exemption, and if not, must apply the homestate's industrial insured test. If the insured meets neither setof criteria, the home state's due diligence submission requirementsmust be followed.

Compacts and conflicts

In a statement to the House Subcommittee on Insurance, Housingand Community Opportunity, the Independent Insurance Agents &Brokers of America (IIABA) cautioned that NRRA's intent could bethwarted by inconsistent rules and procedures set by states. TheIIABA position paper, delivered to Congress just 1 week after NRRAtook effect, commented, "The NRRA was intended to streamline andsimplify the surplus lines regulatory system. It would be a verypeculiar outcome and an unintended consequence of Congress's actionif the NRRA's enactment ultimately prompted state officials todevelop an even more complex and cumbersome regulatory structurefor the agents, brokers, and purchasers of surplus linesinsurance."

Related: Read Neil Alldredge's article "Legislature WrapUp."

In particular, the IIABA was critical of one of the multi-statecompacts, the Nonadmitted Insurance Multi-State Agreement (NIMA),because its allocation methodology "is of considerable concern tothe private sector, and it is one that fails to satisfy theprinciples that IIABA and others expect from such a system. NIMA'sproposed allocation system would be more complex and cumbersomethan that in place today and would require the collection ofinformation that is not even utilized in the underwritingprocess."

Both NIMA and its primary competitor, the Surplus LinesInsurance Multi-State Compliance Compact (SLIMPACT-Lite, so calledbecause it is a revised version of an earlier proposal), allowsurplus lines tax revenues to be shared among states that havejoined the same compact. NIMA includes an allocation method and aclearinghouse that will be available only to NIMA member states. Incontrast, SLIMPACT-Lite, would set up a commission to determine themethodology. As a practical matter, neither system will be up andrunning in 2011.

Some states, including California, Colorado, Delaware, Idaho,Illinois, Michigan, Missouri, New York, Pennsylvania, Virginia andWashington, adopted neither NIMA nor SLIMPACT-Lite during theircurrent legislative sessions, instead enacting what might be termed"home state takes all" statutes, under which those states willassess their premium tax rates on 100 percent of surplus linepremiums paid by insureds headquartered there, and have agreed toshare the proceeds with no one.

Related:Read the article "Ready for NRRA?" by Louis Castoria.

For the surplus line broker, the alphabet soup of acronyms doesnot make a nourishing meal. While there are handy online guides toNRRA and the states' statutes (NAPSLO.org and CIAB.com are twoworth visiting), brokers do not need a heaping helping ofcomplexity added to their already challenging jobs.

FIO to the Rescue?

For all the campaign rhetoric about the supposedly "radical" and"socialist" tendencies of the current administration, the twohallmarks of its domestic policy thus far have been half-measures.Healthcare reform did not take the fork of the road toward asingle-payer, federal solution, but an insurance-based path, to besupplemented by state-based exchanges. The Dodd-Frank Act, to whichNRRA was an add-on, left Wall Street still pretty much in charge ofWall Street, and left the majority of insurance regulation to thestates, where it has traditionally been.

Along with NRRA, there was another insuranceadd-on to Dodd-Frank: the creation of a Federal Insurance Office.Michael T. McRaith, who spoke on a panel of experts for the openinggeneral session of the Professional Liability UnderwritingSociety's International 2006 Conference on "the increasing impactof U.S. federal law in defining professional liability risks, andpotentially in regulating the insurance industry," was appointedthis year to head the FIO.

The five-speaker panel, moderated by TV journalist ForrestSawyer, was anything but unanimous in its views. While there wasundeniable federal influence in D&O liability insuranceexposures in the post-Enron era, the prospect of Uncle Sam directlyregulating the insurance industry received mixed reviews. For hispart, Director McRaith stood strongly in favor of continuedinsurance regulation at the state level, while some panelistsfavored bringing down the barriers to a unified system of surplusline approval, either through concerted effort by the states or byfederal preemption.

Related: Read "Kentucky Surplus-Lines Compromise Gains Support" byArthur D. Postal.

In the NRRA and the companion law creating the FIO, everyone onthe panel may have gotten something that he wished for that day.Barriers to surplus lines carrier eligibility have come down,though not quite as dramatically or thoroughly as the Berlin Wall.Focusing on the insured's home state for both regulation andtaxation will eventually simplify the broker's job, though NRRAneeds some serious tweaking through improved multi-state compactsor federal action to make that happen.

For its part, the FIO can help the process simply by encouragingthe organizations that developed the NIMA and SLIMPACT-Lite plansto keep working on simplifying procedures and standardizingfilings.

In the longer term, the FIO is empowered to enter intoagreements with other nations for "prudential measures regardingthe business of insurance," and to determine, subject to judicialreview, whether some types of state laws are preempted by thoseagreements. It can also issue subpoenas, and conduct studiesregarding the "modernization of insurance regulation." Those powersappear to give the FIO a sufficiently large stick to fix NRRA, ifthe states do not find the carrot sufficiently motivating.

For now, the gaps in NRRA and the corresponding state laws leavebrokers with a difficult path to travel. As the orphan statutematures, it may fulfill its original goals and make the U.S. marketa more even and efficient playing field.