From the September 2011 issue of American Agent & Broker • Subscribe!

NRAA Grows Up Fast

FIO may rescue gaps left in the Dodd-Frank Act

We resume our discussion on NRRA, left off from the June 2011 issue. Surplus line brokers found a newborn left on their doorstep on July 21, 2011, the day when the Nonadmitted and Reinsurance Reform Act (NRRA) took effect.

Despite a 12-month gestation from the day NRRA was signed into law as part of the Dodd-Frank financial industry reforms to its effective date, the states failed to use the grace period to reach uniform agreement on any of the proposed interstate compacts to allocate surplus line tax revenues, leaving brokers with a crazy quilt of state "conforming" laws and filing forms to decipher and track.

In fairness, many states had higher priorities on their agendas, such as balancing budgets in times of slashed revenues and increased demands for services. Congress likewise had little time to spare for insurance issues, being preoccupied with raising the debt 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 feed and 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 laws elaborate on NRRA's definition of a corporate insured's "home state," the threshold determination under NRRA as to which state's law apply. NRRA adopts a headquarters test, rather than looking to the state of incorporation. That's an easy standard to apply to, for a company like Apple, but not all organizations have such well defined nerve centers. California's NRRA statute provides that "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" will be the home state. Allocating premium for multi-state property insurance is a cinch, but liability insurance isn't so simple. The test also leads to the prospect of multiple home states if, for example, a company that is directed from two states has a predominance of its D&O premium allocated to State A, but its EPLI premium is more heavily weighted toward State B.
  2. Paperwork. NRRA does not establish a national clearinghouse or similar mechanism to allocate premium taxes among states that have joined either of the two competing, and inconsistent, multi-state compacts for tax sharing. In the absence of a national system, some states have developed their own forms and formulas for surplus line brokers to report on how premiums are allocated, even where the result under the NRRA is that only one state receives all of the premium tax revenue. California's Assembly Bill 315, for example, requires surplus line brokers to provide data on tax allocations on multi-state premiums beginning on March 1, 2012, though the California Commissioner of Insurance can decide to forego the report. Thus, a "simplified" system under NRRA becomes more burdensome and less predictable. It also outsources government data-collection functions to the brokerage community.
  3. Other loose ends. NRRA left at least as many issues unanswered as it answered. Though it established an exception for "exempt commercial purchasers" to state-based requirements that brokers submit proposed insureds to multiple admitted carriers before resorting to the surplus lines market, NRRA did not expressly preempt existing state rules that similarly exempted "industrial insureds." The two terms are not synonymous, each having complex definitions. The result: Having determined the commercial insured's home state, the broker must next determine whether the insured meets NRRA's test for exemption, and if not, must apply the home state's industrial insured test. If the insured meets neither set of criteria, the home state's due diligence submission requirements must be followed.

Compacts and conflicts

In a statement to the House Subcommittee on Insurance, Housing and Community Opportunity, the Independent Insurance Agents & Brokers of America (IIABA) cautioned that NRRA's intent could be thwarted by inconsistent rules and procedures set by states. The IIABA position paper, delivered to Congress just 1 week after NRRA took effect, commented, "The NRRA was intended to streamline and simplify the surplus lines regulatory system. It would be a very peculiar outcome and an unintended consequence of Congress's action if the NRRA's enactment ultimately prompted state officials to develop an even more complex and cumbersome regulatory structure for the agents, brokers, and purchasers of surplus lines insurance."

Related: Read Neil Alldredge's article "Legislature Wrap Up."

In particular, the IIABA was critical of one of the multi-state compacts, the Nonadmitted Insurance Multi-State Agreement (NIMA), because its allocation methodology "is of considerable concern to the private sector, and it is one that fails to satisfy the principles that IIABA and others expect from such a system. NIMA's proposed allocation system would be more complex and cumbersome than that in place today and would require the collection of information that is not even utilized in the underwriting process."

Both NIMA and its primary competitor, the Surplus Lines Insurance Multi-State Compliance Compact (SLIMPACT-Lite, so called because it is a revised version of an earlier proposal), allow surplus lines tax revenues to be shared among states that have joined the same compact. NIMA includes an allocation method and a clearinghouse that will be available only to NIMA member states. In contrast, SLIMPACT-Lite, would set up a commission to determine the methodology. As a practical matter, neither system will be up and running in 2011.

Some states, including California, Colorado, Delaware, Idaho, Illinois, Michigan, Missouri, New York, Pennsylvania, Virginia and Washington, adopted neither NIMA nor SLIMPACT-Lite during their current legislative sessions, instead enacting what might be termed "home state takes all" statutes, under which those states will assess their premium tax rates on 100 percent of surplus line premiums paid by insureds headquartered there, and have agreed to share 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 does not make a nourishing meal. While there are handy online guides to NRRA and the states' statutes (NAPSLO.org and CIAB.com are two worth visiting), brokers do not need a heaping helping of complexity 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 two hallmarks of its domestic policy thus far have been half-measures. Healthcare reform did not take the fork of the road toward a single-payer, federal solution, but an insurance-based path, to be supplemented by state-based exchanges. The Dodd-Frank Act, to which NRRA was an add-on, left Wall Street still pretty much in charge of Wall Street, and left the majority of insurance regulation to the states, where it has traditionally been.

Along with NRRA, there was another insurance add-on to Dodd-Frank: the creation of a Federal Insurance Office. Michael T. McRaith, who spoke on a panel of experts for the opening general session of the Professional Liability Underwriting Society's International 2006 Conference on "the increasing impact of U.S. federal law in defining professional liability risks, and potentially in regulating the insurance industry," was appointed this year to head the FIO.

The five-speaker panel, moderated by TV journalist Forrest Sawyer, was anything but unanimous in its views. While there was undeniable federal influence in D&O liability insurance exposures in the post-Enron era, the prospect of Uncle Sam directly regulating the insurance industry received mixed reviews. For his part, Director McRaith stood strongly in favor of continued insurance regulation at the state level, while some panelists favored bringing down the barriers to a unified system of surplus line approval, either through concerted effort by the states or by federal preemption.

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

In the NRRA and the companion law creating the FIO, everyone on the 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 and taxation will eventually simplify the broker's job, though NRRA needs some serious tweaking through improved multi-state compacts or federal action to make that happen.

For its part, the FIO can help the process simply by encouraging the organizations that developed the NIMA and SLIMPACT-Lite plans to keep working on simplifying procedures and standardizing filings.

In the longer term, the FIO is empowered to enter into agreements with other nations for "prudential measures regarding the business of insurance," and to determine, subject to judicial review, whether some types of state laws are preempted by those agreements. It can also issue subpoenas, and conduct studies regarding the "modernization of insurance regulation." Those powers appear to give the FIO a sufficiently large stick to fix NRRA, if the states do not find the carrot sufficiently motivating.

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

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