Unnecessary SMART Act Distinctions Could Restrict E&S Market Access For Some Buyers
Inconsistent definitions of sophisticated buyers may leave some in tough spot

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

Distinctions between insurance buyers buried in the language of the proposed federal State Modernization and Transparency Act will create inconsistencies in their access to admitted and surplus lines markets, if draft language is adopted.

In August 2004, the House Financial Services Committee unveiled a discussion draft of the SMART Act, on the heels of an ongoing debate concerning the potential role of the federal government in the regulation of insurance.

The 300-page insurance regulatory reform measure is designed to be a compromise proposalone which would eliminate, or at least greatly reduce, state-to-state variances with respect to certain regulatory issues while avoiding the creation of a federal bureaucracy.

The draft legislation also preserves the states role in insurance 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 the states’ adoption within two or three years of various “model” laws and 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-easy vehicle to create harmonization of state insurance laws, there are inherent inconsistencies with such an approach, particularly in the treatment of large commercial policyholders.

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

Title VI defines an “exempt commercial policyholder” as “at least” any policyholder meeting unspecified criteria in any two of the 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 public entity).

Population (if the entity is a municipality).

Only in the case of a population of 50,000 inhabitants does Title VI specify the threshold criterion to qualify for exempt commercial policyholder status.

Alternatively, this section allows a state to use the definition of “exempt commercial policyholder” from the National Association of Insurance Commissioners Property and Casualty Commercial Rate and Policy Form Model Law as adopted at an undetermined future date.

Title VIII of the SMART Act, which deals with surplus lines and independently procured insurance, defines a “sophisticated commercial purchaser” as an insured with which a surplus lines broker may place insurance procured from a non-admitted insurer on an “automatic export” basisthat is, without the broker making a diligent search to determine the availability of the same coverage in the admitted market.

“Sophisticated commercial purchaser” is defined as an insured having 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 risk manager.

Annual aggregate premiums of $500,000.

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

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

The SMART Acts bifurcated treatment of sophisticated buyers reflects the industry’s divergent perspectives on commercial lines deregulation. Buyers and brokerage firms tend to view it as the deregulation of large sophisticated policyholders and the brokers representing those buyers. To many admitted insurers, commercial lines deregulation simply means the elimination of rate and form filing burdens to bring products to market faster and more effectively tailor them to the sophisticated customer’s needs.

While these two views of deregulation are neither conflicting nor inconsistent, the use of two terms to represent the same concept is unnecessary and confusing. At the very least, Title VI and Title VIII should use the same defined term to represent sophisticated buyers.

Also, Title VIII’s inclusion of minimum thresholds for qualifying as a sophisticated commercial purchaser and Title VI’s omission of corresponding thresholds for qualifying as an exempt commercial policyholder suggests that Congress might be planning to allow only the largest group of buyers affected by admitted market regulation to purchase surplus lines coverage on an automatic export basis.

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

The “majority rule” referred to in Title VIII and the NAIC model referred to in Title VI could differ from the default rules set forth in either title and, therefore, from each other. This could further impede unrestricted access to markets for admitted companies selling deregulated products and surplus lines insurersclearly a result contrary to the best interests of the sophisticated buyer.

In view of these inconsistencies, Congress would be well advised to consider consolidating the definitions of “sophisticated commercial purchaser” and “exempt commercial policyholder” and establishing 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 leveling the playing field for surplus lines insurers and admitted companies selling deregulated products, and ultimately making the insurance-buying process more efficient and accessible to risk managers and commercial lines purchasers nationwide.

John P. Dearie Jr. is a partner and Lewis Fickett is an associate in the Insurance and Reinsurance Department of Edwards & Angell, LLP. They can be reached at: JDearie@EdwardsAngell.com, and LFickett@EdwardsAngell.com.

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