Tucked into 2,000-plus pages of federal financial servicesreform legislation are just 10 relating to the surplus linesindustry, but those pages will put an end to decades of brokerfrustration, legislative experts say.

Most excess and surplus lines brokers understand that their daysof complying with a maze of conflicting state rules about diligentsearch efforts, taxation of multi-state risks and multiplelicensing requirements for a single risk will be over on July 21,2011.

Questions remain, however, about exactly what will happen whenSections 521 through 527 of the Dodd-Frank Wall Street Reform andConsumer Act take hold. What exactly do these sections related tononadmitted insurance say? What new rules will the E&S brokershave to follow?

With the reforms on the minds of brokers attending last week'sannual convention of National Association of Professional SurplusLines Offices, Ltd., NU has compiled a list of frequentlyasked questions and answers relating to these sections of the newlaw–sections commonly referred to as NRRA, or the Nonadmitted andReinsurance Reform Act (the name given to a version of these 10pages that repeatedly passed the House of Representatives in recentyears.)

The following Q&A focuses on the first three sections, whichdirectly impact brokers. For information on the effects of the lawon E&S insurers and exempt commercial purchasers, refer to theaccompanying resource list.

What will the NRRA mean for E&Sbrokers?

The principal reforms involve regulatory control and taxation ofmulti-state transactions–both of which will rest with the homestate of the insured under the new law. "In its own way, it's afairly simple and blunt concept, [but] members struggle a littlebit to get their heads around the fact that things have changed–andit's a fairly dramatic change, " said Hank Haldeman, co-chair ofNAPSLO's legislative committee.

"What all this means is that [brokers] have to make adetermination of the home state, but beyond that compliance is mucheasier with the new set of rules," said Steve Stephan, NAPSLO'sdirector of government relations.

The new rules are:

o One tax filing/one tax rate per policy.

On a multi-state E&S transaction, a broker will pay a singlepremium tax to the home state of insured only, according to Section521.

o One regulator per placement. E&Splacements will be regulated solely by the home state, according toSection 522.

NAPSLO believes this provision encompasses broker activitiessuch as conducting a diligent search of the admitted market beforeplacing a risk in the surplus lines market, filing an affidavit todemonstrate that a diligent search was done, and putting a surpluslines notice on the policy.

o One license. A broker will need only onesurplus producer's license to write a multi-state risk, accordingto Section 522.

In other words, to write a manufacturing plant in Missouri withadditional operations in the remaining 49 states, the E&Sbroker needs a Missouri E&S license only, not more than 100licenses, as may now be the case (when 50 surplus lines licenses,50 property-casualty license and 35 entity licenses could berequired).

o License Registry. Section523 describes a national producer registry for surplus lines thatwill further alleviate the licensing burden. States have two yearsto accomplish the objective of setting up the database and passinglaws to participate, but this issue was "front-and-center" at thesummer NAIC meeting, NAPSLO reported.

Where is the home state?

NRRA defines the home state as the "principal place of business"or "principal residence" of the insured.

Mr. Stephan reported that the Supreme Court tackled the meaningof the language "principal place of business" in a February courtruling unrelated to NRRA. In Hertz vs. Friend, theorganization at the center of the case had 48 percent of itsbusiness in California, but with New Jersey headquarters. The HighCourt ruled that it would use the "nerve center test" to identifythe "principal place of business"–looking to the place wherehigh-level officers direct, control, and coordinate corporateactivities.

Since Congress used exactly the same terminology–"principalplace of business" in NRRA months later, Mr. Stephan believes thereis a good chance that courts interpreting NRRA will apply the sametest.

As for "principal residence," numerous courts have interpretedthe term because it is also used in the bankruptcy and tax codes.Courts typically look at voting records, tax records, driver'slicenses, and physical occupancy.

What if 100 percent of the risk is outside the homestate?

The classic example involves insurance for a Florida condo ownedby a New York snowbird. With a special exception to the home statedefinition, Congress decided that Florida should be the stateregulating and taxing that transaction. The exception language saysthat if 100 percent of the risk is located out of the principalresidence, then the home state is the state where "the largestpercent of the taxable premium for that insurance contract isallocated."

o An insured's home state may require E&S brokers toannually file tax allocation reports detailing the portion ofpremium attributable to exposures located within the state.

o "Congress intends that each state adopt nationwide uniformrequirements, forms, and procedures, such as an interstate compact,that provide for the reporting, collection and allocation ofpremium taxes for nonadmitted insurance."

The prospect of filing one annual tax allocation form contraststhe current regime where in many states–on a policy-by-policybasis–brokers have to allocate the taxes 30 days after the policyis written.

The prospect of uniformity expressed in the Congressional"statement of intent" of part (b)(4) of Section 521 is not areality yet, although state regulators are currently reviewingvarious ways to get to uniformity.

One proposal, developed and supported by 60 interested insuranceprofessionals back in 2007, including NAPSLO, is known as SLIMPACT,an acronym for Surplus Lines Insurance Multi-State InterstateCompliance compact. (For more on SLIMPACT, see the Oct. 13 ofNAPSLO Daily, a convention newsletter published byNU and available on the exclusives section ofNU's website.)

Explaining the language of Section 521 in simple terms, Mr.Stephan said, "the broker's only job is to pay the tax to the homestate and to file an allocation report, if the home state requiresone. Beyond that it becomes the state's job to figure out how toget the taxes allocated."

Why did tax rules need to change?

In the 1980s, the states started adopting allocation rules, but11 states never did. The result was a confusing environment withmany states requiring allocation, some collecting taxes on totalgross premiums, and a lack of clarity among the allocation statesas to whether revenue, square footage, number of employees or someother exposure measure should be used as a basis forallocation.

Can states other than the home state collect their taxrates on multi-state exposures?

Under the rules effective July 21, 2011, if there is nointerstate compact, then the broker pays the tax rate at the homestate, files a tax allocation form in that state if it's required,and that's it. The broker does not have to figure out applicabletax rates for portions of risk outside the home state.

Mr. Stephan noted that the SLIMPACT model for a compactenvisions a system in which a broker sits down at a Web-basedsystem, keys in the risk characteristics, and the system shows howmuch tax needs to be collected on out-of-state portions of risk–taxrevenues that will otherwise be lost to states beyond the homestate if no such uniform nationwide mechanism is devised.

Will states need to change their codes to reflect theNRRA?

It is very likely, Mr. Stephan believes. While noting that somecurrent state laws are vague, by his count only 11 states now tax100 percent of the gross premium, allowing them to allocate taxeson out-of-state exposures if some uniform mechanism is adopted asCongress intends.

That leaves 39 states that tax only the portion of premiumrelated to exposures in their states. If one of those 39 stateswere the home state, "they would have nothing to allocate."

Unless their laws are changed before the NRRA effective date,the broker will comply with the home state law–collecting andremitting tax only on the portion of premium for a multi-state riskrelated to exposures residing in the home state. The states wouldhave to change their laws to enable them to allocate taxes back toother states.

Do agents still have to file for nonresident surpluslines licenses?

Yes. "If state it is the insured's home state, you have to havea nonresident license in that state to conduct an E&S brokeragebusiness," explained Dan Maher, executive director of the ExcessLines Association of New York.

"What has really changed is that a broker only needs one licensefor any given risk" or policy, he said.

Mr. Maher gave to examples to clarify the response.

A New York-licensed E&S broker, placing a lot of residentrisks, and a few risks that are multi-state but the home state isin New York would only need the New York license. If themulti-state risks have insureds that have principal places ofbusiness–home states–outside of New York, the broker needs alicense in each state where those insureds are home-stated.