Tax Woes Could Drive Some Wholesalers To Support Federal Regulation

"The devil that we currently know might be a lot better than the devil [of federal regulation] down the road," he said, repeating a common refrain among the panelists.

Mr. Johnstons remarks came during a panel on regulation titled "The Federal Imperative vs. States Rights," moderated by Andrew Frazier of Western World Insurance Group in Franklin Lakes, N.J.

Mr. Frazier was one of three members of NAPSLOs regulatory committee jointly awarded the NAPSLO Presidents Award for their work developing a set of Regulatory Principles adopted by the NAPSLO board of directors. Outgoing NAPSLO President Nick Cortezi presented the award to Mr. Frazier at the start of the session. (The two other recipients were John Wood of Special Risk Associates in Shreveport, La., and Mac Wesson of Dallas-based U.S. Risk Insurance Group.)

Mr. Cortezi explained that the nine principles developed by these menadvocating state-based regulation, freedom of rate and form for surplus lines, and uniform tax and licensing among other thingsprovide a road map for future boards. (See sidebar for complete list.)

This visible advocacy role for NAPSLO with respect to regulatory matters is a seeming departure from the past. Just a few years ago, the pages of National Underwriter reported frequently on the reluctance of the wholesale broker and surplus lines insurance group to take positions on the issue of commercial lines deregulation, for example. At the time, NAPSLO executives had cited a split between wholesale broker and insurance company member interests in explaining the failure of the group to take an official posture.

Now, although NAPSLOs Regulatory Principle VII addresses commercial deregulation (calling for exempt commercial policyholders under state deregulation laws to automatically qualify for export to the surplus lines market without a diligent search), the hot-button issues for the panel were the rejection of federal regulation (Principles VIII and IX) and the standardization of taxation for multi-state surplus lines risks (Principle V).

"Over the past few years, weve had a taste of federal regulation," Mr. Frazier said, referring to the provisions of the Terrorism Risk and Insurance Act mandating the offer of terror coverage, and the privacy requirement and compliance features of Graham-Leach-Bliley. "We have had a glimpse of why [the issue of] federal versus state regulation means something to our industry," he said.

Mr. Johnston said that "brokers, Im confident, are interested in freedom of rate and form" and principles related to commercial deregulation. "But when you cut to the chase, from a broker perspective, its all about making those tax filings and trying to figure out maze of laws on tax."

Noting that larger brokers are more apt to deal with multi-state risks and out-of-state risks, he suggested that those activities might lead them to support a federal system of regulation if the tax situation doesnt improve.

"I think the single biggest problem, day-to-day, is just how to make the [tax] filings," he said. "We spent a considerable amount of moneyon the licensing costs to do that," he added, referring to the need to get nonresident surplus licenses to pay taxes to states other than those in which a surplus lines broker is licensed.

Richard Bouhan, NAPSLOs executive director, another panel participant, explained that state laws concerning tax payments on multi-state risks placed in the surplus lines market are conflicting and cumbersome. (See NU, Oct. 4, 1999, for a comprehensive article by Mr. Bouhan on the subject. In the article, Mr. Bouhan notes that some states, for example, require surplus lines brokers to pay tax on the entire premium to the state which licenses them, while others require brokers to allocate premiums, and the corresponding taxes, based on the portion of the risk located in each state.)

During his presentation at the annual meeting, Mr. Bouhan noted that state actions toward agent licensing reforms required by Graham-Leach-Bliley Act give an indication of whether states can ever create an efficient system of regulation and avoid a move to a federal scheme.

"They canand will do it," he said. Supporting his conclusion, he noted that under the Gramm-Leach-Bliley Act of 1999, 29 states were required to enact laws for reciprocal treatment of non-resident producers to avoid the creation of a federal producer licensing system, and that more than 29 have, in fact, adopted such laws.

However, "I think theyre off to a kind of poor start," he added, noting that several major states had not enacted reciprocity laws at the time of the NAPSLO meeting. "Part of [the reason for] that is due to construction of the federal law itselfthat 29 states would bring this into effect."

(A week after the meeting, New York enacted a reciprocal licensing law. In Florida, a U.S. District court recently ruled that Floridas countersignature law and its denial of surplus lines licenses to nonadmitted agents were unconstitutional. There, however, a state regulator indicated that the Florida department may seek to appeal the surplus lines part of the ruling.)

At the NAPSLO meeting, Mr. Bouhan went on to observe that, in those states that have enacted agent licensing reforms, it hasnt been smooth sailing for surplus lines brokers that have gone out and tried to get nonresident surplus lines licenses. Basing his remarks on anecdotal reports from NAPSLO members, he said: "Some states dont have the rules written yet on how to do that. Some states are putting up barriers and putting up what appear to be additional requirements than the law suggests."

"Having said that, I also understand that some of the inconsistency, as time is going on, is being removedand things are getting better," he added.

Mr. Johnston said: "The ability to obtain nonresident surplus lines licenses has helped [with the tax issue] to a great extent, [but] its probably helped a little more on the single state out-of-state risk. On a multi-state risk, it gives the illusion of helping, but theres some confusion in that regard as to which state law are you now filing the multi-state risk in."

The answer probably is that "youre filing under all of those states laws," he concluded. "But if the allocation is different [in each state] and the amount of taxes you owe is different, then theres just no way to comply with all the laws."

What surplus lines brokers would really like to have "is just a very simple filing system supported by all 50 states with the exact same laws in all 50 states." Short of this "perfect world" scenario, "we would like to just make a filing in the state where the broker resides."

Even there, he said, "we are quite aware that trying to get all 50 states to agree to that proposition is almost impossible. The smaller states, in my opinion, would be very concerned about the amount of taxes that they would probably no longer receive. Thats what we would like, but its never going to happen."

He then asked: "So why wouldnt the brokers support federal regulation? Why wouldnt that be a solution?"

His answer: "Im not sure that the surplus lines business, as we know it today, would continue to exist under a federal system of regulation. Im not sure why we would even need surplus lines licenses anymore? Im not sure why the carriers couldnt make the tax payments just like the admitted insurers pay their taxes."

He added that "the distribution system of this organization is based on certain carriers[also] members of this organizationchoosing to distribute their products through wholesale brokers. But once there are massive changes in an industry such as ours, Im very uncomfortable with supporting any sort of revision [when] I just dont know what its going to end up being."

Mr. Bouhan echoed his comments. "The surplus lines industry is really connected to the state regulatory system. It rises and falls with that system," he said. "The ability of a [insurance] company to be licensed in a state, and operate in 50 more jurisdictions on an unlicensed basis, is solely a creature of the McCarran-Ferguson Act, which is the Act that gives states the authority to regulate the insurance business," Mr. Bouhan added.

As for the tax issue, Mr. Johnston reported that the NAPSLO legislative committee has resurrected the proposition of a tax clearinghouse, describing it as an "alternativedecent middle ground that still retains the state system." (This has been proposed by NAPSLO members, on and off, for a number of years.)

Under the proposal, a single clearinghouse could calculate the surplus lines taxes on multi-state risks, tell the broker what that is, the wholesale broker can bill it, collect one check, send it to the clearinghouse, and then the clearinghouse would distribute the appropriate amount of tax to each state, he said.

"Its in the talking stages right now. But if something like that could be worked out in a significant number of states, I believe wholesale brokers would remain loyal to the state-based system and would definitely not be proponents of federal regulation," he concluded.

Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, October 24, 2003. Copyright 2003 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.