Premium Taxes: The New Accuracy Imperative

States and Municipalities Take Action on Premium Taxes

Now, thanks to high-profile enforcement actions in several states, insurers are being required not just to pay the correct amount of premium taxes, but to pay them to the correct municipal district.

"All of a sudden, the premium tax area is in the limelight – whereas before it was more or less a hidden issue," Whitcomb says. And the stakes are high for local governments. "Many municipalities rely heavily on premium taxes – to the point where it really affects their budgets if there are changes in premium volume and taxes paid. You've got insurance companies that will pay a single town $80,000 – that's probably two FTEs [full-time equivalents] in the fire department."

For instance, the Municipal Association of South Carolina now requires insurance companies to include – in the municipality where the agent is located – all agent-produced written premiums from unincorporated (non-taxed) jurisdictions.

Things have gotten even more interesting in the state of Florida, where Rule 12B-8.0016 requires all companies to follow new database rules for the location of premiums. Since March 17, 2008, insurance companies have been able to register, create a user name and password, and download address and jurisdiction database files. In calendar year 2009, the state now requires use of this database to report premiums. Premium taxes certainly matter to the state's municipalities: for more than three years, Naples and North Naples have been litigating against each other to obtain their "fair share" of premium tax revenue.

But Kentucky has done the most to thrust the premium tax issue to the forefront. For decades, in addition to state excise taxes on insurance, Kentucky's local governments have been allowed to apply a separate local government premium tax (ranging from two percent to 10 percent) to insurance policies. More recently:

• State legislation HB 524 has mandated (as of January 1, 2009) that insurers that include local premium taxes as part of the policyholder premium charge must separately state the amount of tax charged and the name of the taxing jurisdiction on the renewal certificate. Moreover, under the law, insurers that issue and renew more than 2,000 policies in the preceding year must use a verified electronic risk location system to identify correct local taxing districts – penalties will be incurred if insurers are unable to comply.
• The city of Hurstbourne sent letters to all residents requesting they provide information on which insurance company provides their coverage – and filed a consumer complaint with the Kentucky Department of Insurance to obtain municipal coding.
• Various Kentucky cities and counties are threatening – and taking – legal actions over misdirected premiums. Confusion around municipalities' differing tax rates almost guarantees over- or under-payment of premium taxes. Insurance companies are threatened with huge financial and regulatory exposure thanks to a recent class-action lawsuit involving misapplication of premium tax jurisdiction to policies.

On top of these concerns, any insurance company that does business in Kentucky groans about the state's onerous filing requirements, Whitcomb says, "because they have to file five times a year – once each quarter, plus an annual reconciliation – for every municipality where the insurance company writes business."

There are 14 states like Kentucky that have premium taxes at the local level, according to Dan Lawson, director of tax applications at First American Spatial Solutions, who has spent the past quarter-century working as an expert in tax research and systems. Six additional states, he adds, "do not impose a premium tax per se, but they capture within their business license requirements insurance premium taxes that are generated from a local office with the city limits."

Moving Target: Accurate Property and Municipal Data

As insurance companies as well as state and local governments are discovering, there's a big difference between (a) taxes imposed on insurance policies and (b) accurate payment and reporting of those taxes. Premium tax compliance fundamentally depends upon knowing the policyholder's (or insurance agency's) precise address and matching that location to its correct taxing authority district.

"Usually, tax compliance is attacked from the spreadsheet side – meeting regulations, knowing the correct amount to pay, and so on – but you can't really be sure that your premium taxes are accurate unless you have the correct underlying geospatial data," explains Brady Foust, Ph.D., professor emeritus of geography at the University of Wisconsin-Eau Claire and consulting geographer for First American Spatial Solutions.

In the past, insurers have interpolated the location based upon the postal service's ZIP code data, Foust says, noting that "ZIP codes don't really exist except as bundles of carrier routes." Postal codes are insufficiently granular and often poorly correspond to taxation authority boundaries, making them an inherently unreliable source of geospatial data for premium tax applications – especially as more states and municipalities are strictly enforcing their tax laws.

On average, 10 to 40 percent of policy locations are miscoded due to inferior geospatial data and systems, according to Foust. Moreover, it's a continuous effort to maintain accurate geospatial data, because local boundaries are frequently in flux.

"City limits are constantly changing, especially in high-growth areas, because annexation nibbles away at the boundaries when people seek services that the city provides such as fire protection, sewer, water, and other infrastructure," Foust says. Boundaries and rates also are subject to revision by the state's legislators and department of insurance. Therefore, to ensure accuracy, insurance companies require geospatial boundary and tax databases that are updated on a quarterly basis.

Keys to Compliance: Accurate Databases and Precise Geocoding

How do insurance companies rectify geospatial inaccuracies and ensure premium tax compliance?

"High-quality geocoding and topologically seamless databases provide the best solutions," Foust says. Compliance involves three key geospatial components:

1. Spatially accurate, spatially precise, and current premium tax districts (referred to as polygons)

2. Spatially precise geocode locations for each premium (a point)

3. A point-in-polygon geographic information system (GIS) operation that precisely places the point – the premium address – within the tax polygon.

Experts in geography and geographical information systems convert boundary descriptions into accurate digital representations known as boundary files. Geocoding, in turn, assigns a latitude and longitude to an address. Combining boundary files with precise geocoding allows the accurate placement of policyholders' addresses within their corresponding tax polygon.

Building accurate geospatial databases requires considerable professional expertise, Foust notes.

"Descriptions can be convoluted, such as 'the centerline of Five Mile Road between Elm Street and Highway 57, following the bank of Fresh Creek to its junction of the Red River.' Boundaries follow streets, streams, railroads, and survey lines," he explains. "Therefore, creation of digital geospatial boundaries for premium taxes is a laborious process requiring an accurate underlying base map and considerable digitizing and geographic experience and skill."

There are different ways insurance companies can acquire geospatial data and geocoding and leverage them to ensure premium tax compliance.

"Insurers can buy the data layers – the shape files with tax information, and also hazard data shape files – or the geocoder, or the combination of both," Lawson explains. "Each has its own intrinsic value, and putting them together increases that value."

Lawson recommends that insurers look for details including not only the state-mandated codes that are applicable to the state and local jurisdictions, but also detailed footnotes for the state and local tax codes that "give you the indication of whether that taxing jurisdiction has a minimum and maximum amount of tax due, etc. – enough tax information to make it easy on the tax department."

It is also vital to incorporate sufficiently granular geospatial data that allows insurers to write business system rules.

"If a property resides less than 1,000 feet from the jurisdiction border, for instance, you need the distance to the border so you can write a business rule to investigate," Lawson says.

The days of insurance companies paying premium taxes utilizing imprecise, inaccurate geospatial data appear to be numbered.

"If Kentucky and Florida have premium tax statutes, how difficult is it for Alabama and Georgia and others to write up the exact same statute in their states and enforce it?" Whitcomb asks. "They can piggyback on it and it doesn't cost them a dime."

Fortunately, "Insurance company management takes premium tax enforcement seriously," Whitcomb adds. "They always do, because the letter always goes to the president of the company."

John W. DeWitt, founder and senior consultant for JW DeWitt Business Communications in New Salem, Mass., is a contributing technology editor for Tech Decisions and National Underwriter. He can be reached at john@jwdewitt.com or www.jwdewitt.com.