Tucked into 2,000-plus pages of federal financial services reform legislation are just 10 relating to the surplus lines industry, but those pages will put an end to decades of broker frustration, legislative experts say.

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

Questions remain, however, about exactly what will happen when Sections 521 through 527 of the Dodd-Frank Wall Street Reform and Consumer Act take hold. What exactly do these sections related to nonadmitted insurance say? What new rules will the E&S brokers have to follow?

With the reforms on the minds of brokers attending last week's annual convention of National Association of Professional Surplus Lines Offices, Ltd., NU has compiled a list of frequently asked questions and answers relating to these sections of the new law–sections commonly referred to as NRRA, or the Nonadmitted and Reinsurance Reform Act (the name given to a version of these 10 pages that repeatedly passed the House of Representatives in recent years.)

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

What will the NRRA mean for E&S brokers?

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

"What all this means is that [brokers] have to make a determination of the home state, but beyond that compliance is much easier with the new set of rules," said Steve Stephan, NAPSLO's director 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 single premium tax to the home state of insured only, according to Section 521.

o One regulator per placement. E&S placements will be regulated solely by the home state, according to Section 522.

NAPSLO believes this provision encompasses broker activities such as conducting a diligent search of the admitted market before placing a risk in the surplus lines market, filing an affidavit to demonstrate that a diligent search was done, and putting a surplus lines notice on the policy.

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

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

o License Registry. Section 523 describes a national producer registry for surplus lines that will further alleviate the licensing burden. States have two years to accomplish the objective of setting up the database and passing laws to participate, but this issue was "front-and-center" at the summer 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 meaning of the language "principal place of business" in a February court ruling unrelated to NRRA. In Hertz vs. Friend, the organization at the center of the case had 48 percent of its business in California, but with New Jersey headquarters. The High Court ruled that it would use the "nerve center test" to identify the "principal place of business"–looking to the place where high-level officers direct, control, and coordinate corporate activities.

Since Congress used exactly the same terminology–"principal place of business" in NRRA months later, Mr. Stephan believes there is a good chance that courts interpreting NRRA will apply the same test.

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

What if 100 percent of the risk is outside the home state?

The classic example involves insurance for a Florida condo owned by a New York snowbird. With a special exception to the home state definition, Congress decided that Florida should be the state regulating and taxing that transaction. The exception language says that if 100 percent of the risk is located out of the principal residence, then the home state is the state where "the largest percent of the taxable premium for that insurance contract is allocated."

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

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

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

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

One proposal, developed and supported by 60 interested insurance professionals back in 2007, including NAPSLO, is known as SLIMPACT, an acronym for Surplus Lines Insurance Multi-State Interstate Compliance compact. (For more on SLIMPACT, see the Oct. 13 of NAPSLO Daily, a convention newsletter published by NU and available on the exclusives section of NU'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 home state and to file an allocation report, if the home state requires one. Beyond that it becomes the state's job to figure out how to get the taxes allocated."

Why did tax rules need to change?

In the 1980s, the states started adopting allocation rules, but 11 states never did. The result was a confusing environment with many states requiring allocation, some collecting taxes on total gross premiums, and a lack of clarity among the allocation states as to whether revenue, square footage, number of employees or some other exposure measure should be used as a basis for allocation.

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

Under the rules effective July 21, 2011, if there is no interstate compact, then the broker pays the tax rate at the home state, files a tax allocation form in that state if it's required, and that's it. The broker does not have to figure out applicable tax rates for portions of risk outside the home state.

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

Will states need to change their codes to reflect the NRRA?

It is very likely, Mr. Stephan believes. While noting that some current state laws are vague, by his count only 11 states now tax 100 percent of the gross premium, allowing them to allocate taxes on out-of-state exposures if some uniform mechanism is adopted as Congress intends.

That leaves 39 states that tax only the portion of premium related to exposures in their states. If one of those 39 states were 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 and remitting tax only on the portion of premium for a multi-state risk related to exposures residing in the home state. The states would have to change their laws to enable them to allocate taxes back to other states.

Do agents still have to file for nonresident surplus lines licenses?

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

"What has really changed is that a broker only needs one license for 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 resident risks, and a few risks that are multi-state but the home state is in New York would only need the New York license. If the multi-state risks have insureds that have principal places of business–home states–outside of New York, the broker needs a license in each state where those insureds are home-stated.

Special Reports /

Dodd-Frank Delivers Single-State Tax & Regs For Multi-State Risks

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