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Surplus Lines Marketin the Shifting Regulatory Sands
Dan BrownSONNENSCHEIN NATH
& ROSENTHAL LLP
Steve StephanNapslo
SURPLUS LINES OVERVIEW
Market for hard to place risks
Operates as a supplemental/secondary market to the admitted market
**REGULATED – IN EVERY STATE**
ROADMAP FOR TODAY’S DISCUSSION
Brief History of Surplus Lines Certain Definitions Insurance Company Eligibility Eligible Risks Size and Nature of the Market Broker Issues Insurer Reporting and Recordkeeping Premium Taxation Limits to Regulation Applicable Federal and State Laws Stamping Offices Snapshot of the Market Future of the Market
HISTORY OF SURPLUS LINES REGULATION
1752 Philadelphia Contributorship 1st P&C Company protects houses from liability due to fire
1890’s Lloyds of London a player in U.S. commercial property risks
1890 N.Y. enacts America’s 1st Surplus Lines Law designed to control not eliminate the market similar to law today with producer regulated few states follow N.Y. lead (notable exceptions IL & MA)
1897 NAIC appoints Unauthorized Insurance Committee charge: to study the “problem of underground insurance”
HISTORY OF SURPLUS LINES REGULATION (cont.)
1900-1960 Misunderstood market and unresolved debate among Regulators NAIC Proceedings about “undesirable” “lawless”
“illegitimate” 1960 U.S. Senate’s Antitrust and Monopoly
Subcommittee Hearings inquiry into alien surplus lines prompts NAIC to act
1962 NAIC adopts Non-Admitted Insurers Information Office reviews financial condition, trust funds and deposits
1970’s-mid-80’s availability/affordability concerns in product and professional liability lines
1982 NAIC adopted the Surplus Lines Model Act some form of the Act in all states
SURPLUS LINES DEFINED
Insurance that the admitted companies (the market) will not write Ebbs and flows with the market
Nonadmitted means not licensed aka unauthorized Not transacting business in the state where the risk is
located/resides Current dispute in California on this point
Critical Supplemental/Secondary Market
INSURER ELIGIBILITY
Must be admitted in at least one state Exception: Illinois
Financial and statutory requirements vary by state
Specialized knowledge and expertise
“White lists”
ELIGIBLE RISKS Mostly commercial Capacity driven Distressed risk driven Focus is on unique, exotic, novel, or unusual
risks Diligent search required (to maintain the
focus) Broker affidavits required (to confirm the
focus) Export lists - export without diligent search
permitted (but still subject to remaining surplus lines laws)
SURPLUS LINES MARKET Nature of surplus lines business makes it difficult to
get an accurate count There is no agreement on what makes up surplus lines
premium What we do know
Surplus Lines business goes by many different names• Domestic, Foreign, Alien, Offshore, Onshore, Independent
Procurement, Direct Procurement• Lloyd’s of London is unique (70 Lloyd’s syndicates per NAIC
Quarterly Listing of Alien Insurers)• A.M. Best reported top 25 Surplus Lines Carriers represented 80%
of the market with a premium volume of $30 billion
ROLE OF THE BROKER
Client eligibility
Insurer selection
Record maintenance
Affidavits
Surplus lines placements filings
Collect and remit taxes and fees
Policyholder disclosure
BROKER LICENSING REQUIREMENTS
Surplus lines licenses - required for brokers to place business
“Courtesy filings” – less common
Independent procurement – the [i] insureds place business [ii] directly with Surplus Lines carrier [iii] from outside the state [iv] without broker involvement
INSURER REPORTING REQUIREMENTS
21 states require reports from insurers
Report format and deadlines vary by state
Data calls – do they apply to surplus lines (nonadmitted) insurers?
• NAIC Medical Malpractice Data Reporting• 2007 CA Wildfire Data Call
STATE REPORTING DUE DATES
AS OF 12/31/07
AL – 3/1 LA – 4/15 NV – 3/1
CO – 3/1 MA – 3/1 NY – 3/15
CT – 3/1, 5/15, 8/15, 11/15
MO – 6/1 OK – 3/1
FL – 3/31, 6/1, 9/30, 12/31
MT – 4/1 RI – 7/31
HI – 3/15 MS – 3/1 SD – 4/1
IA – 4/30 NH – 4/30 TX – 3/31
KS – 5/1 NM – 3/1 VI – 5/30
SUGGESTED BEST PRACTICES FOR INSURERS
Provide policyholder disclosure noticeswith all policies
Track info on surplus lines placements for all states Request at time of binding Update continuously Create reporting database
SAMPLE COMPANY DATABASE
Policy number
Name/address of Insured
Premium – Commission paid
Policy Eff. Date / Exp. Date – Limits
Account producer and contact info
Surplus lines licensee, contact info, license
number
PREMIUM TAX ISSUES
Broker collects taxes – remits to states
Amount of tax varies by state
Multi state exposures present complex tax allocation issues
Various parties seeking to resolve (to be discussed)
LIMITS TO REGULATION U.S. Constitution requires due process
Todd v Shipyards (U.S. Supreme Court - 1962)• tax case• transacting business within vs. outside the state where the
risk is located
Numerous state cases have followed• taxation and regulation• Notable: N.J. established a guarantee fund
Evanston Ins. Co. v Merin (N.J. 1984) challenge failed
APPLICABLE LAWS Federal Liability Risk Retention Act of 1986
specifically allows surplus lines availability to purchase groups
State Laws or Regulations - Do they Apply? Solvency Claims Handling Unfair Trade Practices Fraud Reporting Cancellation Laws Special Assessments Rate and Form Filings
• Essex Insurance Co. v Zota (Florida)
STAMPING OFFICES
Stamping Offices - 15 states (MN added 1/09) Surplus Lines Brokers become members of Surplus
Lines Association
Quasi-regulatory agencies
Financial security review and market conduct of
surplus lines brokers
Collectors of surplus lines taxes
STATES WITH STAMPING OFFICES AS OF 6/15/08
*Source: U.S. Stamping Office Directory
Courtesy of the Surplus Lines Stamping Office of Texas and the Excess Lines Association of New York (ELANY)
COMPOSITION OF THE SURPLUS LINES MARKET
TODAY Alternative Market or Market of Choice* U.S. Surplus Lines Share of Commercial Lines in
2006 was 14.4% vs 85.6% for Admitted Carriers Surplus Lines grew 173% among U.S. domestic
carriers over the past 5 years Far outpacing the total U.S. Property & Casualty
Industry 2001 and 2002 saw a dramatic increase in surplus
lines writings up 35.7% and 61.7% respectively 2007 had a drop of -3.5%
Backbone of Surplus Lines business is experienced underwriting
Nimble and innovative with forms Nimble and flexible with rates
*Source A.M. Best Research 2008 Special Report
SURPLUS LINES OF THE FUTURE
Surplus Lines IndustryWill Remain Strong
IFIt Remains Nimble
Standard Carriers
Self Insured
Risk Retention Groups
Captives
“Wall Street Insurance”
THE MARKETTHE MARKET
SUMMARY
Surplus lines is regulated – brokers and insurers have specific responsibilities
Designed to be a supplemental/secondary market
Maintain complete and accurate records Update records and monitor reporting
requirements continuously Communicate with brokers Complex interplay of state and federal laws
Surplus Lines Regulatory ReformPresented at
AICP New England Chapter May 15, 2009
Norwood, Massachusetts
Steve Stephan
NAPSLO
Steve StephanDirector of Government RelationsNAPSLO200 NE 54th St. #200Kansas City, MO 64118816-741-3910 (direct)steve@NAPSLO.org
WHY ARE NRRA REFORMS SOUGHT?•State Surplus Lines laws never modernized
•GLBA had unintended consequences for nonresident Surplus Lines producer
•Surplus Lines tax system is dysfunctional
•Surplus Lines placement laws could have unintended consequences
•NRRA– “act of congress” means instant nationwide reform
•Other reform efforts failed
1
Multi-state risks equal mission impossible• Single state risk is clear•Multi-state Mono-line property – based upon property values - manageable except for 10 gross premium states•Typical statute – “allocate taxes based upon risk exposures in state” – at state tax rate•Package, excess, umbrella, casualty, E&O, D&O result in best guess•Allocation methodologies could include revenue, payroll, loss history, number of employees, man hours, and other criteria
SURPLUS LINES REFORM HISTORY• MULTI-STATE RISKS CAUSE PROBLEMS
NRRA Pending in the Senate as S 929 since 2007 Passed the House as HR 5637 in 2006 (no Senate action);
Congress adjourned without action Passed the House as HR 1065 in 2007 Senate held hearings summer 2008 – with a favorable review of
surplus lines reforms NAIC testifies in support of NRRA with changes No Commissioners are openly opposing NRRA at this time
2
Gross Premium Statutes Make Compliance Literally Impossible•Ten States have statutes that tax gross premium, but very few follow the statutes – but there are exceptions• If Gross premium paid to the home state, there is nothing left to allocate to the other states• Should surplus lines broker pay gross premium or allocate the taxes – not clear•State insurance departments audit insurers expecting the annual statement to reconcile with broker filings•The two sets of records never reconcile for multi-state risks, but a lot of time is expended by all parties in the reconciliation effort
Reform efforts at NAIC • 1995 SL multi-state tax working (MSTWG) group formed • 1995 NITCH non-admitted tax clearinghouse –abandoned• 1995 NAIC model regulation for allocation of multi-state tax adopted
by NAIC but never gets state support • 2000 MSTWG reconstituted – asks all stated to adopt allocation
laws instead of gross premium laws– abandoned in 2002• 2005 NAIC MSTWG reconstituted again and surplus lines task
force asks industry/regulatory representatives to investigate a multi-state compact to allocate taxes
• 2008 industry representatives complete draft compact, but NAIC SL task force personnel have changed and opt to reconstitute the MSTWG yet again and explore options other than a compact. They subsequently indicated they could investigate a “light” version of a compact.
• MSTWG Group Leader does not want to seek legislative changes.
NRRA REFORMS
•Single-State Tax Remittance
•Single-State Placement Compliance
•Uniform Nationwide Definition of Exempt Commercial Purchaser
•Uniform Nationwide Definition of Insured’s “Home State”
•One Surplus Lines Broker’s License from the “home state” needed for multi-state placement
3
NRRA OTHER PROVISIONS
•States encouraged to join a compact “or other procedure” to divide taxes
•Uniform insurer eligibility
•Participate in NIPR within 2 yr
•GAO study of surplus lines market required
•Applies to independently procured insurance
4
NRRA STATUS
•NAIC reportedly supports core provisions of Surplus Lines portions of the bill
•NAIC seeks change to definition of home state, insurer eligibility, other provisions
•Some regulators want reinsurance title severed – but negotiations continue
•Some want uniform Co. eligibility revised
•Some want stronger provisions to encourage states to divide taxes
5
SLIMPACT
•CREATED BY GROUP OF 60 VOLUNTEERS•MANY REFORMS SIMILAR TO NRRA
Single-state placement compliance One producer license for a multi-state risk Differs from NRRA in that taxes remitted to all states by broker
based upon uniform formula adopted by compact States must select from four optional uniform payment dates States can opt out of placement compliance rules – not tax
allocation rules Optional uniform placement compliance rules
7
SLIMPACT REFORMS
• Formation of a compact commission• Centralized data clearinghouse• Slimpact does not impact company licensing• Definition of home state differs• 4 optional tax payment dates• Mandatory rules for tax formula, data• Surplus Lines policy in home state is deemed
Surplus Lines in all compacting states
8
SLIMPACT OPTIONAL RULES
•COMMISSION CAN ADOPT OPTIONAL RULES (SUBJECT TO OPT-OUT) FOR:
Diligent search Banking, bond, record keeping Policyholder notice Transaction documentation One tax rate for all non-admitted insurance Preempts inconsistent state laws
9
CHANCES OF SUCCESS
•My view – NRRA good chance
•If NRRA joined with other bills such as NARAB, OII, NICPA, Systemic Regulator?
•SLIMPACT – better chance if NRRA encourages states to join
•SLIMPACT stand-alone – more difficult
•SLIMPACT would need largest Surplus Lines states to take initiative
10
QUESTIONS
Steve StephanDirector of Government RelationsNAPSLO200 NE 54th St. #200Kansas City, MO 64118816-741-3910 (direct)steve@NAPSLO.org
This concludes our presentation.
Thank you!
Dan BrownSONNENSCHEIN NATH &
ROSENTHAL LLP
Steve StephanNapslo
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