After enjoying 4 years of broad bipartisan support, the Non-Admitted and Reinsurance Reform Act (NRRA) finally became law last summer after being folded into the financial services reform legislation passed in June 2010. The federal act, which is slated to take effect July 21, ushers in a new era of surplus lines reform in the United States by establishing one-state compliance on multi¬state risks and nationwide uniform requirements, forms and procedures for non-admitted insurance. But the mounting uncertainty that states will be unable to craft laws that comply with the NRRA when the federal act goes into effect could ultimately serve as the catalyst for more pronounced federal regulation of the surplus lines insurance industry in the U.S.

One-State Compliance

The NRRA grants the insured’s home state with exclusive authority to regulate placement of nonadmitted insurance. The federal act states that no state, other than an insured’s home state, may require a surplus lines broker to be licensed in order to sell, solicit, or negotiate non-admitted insurance with respect to such insured. In addition, the NRRA explicitly provides for the preemption of laws, regulations, provisions, or actions of any state that applies to nonadmitted insurance sold, solicited by, or negotiated with an insured whose home state is another state.

Under the federal act, only the insured’s “home state” will be permitted to collect premium taxes for nonadmitted insurance. The insured’s “home state” is defined as the state of the principal place of business for a commercial insured or the state of residence for an individual insured.

To facilitate the payment of premium taxes, the stated intent of Congress in the NRRA is to allow the states to establish a nationwide or uniform system of reporting, payment, collection and allocation of surplus lines taxes among the states. The states may establish this uniform system by entering into an interstate compact or establish other procedures for the allocation of the surplus lines premium tax. If the states fail to implement a tax allocation system within 330 days after the adoption of the NRRA, then a single state taxation system will become effective on July 21, 2011, which conceivably allows the home state to then retain 100% of the tax on the gross premium, assuming it has amended its own laws to permit taxation of the entire premium.

Uniform Standards for Surplus Lines Eligibility

The NRRA empowers the states to create uniform national requirements, forms and procedures for insurer eligibility for U.S. domiciled (foreign) surplus lines insurers. If the states do not develop a nationwide eligibility standard, the NRRA sets default standards which the states must accept. Specifically, a U.S. domiciled surplus lines insurer will need to meet two substantive requirements under the NAIC Non-admitted Insurance Model Act: 1) maintain capital and surplus of at least $15 million (or the minimum capital and surplus requirement under the law of the insured’s home state if higher); and 2) be “authorized to write in its domiciliary jurisdiction.”

With respect to alien (non-U.S.) surplus lines insurers, states may not prohibit a surplus lines broker from placing non-admitted insurance with, or procuring non-admitted insurance from, a non-U.S., non-admitted insurer that is listed on the Quarterly Listing of Alien Insurers maintained by the NAIC’s International Insurer’s Department (“IID List”).

These relaxed eligibility standards will allow easier access to all states for both U.S. and alien insurers, thus increasing competition and expanding the surplus lines market to include additional alien insurers. Surplus lines brokers will also have a more diverse market to draw from as they will be able to place insurance with all alien insurers on the IID List instead of checking the white list of eligible alien surplus lines insurers in each applicable state.

What remains to be seen is whether the states will choose to amend their laws to incorporate the NRRA requirements while keeping existing state regulations that allow them to charge filing fees or to delist an insurer based on unsound financial condition or improper claims practices. Some states have indicated that they will continue to request financial, premium or other information from foreign and/or alien surplus lines insurers on an optional basis following the effective date of the NRRA. But if a state raises the ante and brings on enforcement action against a broker or company that is expressly contrary to the NRRA, the broker or company could resist (and likely win) in court.

Legislative Response

With NRRA only a few weeks away from final implementation, there are two competing interstate agreement proposals now being considered by the states as a possible response to the congressional mandate. The Surplus Lines Insurance Multi-state Compliance Compact (SLIMPACT), has been endorsed by the National Conference of Insurance Legislators (NCOIL), the Council of State Governments (CSG) and the National Conference of State Legislatures (NCSL). SLIMPACT, which was amended in November and now known as “SLIMPACT-lite”, would authorize a governing commission to establish allocation formulas, uniform payment methods and reporting requirements, to ensure eligibility standards, and a single policyholder notice to replace the various forms used across the country.

An alternative and more scaled-down proposal endorsed by the National Association of Insurance Commissioners (NAIC) is the Non-Admitted Insurance Multi-State Agreement (NIMA). NIMA is a tax-only arrangement that addresses the tax uniformity and allocation issues but offers no guidance on eligibility standards or broader regulatory themes. Specific details regarding NIMA’s governance and operation still need to be developed.

Indiana, Georgia and Kansas were the 18th & 19th and 20th states to sign into law NRRA implementation legislation and bills have been approved by legislatures in seven other states, awaiting action by governors of Alaska, Florida, Hawaii, Missouri, Maryland, Oklahoma, and Vermont. However, only six states have enacted legislation specifically to enter into the SLIMPACT-lite compact while only 2 states have adopted legislation that specifically authorizes NIMA.

There is an additional legislative hurdle that the states must also clear. Under current state laws, the premium for multi-state risks is taxed based on the portion of premium allocable to each individual state. Since the NRRA does not automatically repeal these state laws on its July 21 implementation date, the home state will continue to tax only its pro-rata portion of the premium for multi-state risks unless it adopts new legislation. This would have the unintended consequence of reducing state premium tax revenues while providing a tax savings to purchasers of non-admitted insurance. To avoid this situation, states will need to promptly update their premium tax laws to take account of the “home state” implications of the NRRA. Failing this, the full amount of non-admitted premium allocable to non-home states would be entirely tax free.

Given the intricate legislative maneuverings that need to be performed to meet the NRRA implementation deadline, the leaders of NCOIL, CSG and CSL have written an open letter to Congress requesting a year extension, until July 21, 2012, in which to comply with the surplus lines section of the NRRA. The letter suggests that while there continues to be widespread support for an interstate compact, the chances for fuller participation would be greatly enhanced if the states are given more time.

Outlook

As we reach the end of the 2011 legislative sessions, state regulators and legislators must make a high level decision whether to adopt an interstate compact or other tax allocation procedure consistent with the congressional statement of intent, or to allow the single state tax system to become effective on July 21, 2011. This will not be an easy choice as each state has its own licensing, premium tax rates, filing forms, deadlines and compliance procedures. The ensuing procrastination could quickly turn to ambivalence among the major surplus lines jurisdictions such as California and New York if they determine that an allocation formula does not necessarily inure to their financial benefit.

With competing interests such as healthcare and financial reform still high on their legislative agendas, the states will find it even more challenging to enact rules adopting an interstate compact of any form within the next few months. The fact that Congress may be unwilling to consider the request to extend the July 21, 2011 implementation deadline brings an even greater sense of urgency to state legislators and regulators.

Given the potential loss of substantial tax revenues that would result from their failure to act, the pressure on the states to develop an effective tax allocation process and uniform eligibility standards over the next few months will be enormous. If a consensus can not be reached before the current or extended NRRA deadline, then such inaction will almost certainly hasten more aggressive federal regulatory oversight of the US surplus lines market and, on a broader scale, reignite the larger debate for an optional federal charter and other forms of federal insurance regulation.