July 21 should have been a day of celebration for surplus lines brokers. That was the day the Nonadmitted and Reinsurance Reform Act took effect, finally freeing brokers from the contradictory mess that was state surplus lines regulation.
The good feelings were tempered, however, by the confusion over the states’ attempts to enact the law, particularly its most important reform: surplus lines premium taxation. Instead of taking advantage of the opportunity that the new law presented to the states to devise a uniform approach to surplus lines taxation while maintaining regulatory control at the state level, the states have gone the opposite way: devising multiple approaches that are causing confusion and compliance headaches.
Much of the uncertainty centers on two issues: how to determine the home state of the insured (and therefore which state’s laws should govern) when there are multiple insureds under a contract, and the application of a home state’s premium tax laws. The Council has published an FAQ on its website to address these questions.
Home State of the Insured: When there are multiple insureds, this is not always a straightforward exercise. The first step is to determine if the insureds are affiliated. Non-affiliated groups (risk purchasing groups, for example) are treated differently from affiliated groups, which are specifically defined under the reform act.
The law’s framework is based on identifying the home state of each insured. For non-affiliated groups, a home-state determination must be made for every insured (that is, for each insured member in a non-affiliated group). In a typical scenario, in which non-affiliated group members are named insureds that make premium payments, the home state for each insured member must be identified for regulatory purposes (taxes, licensing requirements, etc.).
Some confusion has arisen regarding non-affiliated groups because the NIMA (Nonadmitted Insurance Multistate Agreement) states and New York have adopted a special home-state rule for “group insurance.” The rule in those states addresses only the limited scenario in which a group policyholder (i.e., the sponsor) pays 100% of the premium from its own funds. In that situation, in the NIMA states and in New York, “home state” means the home state of the group policyholder. In the vast majority of cases, however, brokers must look to the home state of each named insured (i.e., to the home state of each group member). Specifically, the home state will be determined based upon the principal place of business of each named insured.
If a policy covers an affiliated group, the home state is wherever the member of the group that has the largest percentage of premium attributed to it has its principal place of business. If 100% of the insured risk is located outside that state, the home state is the state to which the greatest percent of that affiliated group member’s risk is allocated. The home state or location of a holding company has no significance in this determination.
Finally, the “affiliated group” definition does not apply to families, in which case the home state hinges on the principal residences of the insureds.
Premium Taxes: The states (and Washington, D.C.) are all over the board with respect to premium taxes, although they generally fall into four categories: pro rata states (currently 7); 100% retention states (24); NIMA states (11); and Slimpact states (9). Some states have issued guidelines to assist brokers in complying with their surplus lines tax rules, but numerous questions remain, particularly when a state’s laws and guidelines are insufficiently clear.
Unfortunately, there is no “default” tax payment procedure that is commonly accepted by the states, so when a state’s law is unclear, we are left to our own devices to determine the proper way to comply. These are going to be case-by-case decisions, but brokers should not read more into a state’s law than is actually there. In a state that has neither updated its tax laws to reflect the reform act nor issued guidelines, the state’s existing tax approach stands.
Some states might try to impose a higher tax burden retroactively when they eventually reform their tax laws or join a multi-state tax agreement. In those cases, brokers have a few options. They can pursue litigation to challenge the retroactive tax; collect taxes now based on a potential increase in the tax rate and hold those funds in escrow; or notify insureds now that additional taxes may be due (or a refund issued) later if states change their rates or tax regimes.
So the states have managed to bungle an opportunity to improve regulation for the benefit of all stakeholders. Given the opportunity the new law presents to the states to devise a uniform approach to surplus lines regulation while maintaining regulatory control at the state level, this is especially disappointing.