Industry the July/August 2013 issue

Fare Share

Like herding cats, state regulators can’t agree on surplus lines tax sharing. Some take. Some receive. (But you always pay.)
By John Demott Posted on July 17, 2013

Despite the tortuous and confusing implementation of the premium tax portion of the law, things appear to be getting better, due in part to a healthy collaboration between The Council and the National Association of Professional Surplus Lines Offices (NAPSLO), the umbrella organization for the non-admitted marketplace.

“One standard for transactions, and only the standard of the home state of the insured, is in keeping with the spirit, intent and letter of the law,” says Joel Wood, The Council’s senior vice president for government affairs. Wood credits Brady Kelley, the executive director of NAPSLO since 2011, for much of the progress toward fulfilling the NRRA goal.

“One standard for transactions, and only the standard of the home state of the insured, is in keeping with the spirit, intent and letter of the law.”

But Wood and Kelley continue to see impediments to consistent tax treatment of multistate surplus lines placements, and all eyes are fixed on the efforts of the Florida-led “Nonadmitted Insurance Multistate Agreement” (NIMA) to expand its premium-tax sharing “clearinghouse” beyond the current five states—including Florida and four small-market states—plus Puerto Rico.

This year, NIMA has launched a marketing effort to enlist states to try the clearinghouse for a year so those jurisdictions can see its purported benefits. This may be a last-gasp effort to gain traction for the agreement, which had as many as 12 states signed on before seeing more than half drop out prior to the agreement’s effective date last year.

Or could this be the beginning of yet another tortuous phase of uncertainty and bureaucratic red tape for brokers, who bear the lion’s share of the burden—monetary and otherwise—for surplus lines regulatory compliance? And how effective can this approach be at achieving uniformity since there is little or no incentive for larger states to join the effort?

“These are the questions we’re asking, and NAPSLO’s data helps make the case, which is that, given political reality, we’re better off with every state collecting 100% of the premium taxes for surplus lines transactions where it is the home state of the client,” says Wood.

When the law was passed, NAPSLO, The Council and other stakeholders (including the American Association of Managing General Agents) were agnostic on the question of whether states should “go it alone,” taking 100% of the taxes for their home insureds or whether there should be an allocation scheme. But given the complexity of calculating state allocations, all of the organizations agreed the worst outcome would be a hybrid—with some states going it alone, and others insisting on allocation. But that’s exactly what happened, and states have yet to agree on a consistent tax-sharing arrangement.

NIMA was an early attempt. The other allocation effort, promoted by state legislators, is called SLIMPACT, but it hasn’t gotten off the ground (although nine states are poised to allocate under SLIMPACT if they ever get the additional state participation they need for the compact to go effective). Most of the states, however, opted not to join either allocation scheme, deciding instead to keep all surplus lines premium taxes for their home-state insureds.

The NIMA marketing effort is an attempt to increase NIMA’s membership by offering a “no obligation” test period for non-NIMA states, essentially saying “use us for free for one year and we’ll show you how well this clearinghouse works.”

Wood thinks Florida and the other NIMA states are between a rock and a hard place. NIMA will either grow and continue (causing a great deal of confusion and imposing unnecessary costs on brokers), or it will eventually die of its own accord and the NIMA states will go along with the rest of the country—collecting and keeping 100% of surplus lines premium taxes.

Under the Nonadmitted and Reinsurance Reform Act, taxes are distributed based on the applicable rules of the home state of the insured. In most states, 100% of the premium tax is required to be paid to the home state of the insured. But if a transaction is headquartered in a NIMA state, brokers cut a single check but must go through an elaborate, cumbersome and fragmented process of calculating what portion of the premium and the premium tax must be allocated to other jurisdictions.

Says Kelley: “That’s a burdensome, time consuming process,” and brokers are paying the price. “While we are close and getting closer with home state taxation, we don’t yet have the uniform national solution to surplus lines taxation intended by the NRRA as a result of those states [NIMA states] still working toward some level of premium allocation and/or tax sharing.”

The sharing system, in fact, could cost brokers more in administrative expenses than the taxes collected, Kelley says. It amounts to a lot of time, effort and broker money for a miniscule tax reallocation. And Kelley should know. He previously served on the other side of the issue as the longtime CFO of the National Association of Insurance Commissioners.

Kelley and the surplus lines brokers believe the entire tax-sharing flap amounts to much ado about nothing, or nearly nothing, because there isn’t much tax money involved to justify broker administrative costs—including a 0.30% clearinghouse filing fee.

An example by NAPSLO shows an assessment of the top 10 non-NIMA jurisdictions: Texas, California, New York, Georgia, Illinois, non-U.S. (insureds domiciled outside the U.S.), Pennsylvania, North Carolina, Virginia and Ohio. They represent 54% of non-NIMA state premium. The multistate surplus lines premium reported for these states represents just 0.42% of their total 2011 surplus lines premium and appears to result in a paltry $2.8 million in taxes for the first nine months of NIMA’s operations—just 0.24% of total 2011 surplus lines taxes collected nationwide.

This, Kelley says, illustrates the “potential for immaterial reallocation” to these non-NIMA states, even before accounting for any taxes flowing back from those states to NIMA states, making net tax allocations even less.

Moreover, Kelley says, “We believe it is highly unlikely that [Texas, California, New York, Georgia, Illinois and Pennsylvania] would ever agree to join a tax-sharing arrangement. Thus, NIMA is not a viable national solution to the NRRA’s uniform tax requirements.”

“NIMA is not a viable national solution to the NRRA’s uniform tax requirements.”

Surplus lines premium taxes from multistate placements may represent an insignificant portion of total state surplus lines tax budgets. But, Kelley says, they’re a significant burden on the industry in terms of reporting and compliance, costs the policyholder ultimately may see in premium rates.

While the tax problem has been tough, in other ways, NRRA has been beneficial. “Now in the post-NRRA world,” says Kelley, “there is a national framework for the regulation and taxation of the surplus lines industry, representing a dramatic improvement from the multistate tax, licensing and compliance issues that plagued the industry for decades.” Although we have not reached complete uniformity yet, there are, he says, 46 jurisdictions, representing nearly 80% of nationwide premium volume, that retain 100% of the surplus lines premium taxes they collect for multistate risks. 

“The NRRA’s establishment of home state authority has dramatically reduced the frequent conflict-of-law issues that once existed by ensuring that one state, the home state of the insured, governs multistate risks,” says Kelley. Going forward, “home state taxation, where surplus lines taxes are calculated on 100% of the premium and retained 100% by the home state, is the only viable and uniform national solution.”

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