Surplus Lines Reforms: What You Need to Know About the New Federal Law

1. Surplus Lines Reforms:What You Need to Know About the NewFederal Law August 19, 2010

2. Surplus Lines ReformsPanelists • Steve Stephan • NAPSLO • Michael Byrne • Dewey & LeBoeuf • Dan Maher • Excess Line Association of New York • Libby Baney • B & D Consulting/ Baker & Daniels LLP

3. Webinar Participation Options • Dial-in (audio only) - use phone number on confirmation • Audio & presentations - use GoToMeeting link on confirmation e-mail • Audio, presentations, & videostream - Click on NRRA webinar photo on NAPSLO’s website home page - www.napslo.org • Submit questions during presentation using Question Tool on GotoWebinar or send to mike@napslo.org

4. Impact of the NonAdmitted & Reinsurance Reform Act on BrokersSteve Stephan, JD, CPCU, ASLI • Uniform Forms & Procedures • Home State Definition • Principal Place of Business/Residence • Unique Situations & Tax Payments

5. NRRA Changes Effective July 21, 2011 • Home-state tax payment • Home-state placement regulatory compliance • Uniform nationwide definition of exempt commercial purchaser/qualified risk manager • One SL producer’s license to write a multi state risk • National producer registry for surplus lines • Uniform tax forms - Congress intends • Annual tax allocation form

6. Uniform Forms and Procedures • NRRA – congress intends . . . States adopt nationwide uniform requirements, forms and procedures, such as an interstate compact, for the reporting, payment, collection and allocation of premium taxes • What state can require annual tax allocation reports? • Will states allow other states access to allocation data? • How will they allocate taxes and what allocation formula? • Can states collect their tax rate on multi-state exposures? • Can state collect its share of Assessments? • Is broker forum shopping going to be a problem? • What if states disagree over which is home state? • Will states need to change their codes to reflect NRRA?

7. Home State = Principal Place of Business • Much debated issue 2006-2010 • Controversy in Compact and NRRA • No definition was found to be perfect • Determines who gets to collect tax $$ • Does it matter which is home state if Compact enacted? • Courts were split over definition until 2010

8. Hertz v. Friend • U.S. S. Ct. Feb. 23, 2010 opinion on the definition of “principal place of business” • 48% of business in CA; headquarters in NJ so NJ is “principal place of business” • Uses the “nerve center” test • Nerve Center means where High level officers direct, control and coordinate corporate activities • Will it be applied to NRRA? • Acknowledges no definition is perfect • As much clarity as we can get without litigation

9. Home State of Individual = “Principal Residence” • Home state - “in the case of an individual, the individual’s principal residence” • Probably means personal lines insurance instead of sole proprietor, but could be clearer • “Principal residence” used in bankruptcy code and tax code; litigated many times • Principal means “chief or main” and residence means “place where one lives or has his home” • Courts look at tax records, voting records, drivers license, physical occupancy

10. What if 100% of risk is outside of home state? • If 100% of insured risk out of the home state – the state to which the greatest percentage of the insured’s taxable premium for that insurance contract is allocated • i.e. Florida condo owned by New York snow bird • If any premium is allocated to the home state then it remains the home state • If 100% of insured risk is out of home state, then determine which state has largest percentage of taxable premium for that contract is allocated

11. What if affiliates are insured under a single policy? • If affiliates are insured under a single policy home state means the home state of “member of the affiliated group that has the largest percentage of premium attributed to it.” • Affiliate means an entity that controls or is controlled by or under common control with insured • Control means an entity owns 25 % of voting securities or controls the election of the majority of directors or trustees

12. Impact of the NRRA on CarriersMichael Byrne, Dewey & LeBoeuf • Insurer Eligibility • Exempt Commercial Purchasers

13. Insurer Eligibility and ECPs • The NRRA changes rules both for insurer eligibility and for surplus lines transactions • Backdrop: Currently, states directly regulate insurers to which surplus lines brokers may “export” surplus lines risks. For non-U.S. insurers, the level of state regulation varies significantly from states with no regulation (“broker responsible” states), to minimal regulation (states that automatically accept non-U.S. insurers appearing on the NAIC/IID’s Quarterly Listing), to states that require insurers to file significant financial and business disclosures initially and each year thereafter

14. Insurer Eligibility and ECPs • States also directly regulate the terms and conditions governing the export of surplus lines risks. For example: • Some states have very tough diligent search and other restrictions on the export of surplus lines risks • Other states have lengthy lists of “exportable risks” (for which the surplus lines brokers need not first “diligently search” admitted insurers before exporting) • Some states have adopted exemptions for large commercial policyholders (sometimes referred to as “commercial lines deregulation parity”), permitting export without the need for brokers to perform and document unsuccessful searches of admitted insurers so long as the client insured qualifies under the state-specific criteria

15. Insurer Eligibility • Uniform insurer eligibility standards: • NRRA Section 524: A State may not-- • impose eligibility requirements on, or otherwise establish eligibility criteria for, nonadmitted insurers domiciled in a United States jurisdiction, except in conformance with such requirements and criteria in sections 5A(2) and 5C(2)(a) of the [NAIC] Non-Admitted Insurance Model Act, unless the State has adopted nationwide uniform requirements, forms, and procedures developed in accordance with section 521(b) of this subtitle [regarding premium taxes] that include alternative nationwide uniform eligibility requirements; or • prohibit a surplus lines broker from placing nonadmitted insurance with, or procuring nonadmitted insurance from, a nonadmitted insurer domiciled outside the United States that is listed on the Quarterly Listing of Alien Insurers maintained by the International Insurers Department of the NAIC.

16. Insurer Eligibility • Uniform insurer eligibility standards - U.S. based insurers • NAIC Model Act: • Section 5A(2) – “Each insurer is authorized to write the type of insurance in its domiciliary jurisdiction” • Section 5C(2)(a) – “Has capital and surplus or its equivalent under the laws of its domiciliary jurisdiction which equals the greater of: (i)(I) The minimum capital and surplus requirements under the law of this state; or (II)$15,000,000 ….” • The minimum capital and surplus requirements can be waived by the commissioner based on quality of management, capital and surplus of any parent company, market availability or other factors, provided the insurer has capital and surplus of at least $4,500,000.

17. Insurer Eligibility • U.S. based insurers • NAIC Nonadmitted Insurance Model Act – Sections 5A(2) and 5C(2)(a) UNLESS • The states develop nationwide uniform requirements, forms and procedures • Query: What about the other requirements that may currently apply from state to state - e.g., biographical affidavits, seasoning, business plans, trust funds, in-state deposits, etc., that are not incorporated by the NRRA via the NAIC Model Act?

18. Insurer Eligibility • Non-U.S. insurers • No state may prohibit a surplus lines broker from placing insurance with a nonadmitted insurer that is listed on the NAIC’s Quarterly Listing of Alien Insurers. • Query: We know what the NAIC/IID’s initial application and annual requalification standards and requirements are today … How might they change? • Query: Are states preempted (i.e., prevented) from requiring nonadmitted insurers to submit periodic financial and business (e.g., premium) reports?

19. Exempt Commercial Purchasers • In addition to Home State exclusive regulatory authority, a nationwide system for allocation, reporting and payment of surplus line taxes, and uniform insurer eligibility standards, the other change to the regulation of surplus lines insurance by the NRRA is commercial lines free export for “exempt commercial purchasers” (“ECPs”) • NRRA provides that for placements for an ECP: • No diligent search is required (i.e., there is automatic export), provided: • Surplus lines broker must disclose that coverage may be available in the admitted market “that may provide greater protection with more regulatory oversight” AND • ECP must subsequently request in writing that the broker place coverage with the nonadmitted insurer(s) • Query: What if an insured doesn’t qualify as an ECP – can brokers continue to use existing state-specific surplus lines procedures and other exemptions?

20. What is an ECP? • ECPs must meet the following requirements: • Employ/retain a qualified risk manager to negotiate coverage AND • Pay “aggregate nationwide commercial [P&C] premiums” > $100,000** in preceding 12 months AND • Must satisfy one of following: • Net worth > $20 million* • Annual revenues > $50 million* • Full-time employees > 500 or > 1,000 in a group • Annual budgeted expenditures of > $30 million* (if a nonprofit or public entity) • Population > 50,000 persons (if a municipality) • * Numbers to be adjusted for inflation every five years • ** Number NOT adjusted for inflation!

21. Thank You Michael Byrne Partner Dewey & LeBoeuf LLP 1301 Avenue of the Americas New York, NY 10019 Direct: 212 259 8440 Fax: 212 649 0483 mbyrne@dl.com

22. Surplus Lines Insurance Multi-State Compliance Compact (SLIMPACT) Dan Maher, Excess Lines Association of New York • What is an interstate compact & its purpose • The creation of a compact • SLIMPACT & its goals • Adoption of SLIMPACT • The Commission • The impact of failing to adopt SLIMPACT

23. NonAdmitted & Reinsurance Reform Act • The NRRA which was signed into law on July 21, 2010 empowers the states to create an equitable uniform method by interstate compact or other procedure to allocate and share taxes on multistate surplus lines risks.

24. What is an Interstate Compact? • An interstate compact is a contract between two or more states creating an agreement on a particular policy issue, adopting a certain standard or cooperating on regional or national matters. • Interstate compacts represent an opportunity for multistate cooperation, reinforcing state sovereignty and avoiding federal intervention. • Compacts enable states to act jointly and collectively, generally outside the confines of the federal legislative or regulatory process while respecting the view of Congress on the appropriateness of joint action.

25. Purpose of a Compact • Establish a formal, legal relationship among states to address common problems or promote a common agenda. • Establish uniform guidelines, standards, or procedures for compact member states. • Respond to national priorities in consultation with the federal government. • Retain state sovereignty in matters traditionally reserved for the states. • Create economies of scale to reduce administrative and other costs.

26. Creation of a Compact • Compacts are created when an offer is made by one state, usually by statute that adopts the terms of a compact requiring approval by one or more other states to become effective. Other states accept the offer by adopting identical compact language. • Once the required number of states has adopted the pact, the “contract” among them is valid and becomes effective as provided.

27. Drafting of SLIMPACT • ELANY, NAPSLO, state stamping offices and other organizations drafted an interstate compact (SLIMPACT), so that an electronic state-of-the-art system for the brokers could be delivered, while guaranteeing states a fair share of tax revenues on multi-state E&S risks. • SLIMPACT will be funded by a charge on each policy and therefore cost the states nothing.

28. SLIMPACT’S Goals • Pursuant to the requirements of the NRRA SLIMPACT is designed to create a transparent, efficient system via a clearinghouse which provides one stop shopping where surplus lines brokers can calculate and allocate taxes for each state. • For the states, each state will receive data and taxes even when the risk is home-stated in another state. The allocations will be based on fair, objective, uniform allocation formulas and each state will apply its own particular tax rate to the portion of risk allocated to it.

29. Adoption of SLIMPACT • Every state which adopts SLIMPACT will have an equal vote on the commission which designs, implements and overseas the clearinghouse and its operations. • States that do not want to participate by adopting an interstate compact, may contract with the clearinghouse as a nonvoting associate member to share data, services and receive taxes.

30. Purpose of Commission The commission will: • create a clearinghouse and electronic reporting system for receiving, storing and reporting tax allocation data; • provide one countrywide portal where brokers can go to create a tax billing sheet for each multi-state insured and use the same data to enable the correct share of taxes to be reported and paid to each state; • adopt uniform tax allocation formulae across all states, so fair allocation is assured to the states, and a uniform approach will ease the burdens on brokers; • adopt four, uniform tax payment dates. States can elect to use any one, two or all four dates for tax remittance; • permit each state to charge its own tax rate to any risk allocated to that state; and • charge a fee on a per transaction basis for operating the clearinghouse at no cost to the states.

31. Failure to Adopt SLIMPACT • The NRRA goes into effect with certain exceptions, one year from enactment or July 21, 2011. If the states take no steps to address tax allocation in that time frame, states stand to lose more than millions of dollars in tax revenues. • Lack of state action or response to the NRRA will invite further intervention on the federal level whether that intervention is undertaken by the newly created Federal Insurance Office or by Congress in the form of OFC legislation or mandatory federal insurance regulation.

32. Conclusion • There is no time left to study and defer consideration of SLIMPACT. SLIMPACT is the only viable, readily available solution which has any reasonable chance of passage and adoption by a sufficient number of states to address the NRRA provisions in the time provided.

33. A Washington Perspective on the NRRALibby Baney, J.D. - B&D Consulting / Baker & Daniels LLP • How the NRRA became Federal law • Congressional expectations for the NRRA • FIO and Federal studies of insurance

34. How the NRRA became Federal Law

35. How the NRRA became Federal LawRecipe for Success • The right policy, the right time • NAIC had failed to resolve the problem • Congress was seeking solutions based in efficiency, modernization and consumer benefit • 2. Active advocacy • The Surplus Lines & Reinsurance Coalition represented an industry united in support • Legislative Days in Washington D.C. to show constituent interest • 3. Strong D.C. representation • Members of Congress and staff were well-informed about the problem and saw policy and political reasons to help • Advocates responded to opposition or confusion

36. Congressional Expectations for the NRRA • Brokers remit all premium taxes to the “home state” of the insured • States adopt nationwide uniform requirements, forms and procedures • “Such as an interstate compact”

37. Congressional Expectations for the NRRA Statement in the Congressional Record by Rep. Dennis Moore (D-KS), sponsor of the NRRAJuly 22, 2010 “Section 521(a) of the Dodd-Frank Act is intended to require the broker to pay or remit all tax in a surplus lines transaction to the ‘‘Home State’’ of the insured as defined in the Act and to no other state or political subdivision of any state. If other states are to receive a portion of the tax payment, the Act provides that the states may enter into a compact or otherwise establish procedures to allocate among the states the premium taxes paid to an insured’s ‘‘Home State.’’ Further, it is the intention that as a result of this Act, each State adopt nationwide uniform requirements, forms, and procedures—such as an interstate compact—that provides for the reporting, payment, collection, and allocation of all premium taxes for surplus lines insurance as well as all nonadmitted insurance in the insured’s ‘‘home state’’. Uniformity in the taxation of surplus lines and nonadmitted Insurance will be of great benefit to insurance consumers, brokers and the states. In addition, under Section 522(a) of the Dodd-Frank Act, the placement of all nonadmitted insurance, including surplus lines insurance, shall be subject solely to the statutory and regulatory requirements imposed directly by the insured’s ‘‘Home State’’ and no other state. It is the intention that surplus lines and nonadmitted insurance transactions, particularly when the insurance covers risks in more than one state, be within the sole province of the insured’s ‘‘Home State.’’ “

38. FIO and Federal Studies of Insurance • The Federal Insurance Office, Title V of the Dodd-Frank Act • Charged with studying the insurance industry and reporting yearly to Congress on recommendations concerning Federal regulation of insurance; • May subpoena data and information from insurers after coordination with state and federal regulators; • Authorizes the Treasury Secretary and the United States Trade Representative to negotiate international insurance agreements. • Studies of Insurance • GAO will study of the nonadmitted insurance market to determine the effect the NRRA has on the size and market share of the surplus lines market for providing coverage typically provided by the admitted insurance market (due January 21, 2013) • FIO will study how to modernize and improve the system of insurance regulation in the U.S., including examination of potential Federal regulation of insurance (due by January 21, 2012); • FIO will also study the global reinsurance market and the role the market plays in supporting US insurance (due September 30, 2012), and other reinsurance issues.

39. Thank You • Libby Baney, J.D. • B&D Consulting / Baker & Daniels LLP • Libby.baney@bakerd.com • Phone: 202-312-7434 • B&D Consulting is a national advisory and advocacy firm based in Washington, D.C. and is a division of Baker & Daniels LLP, an international law firm with offices in Indiana, Chicago, Washington, D.C. • The firm’s Insurance & Financial Services team advises clients on: • Federal and state legislation and regulations, • Entity formation issues, • Holding company transactions, • Insurance company transactions, • Regulatory and business activities, and • Captive insurance programs.

40. Questions & Answers Use Question Tool on GotoWebinar or e-mail mike@napslo.org

41. Surplus Lines Reforms:What You Need to Know About the NewFederal Law August 19, 2010 www.napslo.org