Surplus lines brokers will no longer fight with 52 different regulators to achieve some sanity with regulation. Now they can deal with a single state regulator.

By  Scott Sinder and John Fielding

Signing the massive financial services regulatory reform legislation into law in July near Independence Day wais appropriate since the new law includes surplus lines regulatory reform, which is something The Council has pursued for a long time.

Starting in July 2011, surplus lines transactions will be freed. They will be governed solely by the rules of the insured’s home state, and all premium taxes arising out of the placement of a surplus lines policy will be paid only to the insured’s home state, following that state’s requirements.

Policyholders are likely to see an influx of new surplus lines products because the Holy Grail for property-casualty carriers has been deregulation of policy rates and forms. But in the surplus lines market, that reality already exists. The new deregulated surplus lines market changes compliance requirements in five fundamental ways:

Premium taxes: The home state of the insured will now have sole regulatory authority over the collection and allocation of surplus lines premium taxes. “Home state” is defined as the state where an insured maintains its principal place of business or its principal residence. If, however, no part of the insured risk is located in that state, then the home state will be the one where the greatest percentage of the insured’s taxable premium is located.

The new law prohibits any state (other than the insured’s home state) from requiring any premium-tax payment for surplus lines insurance. This means that surplus lines brokers will submit a single premium-tax payment on a surplus lines transaction to the insured’s home state. There will be no more separate payments to each state where a covered risk exists.

The new law leaves it to the states to determine allocation of surplus lines premium tax payments among themselves. Brokers likely will still have to provide the home state with documentation regarding allocation by state of the risks covered by a transaction so the states can then determine how to allocate the premium tax.

Single-state compliance: The single-state compliance regime applies to the full panoply of surplus lines placement requirements: obtaining declinations from the admitted market before placing a policy in the non-admitted market; placing surplus lines coverage only with insurers that meet the state’s eligibility requirements, filing submissions, etc.

Insurer eligibility: The financial criteria that states use to determine the eligibility of surplus lines insurers varies by state, but under the new law, eligibility requirements will be uniform across the country. The law requires that all standards conform to the National Association of Insurance Commissioners’ Non-Admitted Insurance Model Act or a compact or other agreement among the states that supersedes that model act. States must also permit placement of surplus lines coverage with non-admitted insurers domiciled outside the U.S. that are listed on the NAIC’s Quarterly Listing of Alien Insurers.

Commercial purchaser exemption: The new law establishes a single definition of an “exempt commercial purchaser” and a single exemption standard for all states. Under that provision, no diligent search in the admitted market is required (therefore, a broker can go directly to the surplus lines market) to place a policy for an exempt commercial purchaser, if:

• The broker has disclosed to the exempt commercial purchaser that coverage may be available from the admitted market, which may provide greater protection with more regulatory oversight, and
• The exempt commercial purchaser has requested in writing that the broker procure or place the coverage with a surplus lines insurer.

An “exempt commercial purchaser” is a purchaser of commercial insurance that:

• Employs or retains a qualified risk manager (also defined in the bill) to negotiate insurance coverage;
• Has paid aggregate nationwide commercial property and casualty insurance premiums in excess of $100,000 in the preceding 12 months; and
• Meets at least one of the following criteria: possesses a net worth in excess of $20 million; generates annual revenues in excess of $50 million; employs more than 500 full-time employees or is a member of an affiliated group employing more than 1,000 employees; is a not-for-profit organization or public entity generating annual budgeted expenditures of at least $30 million; or is a municipality with a population of more than 50,000.

Surplus lines broker licensing: The federal law prohibits any state except the insured’s home state from requiring the insured’s surplus lines broker to be licensed to sell, solicit or negotiate coverage. Beginning in July 2012, the new law will prohibit a state from collecting broker and brokerage licensing fees unless the state participates in the NAIC’s national insurance producer licensing database. This provides an incentive for states to utilize the NAIC’s uniform producer licensing applications and to license surplus lines brokers through the National Insurance Producer Registry.

Free at last. Happy belated Independence Day!

Sinder, a partner at Steptoe & Johnson, is CIAB General Counsel. Fielding is of counsel at Steptoe & Johnson.