Surplus Lines Marketin the Shifting Regulatory Sands

Dan BrownSONNENSCHEIN NATH

& ROSENTHAL LLP

Steve StephanNapslo

SURPLUS LINES OVERVIEW

Market for hard to place risks

Operates as a supplemental/secondary market to the admitted market

**REGULATED – IN EVERY STATE**

ROADMAP FOR TODAY’S DISCUSSION

Brief History of Surplus Lines Certain Definitions Insurance Company Eligibility Eligible Risks Size and Nature of the Market Broker Issues Insurer Reporting and Recordkeeping Premium Taxation Limits to Regulation Applicable Federal and State Laws Stamping Offices Snapshot of the Market Future of the Market

HISTORY OF SURPLUS LINES REGULATION

1752 Philadelphia Contributorship 1st P&C Company protects houses from liability due to fire

1890’s Lloyds of London a player in U.S. commercial property risks

1890 N.Y. enacts America’s 1st Surplus Lines Law designed to control not eliminate the market similar to law today with producer regulated few states follow N.Y. lead (notable exceptions IL & MA)

1897 NAIC appoints Unauthorized Insurance Committee charge: to study the “problem of underground insurance”

HISTORY OF SURPLUS LINES REGULATION (cont.)

1900-1960 Misunderstood market and unresolved debate among Regulators NAIC Proceedings about “undesirable” “lawless”

“illegitimate” 1960 U.S. Senate’s Antitrust and Monopoly

Subcommittee Hearings inquiry into alien surplus lines prompts NAIC to act

1962 NAIC adopts Non-Admitted Insurers Information Office reviews financial condition, trust funds and deposits

1970’s-mid-80’s availability/affordability concerns in product and professional liability lines

1982 NAIC adopted the Surplus Lines Model Act some form of the Act in all states

SURPLUS LINES DEFINED

Insurance that the admitted companies (the market) will not write Ebbs and flows with the market

Nonadmitted means not licensed aka unauthorized Not transacting business in the state where the risk is

located/resides Current dispute in California on this point

Critical Supplemental/Secondary Market

INSURER ELIGIBILITY

Must be admitted in at least one state Exception: Illinois

Financial and statutory requirements vary by state

Specialized knowledge and expertise

“White lists”

ELIGIBLE RISKS Mostly commercial Capacity driven Distressed risk driven Focus is on unique, exotic, novel, or unusual

risks Diligent search required (to maintain the

focus) Broker affidavits required (to confirm the

focus) Export lists - export without diligent search

permitted (but still subject to remaining surplus lines laws)

SURPLUS LINES MARKET Nature of surplus lines business makes it difficult to

get an accurate count There is no agreement on what makes up surplus lines

premium What we do know

Surplus Lines business goes by many different names• Domestic, Foreign, Alien, Offshore, Onshore, Independent

Procurement, Direct Procurement• Lloyd’s of London is unique (70 Lloyd’s syndicates per NAIC

Quarterly Listing of Alien Insurers)• A.M. Best reported top 25 Surplus Lines Carriers represented 80%

of the market with a premium volume of $30 billion

ROLE OF THE BROKER

Client eligibility

Insurer selection

Record maintenance

Affidavits

Surplus lines placements filings

Collect and remit taxes and fees

Policyholder disclosure

BROKER LICENSING REQUIREMENTS

Surplus lines licenses - required for brokers to place business

“Courtesy filings” – less common

Independent procurement – the [i] insureds place business [ii] directly with Surplus Lines carrier [iii] from outside the state [iv] without broker involvement

INSURER REPORTING REQUIREMENTS

21 states require reports from insurers

Report format and deadlines vary by state

Data calls – do they apply to surplus lines (nonadmitted) insurers?

• NAIC Medical Malpractice Data Reporting• 2007 CA Wildfire Data Call

STATE REPORTING DUE DATES

AS OF 12/31/07

AL – 3/1 LA – 4/15 NV – 3/1

CO – 3/1 MA – 3/1 NY – 3/15

CT – 3/1, 5/15, 8/15, 11/15

MO – 6/1 OK – 3/1

FL – 3/31, 6/1, 9/30, 12/31

MT – 4/1 RI – 7/31

HI – 3/15 MS – 3/1 SD – 4/1

IA – 4/30 NH – 4/30 TX – 3/31

KS – 5/1 NM – 3/1 VI – 5/30

SUGGESTED BEST PRACTICES FOR INSURERS

Provide policyholder disclosure noticeswith all policies

Track info on surplus lines placements for all states Request at time of binding Update continuously Create reporting database

SAMPLE COMPANY DATABASE

Policy number

Name/address of Insured

Premium – Commission paid

Policy Eff. Date / Exp. Date – Limits

Account producer and contact info

Surplus lines licensee, contact info, license

number

PREMIUM TAX ISSUES

Broker collects taxes – remits to states

Amount of tax varies by state

Multi state exposures present complex tax allocation issues

Various parties seeking to resolve (to be discussed)

LIMITS TO REGULATION U.S. Constitution requires due process

Todd v Shipyards (U.S. Supreme Court - 1962)• tax case• transacting business within vs. outside the state where the

risk is located

Numerous state cases have followed• taxation and regulation• Notable: N.J. established a guarantee fund

Evanston Ins. Co. v Merin (N.J. 1984) challenge failed

APPLICABLE LAWS Federal Liability Risk Retention Act of 1986

specifically allows surplus lines availability to purchase groups

State Laws or Regulations - Do they Apply? Solvency Claims Handling Unfair Trade Practices Fraud Reporting Cancellation Laws Special Assessments Rate and Form Filings

• Essex Insurance Co. v Zota (Florida)

STAMPING OFFICES

Stamping Offices - 15 states (MN added 1/09) Surplus Lines Brokers become members of Surplus

Lines Association

Quasi-regulatory agencies

Financial security review and market conduct of

surplus lines brokers

Collectors of surplus lines taxes

STATES WITH STAMPING OFFICES AS OF 6/15/08

*Source: U.S. Stamping Office Directory

Courtesy of the Surplus Lines Stamping Office of Texas and the Excess Lines Association of New York (ELANY)

COMPOSITION OF THE SURPLUS LINES MARKET

TODAY Alternative Market or Market of Choice* U.S. Surplus Lines Share of Commercial Lines in

2006 was 14.4% vs 85.6% for Admitted Carriers Surplus Lines grew 173% among U.S. domestic

carriers over the past 5 years Far outpacing the total U.S. Property & Casualty

Industry 2001 and 2002 saw a dramatic increase in surplus

lines writings up 35.7% and 61.7% respectively 2007 had a drop of -3.5%

Backbone of Surplus Lines business is experienced underwriting

Nimble and innovative with forms Nimble and flexible with rates

*Source A.M. Best Research 2008 Special Report

SURPLUS LINES OF THE FUTURE

Surplus Lines IndustryWill Remain Strong

IFIt Remains Nimble

Standard Carriers

Self Insured

Risk Retention Groups

Captives

“Wall Street Insurance”

THE MARKETTHE MARKET

SUMMARY

Surplus lines is regulated – brokers and insurers have specific responsibilities

Designed to be a supplemental/secondary market

Maintain complete and accurate records Update records and monitor reporting

requirements continuously Communicate with brokers Complex interplay of state and federal laws

Surplus Lines Regulatory ReformPresented at

AICP New England Chapter May 15, 2009

Norwood, Massachusetts

Steve Stephan

NAPSLO

Steve StephanDirector of Government RelationsNAPSLO200 NE 54th St. #200Kansas City, MO 64118816-741-3910 (direct)steve@NAPSLO.org

WHY ARE NRRA REFORMS SOUGHT?•State Surplus Lines laws never modernized

•GLBA had unintended consequences for nonresident Surplus Lines producer

•Surplus Lines tax system is dysfunctional

•Surplus Lines placement laws could have unintended consequences

•NRRA– “act of congress” means instant nationwide reform

•Other reform efforts failed

1

Multi-state risks equal mission impossible• Single state risk is clear•Multi-state Mono-line property – based upon property values - manageable except for 10 gross premium states•Typical statute – “allocate taxes based upon risk exposures in state” – at state tax rate•Package, excess, umbrella, casualty, E&O, D&O result in best guess•Allocation methodologies could include revenue, payroll, loss history, number of employees, man hours, and other criteria

SURPLUS LINES REFORM HISTORY• MULTI-STATE RISKS CAUSE PROBLEMS

NRRA Pending in the Senate as S 929 since 2007 Passed the House as HR 5637 in 2006 (no Senate action);

Congress adjourned without action Passed the House as HR 1065 in 2007 Senate held hearings summer 2008 – with a favorable review of

surplus lines reforms NAIC testifies in support of NRRA with changes No Commissioners are openly opposing NRRA at this time

2

Gross Premium Statutes Make Compliance Literally Impossible•Ten States have statutes that tax gross premium, but very few follow the statutes – but there are exceptions• If Gross premium paid to the home state, there is nothing left to allocate to the other states• Should surplus lines broker pay gross premium or allocate the taxes – not clear•State insurance departments audit insurers expecting the annual statement to reconcile with broker filings•The two sets of records never reconcile for multi-state risks, but a lot of time is expended by all parties in the reconciliation effort

Reform efforts at NAIC • 1995 SL multi-state tax working (MSTWG) group formed • 1995 NITCH non-admitted tax clearinghouse –abandoned• 1995 NAIC model regulation for allocation of multi-state tax adopted

by NAIC but never gets state support • 2000 MSTWG reconstituted – asks all stated to adopt allocation

laws instead of gross premium laws– abandoned in 2002• 2005 NAIC MSTWG reconstituted again and surplus lines task

force asks industry/regulatory representatives to investigate a multi-state compact to allocate taxes

• 2008 industry representatives complete draft compact, but NAIC SL task force personnel have changed and opt to reconstitute the MSTWG yet again and explore options other than a compact. They subsequently indicated they could investigate a “light” version of a compact.

• MSTWG Group Leader does not want to seek legislative changes.

NRRA REFORMS

•Single-State Tax Remittance

•Single-State Placement Compliance

•Uniform Nationwide Definition of Exempt Commercial Purchaser

•Uniform Nationwide Definition of Insured’s “Home State”

•One Surplus Lines Broker’s License from the “home state” needed for multi-state placement

3

NRRA OTHER PROVISIONS

•States encouraged to join a compact “or other procedure” to divide taxes

•Uniform insurer eligibility

•Participate in NIPR within 2 yr

•GAO study of surplus lines market required

•Applies to independently procured insurance

4

NRRA STATUS

•NAIC reportedly supports core provisions of Surplus Lines portions of the bill

•NAIC seeks change to definition of home state, insurer eligibility, other provisions

•Some regulators want reinsurance title severed – but negotiations continue

•Some want uniform Co. eligibility revised

•Some want stronger provisions to encourage states to divide taxes

5

SLIMPACT

•CREATED BY GROUP OF 60 VOLUNTEERS•MANY REFORMS SIMILAR TO NRRA

Single-state placement compliance One producer license for a multi-state risk Differs from NRRA in that taxes remitted to all states by broker

based upon uniform formula adopted by compact States must select from four optional uniform payment dates States can opt out of placement compliance rules – not tax

allocation rules Optional uniform placement compliance rules

7

SLIMPACT REFORMS

• Formation of a compact commission• Centralized data clearinghouse• Slimpact does not impact company licensing• Definition of home state differs• 4 optional tax payment dates• Mandatory rules for tax formula, data• Surplus Lines policy in home state is deemed

Surplus Lines in all compacting states

8

SLIMPACT OPTIONAL RULES

•COMMISSION CAN ADOPT OPTIONAL RULES (SUBJECT TO OPT-OUT) FOR:

Diligent search Banking, bond, record keeping Policyholder notice Transaction documentation One tax rate for all non-admitted insurance Preempts inconsistent state laws

9

CHANCES OF SUCCESS

•My view – NRRA good chance

•If NRRA joined with other bills such as NARAB, OII, NICPA, Systemic Regulator?

•SLIMPACT – better chance if NRRA encourages states to join

•SLIMPACT stand-alone – more difficult

•SLIMPACT would need largest Surplus Lines states to take initiative

10

QUESTIONS

Steve StephanDirector of Government RelationsNAPSLO200 NE 54th St. #200Kansas City, MO 64118816-741-3910 (direct)steve@NAPSLO.org

This concludes our presentation.

Thank you!

Dan BrownSONNENSCHEIN NATH &

ROSENTHAL LLP

Steve StephanNapslo