Surplus Lines Market
in the Shifting Regulatory Sands
Dan Brown
SONNENSCHEIN NATH
& ROSENTHAL LLP
Steve Stephan
Napslo
SURPLUS LINES OVERVIEW
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Market for hard to place risks
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Operates as a supplemental/secondary
market to the admitted market
**REGULATED – IN EVERY STATE**
ROADMAP FOR TODAY’S
DISCUSSION
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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
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1752 Philadelphia Contributorship 1st P&C Company
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1890’s Lloyds of London a player in U.S. commercial
property risks
1890 N.Y. enacts America’s 1st Surplus Lines Law
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protects houses from liability due to fire
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
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charge: to study the “problem of underground insurance”
HISTORY OF SURPLUS LINES
REGULATION (cont.)
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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
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Insurance that the admitted companies (the
market) will not write
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Nonadmitted means not licensed aka
unauthorized
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Ebbs and flows with the market
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
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Must be admitted in at least one state
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Exception: Illinois
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Financial and statutory requirements
vary by state
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Specialized knowledge and expertise
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“White lists”
ELIGIBLE RISKS
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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
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Nature of surplus lines business makes it difficult to
get an accurate count
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There is no agreement on what makes up surplus lines
premium
What we do know
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Surplus Lines business goes by many different names
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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
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Client eligibility
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Insurer selection
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Surplus lines
placements filings
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Collect and remit
taxes and fees
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Policyholder
disclosure
Record
maintenance
Affidavits
BROKER LICENSING
REQUIREMENTS
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Surplus lines licenses - required for brokers
to place business
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“Courtesy filings” – less common
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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
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21 states require reports from insurers
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Report format and deadlines vary by state
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Data calls – do they apply to surplus lines
(nonadmitted) insurers?
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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
FL – 3/31, 6/1,
9/30, 12/31
HI – 3/15
MO – 6/1
OK – 3/1
MT – 4/1
RI – 7/31
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
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Provide policyholder disclosure notices
with all policies
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Track info on surplus lines placements for all
states
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Request at time of binding
Update continuously
Create reporting database
SAMPLE COMPANY DATABASE
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Policy number
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Name/address of Insured
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Premium – Commission paid
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Policy Eff. Date / Exp. Date – Limits
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Account producer and contact info
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Surplus lines licensee, contact info, license
number
PREMIUM TAX ISSUES
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Broker collects taxes – remits to states
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Amount of tax varies by state
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Multi state exposures present complex tax
allocation issues
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Various parties seeking to resolve (to be discussed)
LIMITS TO REGULATION
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U.S. Constitution requires due process
 Todd v Shipyards (U.S. Supreme Court - 1962)
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tax case
transacting business within vs. outside the state where the
risk is located
Numerous state cases have followed
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taxation and regulation
Notable: N.J. established a guarantee fund
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Evanston Ins. Co. v Merin (N.J. 1984) challenge failed
APPLICABLE LAWS
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Federal Liability Risk Retention Act of 1986
specifically allows surplus lines availability to
purchase groups
State Laws or Regulations - Do they Apply?
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Solvency
Claims Handling
Unfair Trade Practices
Fraud Reporting
Cancellation Laws
Special Assessments
Rate and Form Filings
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Essex Insurance Co. v Zota (Florida)
STAMPING OFFICES
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Stamping Offices - 15 states (MN added 1/09)
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Surplus Lines Brokers become members of Surplus
Lines Association
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Quasi-regulatory agencies
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Financial security review and market conduct of
surplus lines brokers
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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
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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
THE MARKET
Self Insured
Risk Retention Groups
Standard
Carriers
Captives
“Wall Street Insurance”
Surplus Lines Industry
Will Remain Strong
IF
It Remains Nimble
SUMMARY
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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 Reform
Presented at
AICP New England Chapter
May 15, 2009
Norwood, Massachusetts
Steve Stephan
NAPSLO
Steve Stephan
Director of Government Relations
NAPSLO
200 NE 54th St. #200
Kansas City, MO 64118
816-741-3910 (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
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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 multistate 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
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SLIMPACT REFORMS
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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
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SLIMPACT OPTIONAL RULES
•COMMISSION CAN ADOPT OPTIONAL RULES
(SUBJECT TO OPT-OUT) FOR:
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Diligent search
Banking, bond, record keeping
Policyholder notice
Transaction documentation
One tax rate for all non-admitted insurance
Preempts inconsistent state laws
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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 Stephan
Director of Government Relations
NAPSLO
200 NE 54th St. #200
Kansas City, MO 64118
816-741-3910 (direct)
steve@NAPSLO.org
This concludes our presentation.
Thank you!
Dan Brown
SONNENSCHEIN NATH &
ROSENTHAL LLP
Steve Stephan
Napslo