Federal and State Regulation of Nonadmitted Insurance: Something New, Something Old for 2011 Thomas M. Dawson New York

1. Presentation to Houston Marine Seminar September 20, 2010 Federal and State Regulation of Nonadmitted Insurance: Something New, Something Old for 2011Thomas M. DawsonNew York Office

2. Federal Legislative Sea Change For Nonadmitted Insurance • Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) • One title of Dodd-Frank (Title V); one subtitle – “Nonadmitted and Reinsurance Reform Act” (“NRRA”) – one part of one subtitle – six pp in all – out of 850+ pp • These six pages are going to change our world in at least three ways: • Only one state’s law governs nonadmitted insurance placements • States may agree on uniform nationwide premium and tax allocation and reporting • Brokers may export larger commercial lines risks direct to surplus lines insurers without the need for diligent searches

3. Federal Legislative Sea Change For Nonadmitted Insurance • But not every aspect of handling nonadmitted insurance will change • What remains untouched by Dodd-Frank? • Surplus lines: single state risks that are not large commercial accounts • Line of business exemptions – marine, aviation, transportation • Existing “industrial insured exemptions” • Traditional independent procurement and direct placements

4. Surplus Lines: ca. 2010 • What is “surplus lines”? • “Surplus Lines” is a unique mechanism permitting specially-licensed brokers to “export” certain coverages to non-admitted insurers • “Surplus Lines” is a universal exception to state licensing (or “doing business”) laws • Non-admitted = unlicensed = unauthorized • Surplus lines insurers may be “approved” or “eligible” – but they are never admitted/licensed/authorized • Insurers may be domestic or alien • Roughly 50 non-U.S. companies and 70 Lloyd’s Syndicates • Roughly 200 domestic surplus lines insurers

5. Surplus Lines Compliance: ca. 2010 • Officially the responsibility of the surplus lines broker, BUT states will penalize insurers for improper placements– “unauthorized insurance” • Surplus lines broker must be involved in each transaction • Conduct “diligent search” of admitted market • Generally, obtain declinations from at least 3 licensed insurers in state where risk is located • File affidavit of diligent search with Insurance Department • Report transaction and pay premium tax to multiple states • Insurance Departments/stamping offices compare figures to premium statistical reports provided by insurers– to be discussed later

6. Other Exemptions: ca. 2010 • Line of business • Marine, Aviation, Transportation • Some states require licensed broker to be involved and pay premium tax • Diligent search not required, insurer need not be eligible for surplus lines • Exemptions not available in every state • E.g. Marine only available in 43 states– NOT everywhere • Texas affords no “exemptions” other than surplus lines • Definitions of exempt business vary from state to state • E.g. Louisiana’s marine exemption does not apply to off-shore energy risks

7. Other Exemptions cont. • Industrial Insured Placements • Definitions vary, but insured usually must: • Procure insurance through full-time risk manager or retain consultant • Aggregate annual premium for all risks excluding workers compensation and life insurance exceeds $25,000 • Have at least 25 full-time employees • Insurer need not be eligible for surplus lines • Broker need not be involved • Insured must pay premium tax to state • If not paid, insurer can be penalized for unauthorized insurance • Available in about 20 states

8. Other Exemptions cont. • Direct Placements/Independently Procured Insurance • Constitutional right to procure insurance on one’s own behalf • BUT when insurance is transacted in-state, then it can be regulated • If US broker involved in the chain, it is NOT a direct placement • E-mails, telephone calls to insured while insured is in-state could all jeopardize “direct placement” status • Many states have codified this right in their insurance laws • Insured must pay premium tax and report transaction to insurance department

9. Penalties: ca. 2010 • Insurers: “Doing Business” without a license may attract fines up to $10,000 per transaction and/or possible jail sentences up to 20 years in some states. • Brokers: “Aiding and Abetting” insurers in the doing of an insurance business also may attract fines up to $10,000 per transaction (New York’s proposed increase in fines). • Non-monetary penalties include: in Texas, insurers may be stripped of policy defenses; in many states, for brokers, “guarantor” liability attaches---brokers responsible for unpaid claims. • Reputational risk as well as ongoing disclosure in state filings.

10. Surplus Lines Premium Statistical Reporting: ca. 2010 • At present approx. 25 states require “business written” reports with policy level detail of some kind, generally in effort to cross-check against “business placed” reports filed by brokers • Some reports are for unique lines of business (e.g., liquor liability, med mal) • Each state has different forms • Various due dates throughout the calendar year • NAIC Working Group has developed a possible uniform approach (i.e., a single, rather large, excel spreadsheet with a tab for every state’s peculiar surplus lines reporting requirements)

11. Premium Statistical Reporting • Discrepancies between figures reported by insurers and brokers have increased • Brokers reporting placements as independently procured insurance while insurers believe business is being written on a surplus lines basis • More and more states making more serious attempts to reconcile broker and insurer reports (e.g., FL, MS and TX) • Regulatory compliance risk for brokers and insurers has grown as a result

12. Handling Multi-State Risks ca. 2010 • In recent years, brokers have refrained from showing business to surplus lines insurers that are not eligible in all U.S. jurisdictions • Some “problem” states require full surplus lines compliance • This position can be inconsistent with placement in “home state” of insured • Regulatory Compliance Initiative regarding multi-state business • NAIC Working Group has developed a massive “universal” broker reporting form (a 53 tab spreadsheet), but it remains uncertain whether states will adopt it

13. NRRA • Effective date • 12 months after enactment, i.e., July 21, 2011 • Addresses • Surplus lines • Reinsurance continued >

14. NRRA – Background • Surplus lines insurance • 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. continued >

15. NRRA – Background cont. • 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” (those as to which the surplus lines brokers need not first “diligently search” admitted insurers before exporting) • Some states adopted “commercial lines deregulation parity” rules permitting export without the need for brokers to perform and document unsuccessful searches of admitted insurers so long as the client insured qualifies as an “exempt commercial purchaser” continued >

16. NRRA – Background cont. • Every state taxes surplus lines premium – rates vary but average out to 3.5% to 4.0%. For risks with locations or exposures in two or more states life used to be a lot simpler for brokers who frequently filed only in the state where the insured is based • In the old days, pre-Gramm Leach Bliley (ca. 1999), very few states allowed non-residents to become licensed to handle surplus lines business. Today, the good news is that GLBA required states to license non-resident surplus lines brokers. That’s been the bad news for brokers, too. The states have in recent years really stepped up pressure on surplus lines brokers to report, allocate and pay surplus lines tax if part of the risk is resident, located or to be performed in that state even if the placement is principally made in another state. continued >

17. NRRA – Background cont. • But in trying to collect every penny of tax, states also require brokers to use their tax reporting forms and most of these forms require the filer to swear, under penalty of perjury, that the filer complied with that state’s surplus lines law in exporting the risk to the surplus lines market. • These state tax form affirmations have presented real compliance/regulatory enforcement exposure for brokers. They presumably complied with the surplus lines of one state – the insured’s home state – when handling the placement. They searched among licensed insurers in that home state as diligently as required, they provided the insured with that home state’s required disclosures about the surplus lines market, they used surplus lines insurer approved or eligible in the home state, etc., etc. continued >

18. NRRA – Background cont. • But now brokers must comply with transaction rules in all states to which premium tax is being allocated? That’s how the brokers see it and that’s what they have been trying to accomplish during the past several years – post-Spitzer. • So – how does this fit in the NRRA? • The NRRA contains three surplus lines mantras: • Home state authority • Uniform nationwide premium and tax allocation and reporting • Commercial lines free export continued >

19. NRRA – ca. 2011 • Mantra #1: Home State Authority • Placement of nonadmitted insurance subject to statutory/regulatory requirements “solely of the insured’s home state” • For brokers – only the insured’s home state may require a surplus lines broker’s license to “sell, solicit or negotiate” • “Home State” is defined as state in which insured maintains: • Principal place of business or • Principal residence (for individuals) OR • If 100% of insured risk is outside the above, then Home State is the state to which greatest % of premium is allocated continued >

20. NRRA – ca. 2011 • Preemption – “Any law, regulation, provision or action of any state that applies or purports to apply to nonadmitted insurance sold to, solicited by, or negotiated with an insured whose home state is another state shall be preempted with respect to such application.” • This is powerful stuff – note however that workers comp business is carved out from the preemption – states can restrict or prohibit brokers from sending that business to nonadmitted insurers. continued >

21. NRRA – ca. 2011 • Mantra #2: Nationwide system for allocation, reporting and payment of surplus line taxes • Interstate compact or “otherwise” • Limited to “uniform requirements, forms and procedures . . . That provide[ ] for the reporting, payment, collection and allocation of premium taxes for nonadmitted insurance.” • Home state reporting authorization: • Home states can require brokers and buyers to annually file tax allocation reports, showing premium “attributable to properties, risks or exposures located in each state.” • NAIC Executive Committee has formed the Surplus Lines Implementation Task Force. It met for the first time on August 30th. Taxes are Item No. 1 on the Task Force’s agenda. continued >

22. NRRA – ca. 2011 • Mantra #3: Commercial Lines Free Export • Exempt commercial purchasers • No diligent search/automatic export • Broker must disclose that coverage may be available in admitted market “that may provide greater protection with more regulatory oversight” • ECP must subsequently request in writing that broker place coverage with one or more nonadmitted insurers • Who are exempt commercial purchasers? continued >

23. NRRA – ca. 2011 • ECPs must meet following requirements: • Must employ/retain qualified risk manager to negotiate coverage AND • Must 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* • Employs > 500 full-time employees or > 1000 employees 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! continued >

24. NRRA – For Insurers • Uniform insurer eligibility standards • For U.S. based insurers – either • Nationwide uniform requirements, forms and procedures (to be developed) OR • Fallback: Nonadmitted insurance model act • For non-U.S. insurers – no state may “prohibit a surplus lines broker from placing . . . with, or procuring nonadmitted insurance from, a nonadmitted insurer . . . that is listed on the [NAIC’s] Quarterly Listing of Alien Insurers . . . ”

25. NRRA – Implications • For insurers – on the IID list . . . AUTOMATIC NATIONWIDE SURPLUS LINES ELIGIBILITY • For brokers – a national definition for large commercial clients and no diligent search required – home state rules – means surplus lines tax is paid once to buyer’s home state – means that the ONLY surplus lines compliance rules that apply are those in the buyer’s home state • RESULTS? • More business is placed as surplus lines • Less business written in admitted companies • Less business directly placed

26. NRRA – Implications • Are non-U.S. surplus lines start ups (e.g., in Bermuda) competition for captives? – particularly for U.S. buyers with locations/exposures/risk management challenges in all or most U.S. states? • BUT WHAT ABOUT “OLD” WAYS OF PLACING BUSINESS? • Marine exemptions – still available • Aviation exemptions – still available • Transportation exemptions – still available • Industrial insured exemptions – still available • Direct placements/independent procurements – still available

27. NRRA – Implications • WHY WOULD I STILL USE THESE OLD EXEMPTIONS? • Lower premium tax – or none at all • Non-Lloyd’s insurers need not fund liabilities arising from these “exempt policies” (they do need to fund surplus lines policy liabilities)

28. Questions? Thomas M. Dawson Dewey & LeBoeuf LLP 1301 Avenue of the Americas New York NY, 10019 tdawson@dl.com +1 212 259 8011

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