Multi-state tax issue promises to be  resolved in HR 1065 legislation

Federal Issues
by Steve Stephan

The U.S. House of Representatives is currently reviewing HR 1065, a version of The Non-admitted Insurance and Reinsurance Reform Act of 2007.  The following is a condensed version of the HR 1065 FAQ posted on NAPSLO's website. Some common questions regarding the bill are answered below. 

Why is HR 1065 needed? 
The surplus lines brokers have faced multi-state tax problems for years, and in recent years the multi-state compliance problems have become progressively worse. It is not feasible, for example, to conduct a diligent search, file affidavits, maintain bank accounts and maintain placement records in numerous states. 

With respect to taxes, the state laws are sometimes conflicting in that some states claim 100% of the surplus lines tax is due if they are considered to be the Òhome state.Ó Then there would be nothing left to allocate to the other states.

The tax allocation laws are also inconsistent and overly simplistic so the broker is left to make a series of judgment calls when allocating the taxes. Many states have been auditing the companies to try to reconcile "Schedule T" to the broker filings. The result has been an inordinate waste of time for all involved. 

How does it solve the multi-state tax and compliance problems? 
HR 1065 mandates single-state tax payment in the home state of the insured. The states are encouraged to allocate the taxes pursuant to an interstate compact or other procedure. 

HR 1065 mandates single-state compliance with the laws of the home state of the insured.

What other compliance reforms are  contained in HR 1065? 
HR 1065 contains uniform company eligibility criteria, based upon the NAIC's non-admitted model act, and uniform exemption from diligent search requirements for exempt commercial purchasers. HR 1065 also encourages states to enter into a national producer data base for licensing surplus lines brokers. 

If HR 1065 is enacted, will the tax revenues of the states decline? 
As a whole it is unlikely that tax revenues would decline. Under HR 1065 taxes would be due the home state instead of allocated among the states, but the tax would still be paid. Tax revenues could easily increase because it will be easier to calculate and remit the taxes to a single state. In addition, paying a surplus lines tax in one state eliminates the situation where the insured deems the placement to be surplus lines insurance in the home state and independently procured insurance in the other states. 

What is the definition of home state? 
The definition of home state in HR 1065 is the principal place of business for commercial insurance, or for an individual, the principal residence. 

Most of the time the principal place of business and the principal residence are clear. When it isn't clear which state is considered the principal place of business, the federal court interpretations of the terms provide guidance. 

For example, most federal courts would use what is known as the 'total activity test' to determine the principal place of business of an insured entity.  

Neither the insured nor the broker can simply select a state to be the home state based on a lower tax rate. Note that selecting the wrong state to obtain a lower tax rate could have serious consequences, because if another state is legally considered to be the home state, the broker could be required to pay in both states. 

If HR 1065 is passed, will consumer protections remain adequate? 
Yes. Under HR 1065 the statutory and regulatory requirements of the home state of the insured would apply to a multi-state surplus lines placement. There is no reason to think the consumer protections of the home state would be inadequate. State-based insurance regulation routinely relies on one state to assume primary regulatory responsibility for an issue. 

Will the company eligibility requirements  provide adequate consumer protections? 
Yes. HR. 1065 does not limit the evaluation that is required by statute to be performed by the domiciliary state of the surplus lines insurer. There is also a thorough evaluation performed by the rating agencies.  International insurers are evaluated by the NAIC.  In addition,  a state or stamping office may elect  to publish financial evaluations or lists of recommended surplus lines companies. 

Is a voluntary compact an alternative solution to HR 1065? 
No, because it is extremely difficult to get a compact (or model law) passed in enough states to provide regulatory relief. The non-admitted model act has been around for years and has had little acceptance. HR 1065 is viewed as the best chance for uniformity and regulatory reform.