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Leader's Edge A Barrel of Monkeys

Constant membership shifts at the NAIC can’t make uniformity of action any easier.

By  Scott Sinder and John Fielding

One of the vendor gifts at November’s National Association of Insurance Commissioners meeting was the children’s game “A Barrel of Monkeys.” The goal is to make a chain of plastic monkeys that cling to each other—hanging in the air together. When one falls from the chain, you lose (or start all over again). Could the game serve as a paradigm for the NAIC? The organization of insurance commissioners has historically been challenged to hang together, both in the literal sense (an average commissioner’s tenure is 14 months) and in a figurative sense as a membership unified to take action (which has always had been elusive).

The implementation of uniform surplus lines regulatory reform is emblematic of that challenge. Reform continues to elude the states. As you no doubt are aware, the federal law was intended to simplify the regulatory process by subjecting each surplus lines transaction to only a single set of rules: those of the home state of the insured.

The notion was that a single set of rules, including surplus lines premium tax payment requirements, would accomplish all the protective regulatory goals and in a more economical and streamlined way. Unfortunately, thanks to NAIC members, that vision is yet to be realized.

So far the states have come up with four different tax payment approaches that include two different allocation methods. One allocation method will be followed by the 11 states (and Puerto Rico) that have signed NIMA, and the other method will be followed by the nine states that joined Slimpact.

To confuse things further, neither NIMA nor Slimpact is operational yet. That means their allocation formulas are not yet functional. NIMA, however, might become operational in time for the tax filings for the first quarter of 2012.

The Slimpact allocation formula is preferred by brokers over the NIMA formula because NIMA requires the allocation of all casualty lines. This includes lines for which the broker does not have allocation information. Slimpact takes the more rational approach, requiring allocation of casualty lines only when location information is provided in the underwriting process. Slimpact also uses a more streamlined allocation formula for property coverage.

This NAIC meeting was viewed as an opportunity to bridge the NIMA/Slimpact divide and agree to follow the Slimpact formula (which has been dubbed the “Kentucky Compromise” in honor of its drafter). But at least one NIMA state is holding out, objecting to the Slimpact allocation formula on substantive grounds because they believe that all casualty line premiums should be allocated for tax purposes regardless of how difficult (or impossible) it is for the broker to get the correct allocation information.

More troubling, however, is the growing perception that the substance matters little to some NIMA state regulators who, we believe, are more concerned with causing Slimpact to fail than with creating a fair, workable surplus lines tax allocation mechanism. The attitude of one or two of the NIMA regulators appears to be: “We’re winning, so why should we compromise?”

Frustrations with state regulation—the lack of uniformity across the states, the burden of duplicative regulation and questions about the benefit to consumers of such redundancies—have vexed brokers and their clients for years. Surplus lines reforms gave states an incentive to take advantage of the federal push to improve regulation within the state system. Instead, the NIMA and Slimpact states have shown they are not up to the job. As we have argued on numerous occasions, we still hope the other 34 jurisdictions will continue to follow the prudent path and stay out of the allocation business.

There is another Dodd-Frank development intended to help modernize our archaic state insurance regulatory system: the new Federal Insurance Office. Meeting chatter buzzed about FIO director Michael McRaith’s immediate assumption of the mantle of lead U.S. insurance regulatory voice (via his seat on the International Association of Insurance Supervisors’ Executive Committee). He displaced the NAIC. Although its focus is on international matters, the FIO also is to monitor the state insurance regulatory system.

As part of this function, the office will deliver a report to Congress on the current state of the state insurance regulatory system and recommend ways to modernize and improve the system. The report is due early next year, and McRaith says it will be comprehensive, covering the full breadth of insurance regulatory issues. The FIO is now collecting comments from the public. McRaith has indicated he is very interested in hearing detailed information from all stakeholders, including brokers, about how the regulatory process works and when and where it doesn’t.

Surplus lines regulatory reform is the perfect illustration of an opportunity lost, or at least delayed, by state regulators. The FIO report can benefit from lessons learned from the process—from congressional enactment of surplus lines reform through its state implementation (or lack thereof). As a result, the office may be able to guide future reform efforts.

More immediately, however, the office’s report will present an opportunity to highlight the current state of the reform effort and to pressure states to act quickly to implement reforms, particularly the tax provisions. Another meeting in which little was accomplished—about as much fun as a barrel of monkeys.

Sinder, a partner at Steptoe & Johnson, is CIAB general counsel. ssinder@steptoe.com

Fielding is of counsel at Steptoe & Johnson. jfielding@steptoe.com

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