Surplus Lines Analysis: Multistate Clearinghouse Economics Don’t Work

Recent data from Florida indicate that the economics for a multistate surplus lines tax allocation clearinghouse are unworkable. There simply is not enough multistate surplus lines tax to support the cost of a clearinghouse.

This is not new information. (See Much State Regulatory Ado About Little, January 24, 2011, Insurance Journal.)

With the Nonadmitted and Reinsurance Reform Act, (NRRA) effective July 21, 2011, Congress sought to establish a uniform nationwide system of home state taxation and regulation of surplus lines transactions. Surplus lines brokers would remit premium tax to the home state based on 100 percent of the Home State’s tax rate.

In response to state concerns that their premium tax revenues might suffer under home state taxation, Congress offered states the option of creating a mechanism for reallocating premium tax revenues among themselves.

Twelve states (AK, CT, FL, HI, LA, MS, NE, NV, PR, SD, UT and WY) chose to join NIMA (Nonadmitted Insurance Multistate Agreement) to establish a clearinghouse for redistribution of surplus lines premium tax among participating states. The NIMA states selected the Florida Surplus Lines Stamping Office (FLSLSO) to serve as the clearinghouse.

The NIMA clearinghouse was initially intended to be operational in September 2011. That date slipped to November 2011, then to January 2012. The NIMA clearinghouse is now re-estimated to become operational on July 1, 2012, approximately one year after the effective date of the NRRA.

As required by Florida statute, the Florida Office of Insurance Regulation (FLOIR) submitted a report to the Florida Legislature on December 30, 2011, reporting annualized FLSLO multistate premium allocation results for 2011. Per the FLOIR Report, total premium tax collected and reallocated was $2,589,708. Of that grand total, $2,464,153 (95.15%) was allocated to Florida. The eleven other NIMA states collectively received $125,555 (4.85%).

Multistate premium taxes allocated to non-Florida NIMA participants ranged from a high of $40,632 for Louisiana to a low of $230 for Wyoming. These numbers are not in millions of dollars (000’s). Nebraska, which was allocated $11,654 per the FLOIR Report, recently has withdrawn from NIMA. Other NIMA participating states may soon follow.

The FLOIR Report notes estimated clearinghouse start-up costs of $2.8 million and that the clearinghouse will charge the same 0.3% service fee presently charged by the FSLSO.

But the FLOIR Report data reveal only part of the picture. The true economics for NIMA states require consideration of at least three additional factors:

• The FLOIR Report does not reflect the amount of home state premium tax that each NIMA state is required allocate back to the clearinghouse. This means that a NIMA state’s net share of clearinghouse premium tax revenue is less than shown in the FLOIR Report; the net share for some states might even be negative.
• Participating states necessarily must incur costs to monitor and audit their share of premium tax revenues, thereby reducing their net premium tax revenues. Those costs are not reflected in the FLOIR Report.
• The complexity and frequent changes to NIMA allocation formulas likely results in some amount of premium tax not being reported due to inadvertence or otherwise.

Applying a clearinghouse “service fee” of 0.3 percent to the Florida data produces a total annualized service fee of $157,101 – a cost of $31,546 more than the amounts of premium tax allocated to non-Florida NIMA states. If the Florida data are any guide, clearinghouse solutions would appear to be a “lose-lose” proposition for state treasuries.

In the meantime, surplus lines brokers are incurring substantial unnecessary costs to slice and dice multistate premium taxes in anticipation of a clearinghouse. Premium taxes collected in the absence of a clearinghouse are not being banked for future redistribution. These premium taxes will never be shared.

Last and apparently least, the consumer receives no benefit from a multistate tax allocation clearinghouse. The consumer, however, ultimately will bear the systemic costs of a clearinghouse through increased fees, taxes, or other charges.

The multistate clearinghouse approach disserves state treasuries and the consuming public. Under the NRRA there are no frictional costs. 100% of multistate surplus lines premium tax is paid to the Home State at its tax rate.

Given the capital in start-up investment, operating costs and frictional costs associated with a clearinghouse, state treasuries will fare better under home state taxation.

So will consumers.

Brown is an insurance regulatory attorney who has authored previous articles about the NRRA and its implementation, and made presentations on the topic to industry groups. He regularly represents surplus lines brokers, insurers, and industry organizations in a variety of regulatory and other surplus lines matters. Brown can be contacted at RAB@InsuRegulatory.com. Copies of his NRRA articles can be found on his website: www.InsuRegulatory.com.