Federal Regulation of Reinsurance, Surplus Lines and
Producer Licensing May Have a Clear Path to Passage

Written By Attorneys Francine L. Semaya and William K. Broudy

Note: This article is an interpretation of current law and is offered for informational purposes only. This material is not legal advice and should not be construed or used as a substitute for the advice of an attorney.

As reported in our June 18, 2009 article, Read article the Obama Administration's broad proposal for reforming and expanding federal regulation of financial institutions includes limited recommendations for federal regulation of insurance. Congressional hearings held to date have included testimony from the insurance industry, but the timing of any future action by the House and Senate is uncertain.

The U. S. Treasury Department has proposed the creation of the Consumer Financial Protection Agency ("CFPA") and has submitted a lengthy Consumer Financial Protection Agency Act of 2009 to Congress. Under Section 1021(a) of the Act, the CFPA mandate is "to promote transparency, simplicity, fairness, accountability, and access in the market for consumer financial products or services." The Act expressly exempts the business of insurance (with limited exceptions) from the term "financial activity" as follows:

...except that the Agency shall not define engaging in the business of insurance as a financial activity (other than with respect to credit insurance, mortgage insurance, or title insurance...)

The exemption of the business of insurance from CFPA coverage is another signal from the Obama Administration that it intends to leave most of the regulation of insurance to the states, including consumer protection.

Bills pending in the U.S. House of Representatives, however, one for federal regulation of surplus lines insurance and reinsurance and the other for federal regulation of producer licensing, have been under review since the last Congress and stand a good chance of passage now that House leadership has waived committee action. Both bills had been passed by the full House in September, 2008.

Proposed Federal Regulation of Surplus Lines and Reinsurance

The Non-Admitted and Reinsurance Reform Act of 2009, H.R. 2571, S. 1363, brings federal regulation to surplus lines insurance and reinsurance. A key part of H.R. 2571, set forth in Section 101, gives an insured's home State exclusive authority to collect premium tax for nonadmitted insurance. Section 107, Definitions, provides that a "home State" is "the State in which an insured maintains its principal place of business, or, in the case of an individual, the individual's principal residence". Also, if one hundred percent of the insured risk is located outside the insured's home State, the State to which the greatest percentage of the insured's taxable premium for the insurance contract is allocated collects the premium tax.

Section 101 also provides that the States may enter in a compact or otherwise establish procedures to allocate among the States the premium taxes paid to an insured's home State. To that end, Section 101(B)(4) states that:

The Congress intends that each State adopt nationwide uniform requirements, forms, and procedures, such as an interstate compact, that provides for the reporting, payment, collection, and allocation of premium taxes for nonadmitted insurance consistent with this section.

It may be an exercise in wishful thinking to expect the States to adopt nationwide uniform requirements concerning premium tax. Section 102 of H.R. 2571 straddles the state-federal regulatory dividing line by declaring that "Except as otherwise provided in this section, the placement of nonadmitted insurance shall be subject to the statutory and regulatory requirements solely of the insured's home State." That Section provides in part as follows:

Broker Licensing. - No state other than an insured's home State may require a surplus lines broker to be licensed in order to sell, solicit, or negotiate non-admitted insurance with respect to such insured.

Enforcement Provision. - ...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.

The purpose of these provisions is to limit state regulation of the nonadmitted market to the home state of the insured. Among other aspect of H.R. 2571 are:

● A requirement that, as a condition for collecting licensing fees, a State enact laws or regulations that provide for participation by the State in a National Association of Insurance Commissioners ("NAIC") insurance producer database for surplus lines brokers.

● A requirement that eligibility requirements for nonadmitted insurers domiciled in a U.S. jurisdiction conform to the NAIC Non-Admitted Insurance Model Act.

● A State is not permitted to prevent a surplus lines broker from placing nonadmitted insurance with a non-U.S. nonadmitted insurer that is listed on the NAIC's Quarterly Listing of Alien Insurers.

H.R. 2571 creates the concept of an "exempt commercial purchaser", defined as an entity that employs a risk manager and meets various specified requirements for annual premium paid for commercial property/casualty insurance, net worth and number of employees. Under Section 105, a surplus lines broker seeking to obtain nonadmitted insurance for an exempt commercial purchaser is not required to comply with state laws requiring a due diligence search for the full amount or type of insurance from admitted carriers if the broker discloses to the exempt commercial purchaser that the insurance may or may not be available from the admitted market. After disclosure by the broker, the exempt commercial purchaser will be required to advise the broker in writing that the broker may proceed to procure the insurance from a nonadmitted insurer.

This procedure gives larger commercial insureds greater control over the process of obtaining insurance and represents a distinct departure from state laws that typically require the filing of affidavits from brokers describing their efforts to obtain the coverage from admitted carriers.

Proposed Federal Regulation of Producer Licensing

The National Association of Registered Agents and Brokers Reform Act of 2009, H.R. 2554, establishes the National Association of Registered Agents and Brokers ("NARAB" or the "Association"), a nonprofit corporation that will not be an agent or instrumentality of the U.S. Government. As stated in Section 322 of H.R. 2554,

The purpose of the Association shall be to provide a mechanism through which licensing, continuing education, and other nonresident insurance producer qualification requirements and conditions can be adopted and applied on a multi-state basis (without affecting the laws, rules, and regulations pertaining to resident insurance producers or appointments or producing a net loss of producer licensing revenues to States), while preserving the right of States to license, supervise, discipline, and establish licensing fees for insurance producers, and to prescribe and enforce laws and regulations with regard to insurance-related consumer protection and unfair trade practices.

When an insurance producer licensed in its home state becomes a member of the Association, the producer then can become authorized to produce business in states for which the producer pays the required state licensing fees for the lines of business it wants to produce. When the fees are paid, the producer becomes a nonresident producer; is not required to obtain any additional licenses, but is subject to all state laws and regulations concerning suspension or revocation of authority.

The Association cannot offer continuing education courses but is authorized to establish continuing education requirements. H.R. 2554 requires a national criminal background record check for membership in the Association. An Association member is subject to suspension or revocation of membership if the member fails to meet the Association's membership criteria or is subjected to disciplinary action by a state. The legislation authorizes the Association to receive complaints from consumers and from State insurance regulators.

Section 331 of the measure preempts state laws and regulations by prohibiting the States from taking any action against a producer who has applied for or has become a member of the Association, including the imposition of additional fees. No continuing education requirements can be imposed by a State on nonresident producers. As long as a nonresident producer is licensed in the State where an insured maintains its principal place of business, no other State can impose regulatory requirements on the producer as a condition for placing insurance on the insured's risks located in other States.

Section 331 also prevents any State, other than Association member's home state, from imposing, inter alia, licensing, education, continuing education and bonding requirements that differ from the Association's criteria for membership. In addition, a State other than the producer's home State, cannot require an Association member to become licensed or to register with the secretary of state.

The foregoing preemption provisions clearly show how a federal regulatory scheme can be structured to operate in conjunction with the existing state regulatory system. The state system remains in effect, but its applicability to licensees who opt to become members of the Association is restricted. Association members are required to comply with state fee requirements to become licensed as nonresident producers, but are otherwise regulated by NARAB.

The Association would be governed by a Board of Directors appointed by the President consisting of six state insurance commissioners designated by the NAIC and five industry directors appointed by industry trade associations. The Bill authorizes officers and by-laws, requires financial statements and annual reports to the President, Congress and the NAIC. United States District courts shall have exclusive jurisdiction over litigation to which the Association is a party.

Measure Introduced in U.S House of Representatives to Remove the Regulation of Fixed
Indexed Annuities and Insurance Products from the SEC

The Fixed Indexed Annuities and Insurance Products Classification Act of 2009, H.R. 2733, introduced on June 4, 2009, finds that the adoption this year of Rule 151A by the Securities and Exchange Commission ("SEC"), entitled Indexed Annuities and Certain Other Insurance Contracts,

...interferes with State insurance regulation, harms the insurance industry, reduces competition, restricts consumer choice, creates unnecessary and excessive regulatory burdens, and diverts Commission resources, all of which outweighs any perceived benefits.

H.R. 2733 nullifies the applicability of Rule 151A to fixed indexed annuities and insurance products by making it clear that those products are not securities and are therefore exempt from the provisions of the Securities Act of 1933. The Bill offers full support to state regulation by acknowledging in its findings that indexed insurance and annuity products are subject to a wide array of laws and regulations enforced by the States that protect consumers against market related losses.