All placements of insurance in the United States are generally subject to state premium taxation, but the responsible taxpayer depends on the type of insurance policy issued. Premium tax is usually payable by the insurer on admitted insurance policies (insurance issued by a carrier licensed in the jurisdiction where the policy is delivered).
However, surplus lines and direct procurement insurance transactions (often referred to as nonadmitted insurance) are treated a bit differently. As surplus lines and direct procurement insurance transactions necessitate the utilization of unauthorized insurance carriers, other transaction participants traditionally owe the state insurance transaction taxes under these models.
With respect to surplus lines insurance, the surplus lines insurance broker is generally responsible for payment of the surplus lines insurance premium tax and, because insurance brokers are traditionally prohibited from participating in direct procurement insurance transactions, the policyholders themselves are primarily responsible for payment of direct procurement insurance premium taxes.
Until recently, it has been generally presumed that direct procurement insurance taxes must be paid to a policyholder’s home state on the entire premium paid under an insurance policy, regardless of where the insurance risks are located. However, new case law has thrown into question the extent to which states can tax direct procurement insurance transactions on 100% of the premium thereunder when the risks covered are located in multiple jurisdictions.
A Background on Direct Insurance Procurement
Direct procurement of insurance (also known as direct placement, independently procured or self-procured insurance coverage) occurs when an insured travels outside of its home state and purchases coverage directly from an insurance company in a jurisdiction where the insurance company is licensed to transact insurance.
However, to permissibly complete a direct insurance procurement transaction is difficult and requires adherence to specific standards. In order to obtain insurance coverage through direct procurement, most states require that (1) an insured not access the unauthorized insurer through a resident insurance agent, broker or surplus lines broker; (2) no activity occur by the unauthorized insurer (or any agent thereof) in the insured’s home state either in the making or in the performance of the contract prior to policy issuance, and (3) the transaction itself occurs solely (or in some states, principally) outside of the state where the insured is located.
In 2011, Congress enacted the Nonadmitted and Reinsurance Reform Act as part of the Dodd Frank Act, revolutionizing the nonadmitted insurance space by creating a more simplified and efficient state insurance tax and regulatory system.
Before the enactment of the NRRA, multiple states could attempt to regulate and tax a single nonadmitted insurance transaction. Under the NRRA, only the insured’s home state is permitted to collect premium taxes for nonadmitted insurance.
The NRRA defines ‘‘home state’’ as: (1) the state in which an insured maintains its principal place of business or in the case of an individual, the individual’s principal residence; or (2) if 100% of the insured risk is located outside of the state of the principal place of business or residence, the state to which the greatest percentage of the insured’s taxable premium for that insurance contract is allocated by the insurance company.
Post-NRRA, some states attempted to allocate taxes for multistate insurance risks insured by a nonadmitted insurance policy on the back-end by agreement among themselves, but both the nonadmitted insurance multistate agreement and the surplus lines insurance multistate compliance compact interstate compacts were dissolved or failed to go into effect, respectively.
Does the NRRA really provide uniform treatment of taxation of nonadmitted insurance?
After the passage of the NRRA, the general consensus in the industry has been that a surplus lines insurer simply pays 100% of nonadmitted tax (regardless of where the risk is situated) to the home state of the insured. Most states proceeded to update their nonadmitted insurance tax laws to reflect this presumed reality; however, some did not, perhaps relying on the NRRA’s federal preemption of state law.
However, this failure to update direct insurance procurement tax laws may literally prove costly, as illustrated under the recently decided New Jersey Tax Court case, Johnson & Johnson v. Director, Division of Taxation, and Commissioner, Department Of Banking and Insurance. Of critical importance is that the Johnson case found that the NRRA allows, but does not require, the home state to tax nonadmitted insurance on 100% of the risk under a directly procured insurance policy.
Under the Johnson case, Johnson & Johnson, a New Jersey-based pharmaceutical company, formed Middlesex Assurance Co. Ltd., a Vermont-domiciled captive insurance company, to provide insurance coverage for all of Johnson & Johnson’s risks throughout the United States. Johnson & Johnson directly procured insurance coverage from Middlesex.
Due to the nature of this transaction, and in accordance with N.J. Stat. Ann. Section 17:22-6.64, Johnson & Johnson historically remitted direct insurance procurement taxes to the state of New Jersey (which it had been doing since 2008) on the premium it paid to Middlesex.
Fast-forward to November 2011 when New Jersey, in response to the implementation of the NRRA, amended its surplus lines insurance tax laws to require payment of premium taxes on all risks insured under a multistate surplus lines insurance policy be paid to New Jersey when the insured’s place of business in New Jersey meets the NRRA’s “home state” definition.
However, New Jersey did not update its direct insurance procurement tax laws accordingly. Therefore, after paying all direct insurance procurement taxes to the state for many years, in order to preserve its rights, Johnson & Johnson brought a claim seeking a refund of the direct insurance procurement taxes it had paid for nearly $56 million, plus interest.
While the home state rule remains clear, the crux of the matter was the drafting of the New Jersey amendments in reaction to the NRRA. N.J. Stat. Ann. Section 17:22-6.64, which sets forth both the surplus lines and direct insurance procurement tax standards, clearly states that direct insurance procurement tax applies only to premiums paid “upon a subject of insurance resident, located or to be performed within [New Jersey].”
By contrast, in response to the NRRA, New Jersey amended N.J. Stat. Ann. Section 17:22-6.64 as it applies to surplus lines premium taxation such that “[i]f a surplus lines policy covers risk or exposures in [New Jersey] and other states, where [New Jersey] is the home state … the tax payable pursuant to this section shall be based on the total United States premium for the applicable policy.”
The Johnson case found that New Jersey could only tax Johnson & Johnson’s premiums allocable to the portion of the insured risks actually located in New Jersey. The court pounced on the fact that the statutory language limiting Johnson & Johnson’s tax liability to the risks it insured in New Jersey remained unchanged and, despite New Jersey’s NRRA amendments to the surplus lines insurance tax laws, absent clear legislative intent to the contrary, the plain language of the statute should be followed with respect to the direct insurance procurement tax laws.
A practical consequence of the Johnson case is that insureds that have paid direct insurance procurement taxes completely to their home states (or insurers or carriers that have fronted such payments) have real opportunities to seek substantial tax refunds depending on the statutory and regulatory amendments their respective home states have enacted post-NRRA as to insurance policies with multi-state risks.
This, of course, raises the obvious question: Is New Jersey the only state out there that has not updated its direct procurement tax standards to the fullest extent allowed under the NRRA? Moreover, and of broader consequence, have any states failed to update their surplus lines insurance premium tax statutes accordingly?
Other State Examples
While most states appear to have updated their direct insurance procurement tax laws to take full advantage of NRRA, some states have not.
Alabama, for example, failed to update its direct insurance procurement statute altogether after the implementation of the NRRA. The language of the direct insurance procurement tax statute in Alabama mirrors that of New Jersey, limiting the direct insurance procurement tax only to premiums paid “upon a subject of insurance resident, located or to be performed within [Alabama].”
Furthermore, regarding any “subjects of insurance resident, located or to be performed outside [Alabama] a proper pro rata portion of the entire premium payable for all such insurance shall be allocated as to the subjects of insurance resident, located or to be performed in [Alabama].” Therefore, Alabama appears expressly to allow for insureds to remit direct insurance procurement taxes solely on the risks located in the state.
Contrast Alabama with states such as Connecticut and Georgia that have updated their direct insurance procurement statutes to avoid any potential confusion as to the insured’s home state’s ability to tax all premiums paid for self-procured insurance policy.
Connecticut made wholesale changes to its direct insurance procurement taxation mechanics, requiring that all direct insurance procurement taxes be paid to Connecticut regardless of where the risks are located.
Georgia added additional language in its direct insurance procurement tax laws stating that “there shall be collected from every such insured in this state for … insuring … property or interests both in and out of this state, a tax … of the gross premium paid for any such insurance.” (Emphasis added).
Some states, by contrast, have modified their direct insurance procurement tax statutes in response to the NRRA, but ambiguity remains nonetheless.
Maryland, for example, has updated its direct insurance procurement statute in a way that remains silent on the issue, which could lead a court in such jurisdiction to distinguish between it and New Jersey.
Likewise, Florida, which amended its statute in a fashion similar to Georgia, included a slight variation, adding that, “[t]he tax must not exceed the tax rate where the risk or exposure is located.” Based on this wrinkle, an insured paying self-procured insurance tax to Florida (with a direct procurement tax rate of 5%), on a policy that includes risks located in Georgia (with a direct procurement tax rate 4%), cannot be taxed at a rate higher than 4% on the Georgia portion of the risk.
What about surplus lines insurance taxes?
Most states, following the passage of the NRRA, have updated their surplus lines insurance premium tax statutes to require payment of taxes solely to the home state on multistate risks. However, some states still leave a bit of flexibility.
For example, the Idaho legislature updated Idaho Code Ann. Section 41-1229 after the enactment of the NRRA such that “[f]or property and casualty insurance other than worker’s compensation insurance, if Idaho is the home state, then the tax so payable shall be computed on the entire premium … without regard to whether the policy covers risk or exposures that are located in Idaho. For all other lines of insurance … the tax so payable shall be computed upon the proportion of premium that is properly allocable to the risks or exposures allocated in Idaho.”
As such, Idaho expressly allows for workers’ compensation insurance, as well as potentially health insurance, to be written in the state on a surplus lines insurance basis and taxed pro-rata only on the risks located in the state.
In addition, there remains significant ambiguity in the area of surplus lines insurance taxation with respect the taxation of group surplus lines insurance policies. The NRRA only expressly addresses affiliated, rather than nonaffiliated, groups.
As a consequence, a number of states interpret the NRRA differently, with some jurisdictions requiring that a portion of the surplus lines insurance premium taxes be paid as to each group member or certificate holder residing in their jurisdictions, and other states taking the position that all surplus lines insurance premium taxes may be paid to the home state of the “master” policyholder.
With respect to group surplus lines insurance policies written through risk purchasing groups and risk retention groups under the Federal Liability Risk Retention Act, most states generally require allocation of surplus lines insurance premium taxes based on where a group member resides.
Where do we go from here?
Players in the nonadmitted insurance space should be looking both backwards and forwards. While it ultimately remains to be seen whether the states that maintain direct insurance procurement tax laws similar to New Jersey’s endeavor to amend their statutes to take full advantage of the NRRA, there exists a real and substantial opportunity for industry participants, especially those with captive insurance companies within their risk management operations, to seek refunds on direct insurance procurement premium tax payments made in these states.
In addition, as the NRRA defines “nonadmitted insurance” to include property and casualty coverages only, we anticipate further tax challenges as the direct insurance procurement and surplus lines insurance market generally expand to service forms of accident and health coverages that, theoretically, would be governed under the pre-NRRA regime of nonadmitted insurance tax allocation.
Whether the states take a second look at their surplus lines insurance and direct insurance procurement tax laws in the upcoming months and years may have a profound impact on how business is done and how taxes are paid in the unauthorized insurance markets.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
 States differ to a fair degree regarding what actions violate the tenets of direct insurance procurement, including whether local insurance brokers may be utilized as proxies for the insured and what actions may be conducted in the insured’s home state subsequent to policy issuance. For an in-depth look at the various nuances of direct procurement transactions, see Zachary Lerner, “An FAQ On The State Of Direct Procurement Insurance”, Law360, January 10, 2019. Available here: https://www.law360.com/articles/1117416/an-faq-on-the-state-of-direct-procurement-insurance.
 Johnson & Johnson v. Director, Division of Taxation, and Commissioner, Department Of Banking and Insurance, 2019 WL 4658534 (N.J.App., 9/25/2019).
Johnson & Johnson v. Director, 30 N.J.Tax 479 (N.J.Tax Ct., June 15, 2018).
 Ala. Code § 27-10-35.
 Conn. Gen. Stat. § 38a-277.
 Ga. Code Ann. § 33-5-33(b.1).
 Md. Code Ann., Ins. § 4-211.
 Fla. Stat. § 626.938.
 A growing number of states have been recently amending their laws, issuing bulletins or updating their export lists to allows various forms of accident and health insurance to be written through their surplus lines insurance markets in conjunction with related initiatives from the National Association of Insurance Commissioners.