Financial interest clauses: viable, useful, but not a panacea

A financial interest clause (FINC) is not a panacea for issues of compliance and regulation in the context of a global insurance programme, but it is a viable proposition, according to Praveen Sharma, managing director, global leader of the insurance regulatory and tax consulting practice at Marsh. He added that FINCs should be used as a matter of last resort.

In an International Underwriting Association Remote Market Briefing, Mr Sharma explained the history and emergence of FINCs as a concept, pointing to the challenges of global insurance programmes. “Insurance regulations in many countries are unfortunately not fit for multinational companies. They are doing cross-border activities, manufacturing in one country, distributing in another, selling in another, HQ in another country, admin and back office elsewhere, so managing the overall group risk exposure in a cost-effective manner, which doesn’t double up on limits and coverages and cost, can be difficult,” he said.

He continued: “Regulations are designed to protect the local insurance market and the local policyholders, so it is like trying to put a square peg in a round hole. No regulations refer to DIC/DIL policies. They will simply say: non-admitted insurance is not permitted. DIC/DIL coverage in the master policy can give rise to regulatory challenges for insurers, brokers and/or insureds.”

An FINC provides protection from potential regulatory challenges for global insurers and for local insureds, said Mr Sharma. It provides financial loss cover to the parent company, which is the policyholder/named insured, while the overseas subsidiary is not insured and has no beneficial rights under the master/excess policies. The financial loss to the parent is the diminution in share value equal to the underlying uninsured loss of the overseas subsidiary. And the loss will always be paid to the parent company.

For Mr Sharma, an FINC is one tool that can be used to try and balance cover, cost and compliance.

He stressed that an FINC is not an income tax avoidance scheme – the purpose of an FINC is to ensure compliance with insurance regulations only. If you want to deal with income tax, you should increase the local policy limits, he said, adding: “Be careful about FINC; in my view it should be used as a matter of last resort, not first resort.”

Where non-admitted is not permitted, local policies of an appropriate limit should be considered to ensure most, if not all, losses are paid in country to mitigate any potential tax or foreign exchange issues, he explained. Then an FINC can be added in the master/excess policy to make sure that if there is any unforeseeable event, the loss is paid at least to the parent company and any potential challenges from authorities are mitigated.

He stressed that the local policy should be at a limit that is equal to the potential or maximum foreseeable loss, while the unforeseeable losses should be covered under the master.

On the issue of premiums, he said the location of risk for “financial loss” is where the parent company is established and notional allocation of premiums to such entities would be subject to the applicable premium tax at parent company level. Such premiums should be eligible for corporate income tax expense relief at the parent-company level.

As for the claims side, Mr Sharma said the foreign entity is not insured and has no rights under the master and excess policies, and all claim monies would be paid to the parent company by the master/excess insurers, and would be subject to corporate income tax at the parent-company level. The foreign subsidiary should be able to claim tax credit for the uninsured loss.

Mr Sharma noted there a number of common misconceptions about FINCs. Firstly, that FINCs have not been tested in court, which is not true as an Indian tax tribunal has examined FINCs in great depth in the Adidas India fire loss case, and it has also been reviewed by a few regulators. Secondly, that a claim can give rise to adverse income tax. “It is not designed for tax purposes. The claim payment to parent would be subject to corporate income tax, but so can DIC/DIL payments,” he said.

Another misconception is that there may be reduced claim payments for associates and joint ventures, but he explained that a well-constructed ‘financial interest’ definition can overcome this issue. He dismissed another incorrect belief, that premiums can be recharged to subsidiaries in countries where non-admitted insurance is not permitted, by noting that the subsidiaries are not insured and have no beneficial rights and therefore should not bear the premium expense.

He said some believe that an FINC is not necessary if there are local policies, but Mr Sharma said the master/excess policies should include an FINC to ensure regulatory protection in the event that the local policy limits or conditions are inadequate. And finally, there is a misconception that you need a local policy to include an FINC clause in the master/excess policy. “The master/excess policy should still respond to the parent company, if it has a ‘financial interest’ in the overseas subsidiary,” he said.

Mr Sharma concluded his talk by stressing that an FINC clause should be well constructed and should include the following:

• Who is insured: normally the parent company, policyholder, or first name insured?
• Who is not insured: entities located in countries where non-admitted insurance is not permitted?
• Existence of an insurable interest in the foreign entity
• List of countries where non-admitted insurance is not permitted
• Financial interest, not restricted to subsidiaries or majority shareholding – referring to economic, operational and strategic benefits
• Valuation of loss and payment to parent company, policyholder, first named insured
• Claims handling responsibility
• Subrogation clause.

Finally, Mr Sharma called for a market standard to be set on FINCs and said that a universal wording should be formulated to ensure consistency, certainty and compliance.