Praveen Sharma – Time to re-evaluate global programme structures

When the first industrial companies started to expand overseas, it was not long before brokers and insurers began to offer insurance cover for international risks.

Over time, the standard approach adopted has been the Controlled Master programme, with its local ‘fronted’ policies, ultimately governed by the terms and conditions of the head office master policy.

For years, such insurance programmes were generally structured with little or no consideration given to local insurance regulations and tax rules of countries in which the risk is located.

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The risk manager was told that it didn’t matter too much how broad the scope of the local underlying policy was, as the master was the gold standard for all group risks.

For instance, in the case of general liability, a $1m primary would be sufficient, and as long as ‘good local standards’ were met, then the master, DIC and umbrella would take care of unforeseen events.

This comfortable philosophy is increasingly being exposed as being far from panacea.

It has become apparent, particularly from the initiatives and pronouncements of numerous regulatory and tax authorities, that they will no longer tolerate such an approach adopted by the insurance market. These organisations are vigorously enforcing their respective insurance regulations and tax rules.

Income tax liability

Increasingly, multinational companies have faced the wrath of the local tax authorities, such as in Canada, US, and certain EU member states, for unpaid premium related taxes.

Whilst premium related taxes (on average 11% of premiums) cannot be ignored, the most significant cost facing multinational companies is potential income tax liability (at an average rate of 25%) on claims, that is not taken into consideration during the placement phase – and it only comes as a surprise when a loss arises.

This potential income tax liability arises in the event of a loss suffered by an entity that is located in a country where non-admitted insurance is not permitted.

Generally, such an entity is covered under firstly, a local policy, with possibly inadequate limits, and secondly, under a master/excess/umbrella/DIC/DIL policy issued to the parent company by an overseas insurer.

At the time of placement of the master policy no one realises that in the event that the overseas entity suffers a loss, in excess of the local policy limits, the master programme insurer(s) will not pay the claim directly to that entity.

They will pay the loss to the parent company, such that, on receipt of the claim amount, the parent company will incur income tax at an average rate of 25%.

This unforeseen, but possibly avoidable, income tax cost comes as a total surprise to the multinational group. This is particularly the case as this tax cost, depending on the circumstances, is often in excess of the overall cost of risk that the multinational group may be trying to manage. Such significant regulatory and tax questions mean that risk managers, brokers and insurers all need to rethink ‘best practice’.

Insurers and compliance

Encouragingly, insurers have become sensitive not only to the needs of a multinational company, but also their local operations’ licences.

They have come to realise the need to strictly reinforce compliance in line with both the letter and the spirit of local insurance and tax regulations. Therefore, generally they will not offer non-admitted insurance, in say Brazil, Russia, India or China.

A simple omnibus insured wording in a master policy may be interpreted as non-compliant and providing non-admitted cover in such countries.

Insurers are therefore, wrestling with this conundrum and developing their own solutions, for instance by the inclusion of a financial interest clause in the master policy.

Even if such a clause (which has yet to be tested in any court of law) works to ensure greater compliance with the insurance regulation and settling the claim centrally, the multinational group is still left with the potential income tax dichotomy.

One of the ways to address the regulatory and tax challenges is to consider replicating, as far as possible, the terms and conditions of the master policy within the local policy.

In future ‘good local standard’ will no longer be acceptable to the risk manager. But a fully documented, legally binding replica of the master policy conditions, to the extent permitted in each country they operate may be appropriate.

There will still be some challenges where conditions are restricted by tariff, or market conventions. But for the European Union it would be possible to issue a ‘cloned’ Freedom of Services Policy. Many other countries may allow an endorsement of the local standard form with the broader master conditions.

This approach also needs to be considered for liability risks. The days of the $1m primary are behind us and generally now no longer considered appropriate by many risk managers.

The market should be considering a differential approach.

If an operation is particularly large or complex (e.g. a refinery, mine or chemical plant) then the local limit should reflect the potential local exposure, benchmarked with what a local company of similar size and business description would purchase.

Other classes of risks

But the restructuring of global programmes does not stop with the traditional property and liability covers.

A similar approach should be considered for other classes of risks such as D&O, crime, excess liability and other specialist covers, traditionally arranged by head office on behalf of the group.

Risk managers, in recent times, have come to realise that there is a very real requirement for some form of co-ordinated local cover to be put in place in many countries – from both regulatory and commercial perspective. This can be tricky and difficult, compounded by lack of capacity, limited market appetite for providing higher limits and costs.

It has become increasingly obvious that many insurance regulations are not designed to respond to the demands of multinational companies.

It is not unusual for global programmes to have sums insured in excess of $1bn in property and $500m for liability, or D&O programmes of $250m. These amounts cannot be replicated in each and every territory where global corporations do business – as the capacity is just not available in many markets.

Multinational companies are well aware of the need to adhere to local regulations and internal corporate governance, whilst at the same time trying to ensure broad and adequate protection for the group.

So far there is no silver bullet to resolve this dilemma and short cuts must be avoided at all costs.

What is important to understand and acknowledge is that a well-considered global programmes should achieve a delicate balance between cost, coverage and compliance. Consequently, the easy-going approach to global programmes will become a thing of the past.

Risk managers, brokers and insurers, all need to become more skilled in understanding the regulatory and tax challenges around structuring global programmes.

As so often, timidity and protectionist attitudes are standing in the way of allowing best risk management and insurance practices to be implemented for multinational companies.

John F Kennedy once remarked that: “There are risks and costs to a programme of action. But they are far less than the long-range risks and costs of comfortable inaction.”

Praveen Sharma is Global Leader of the Insurance Regulatory & Tax Consulting Practice at Marsh. To contact Praveen, please email: [email protected]