Are you breaking the law?

For a long time the insurance industry has been sitting on a worrying little secret. The unspoken convention was that businesses could buy a single insurance policy to support all their operations worldwide – a global insurance programme. The problem is that it may not have been 100% legal.

When business globalised and moved into uncharted territories in search of cheaper production costs and fresh markets, it continued to demand the same level of financial protection it was used to at home. But how, given the complexities of the modern world, could that be done? The solution was a simple one.

International companies started buying global insurance programmes. These involved master policies in the home jurisdiction and local policies in the various other jurisdictions where the policyholder operated. Insurers offered these for a single fee.

Rather than getting bogged down with legal particularities, it was far easier for everyone, to bundle everything up in a DIC/DIL (difference in conditions, difference in limits) master policy.

They were designed to provide a central uniform insurance programme that met corporate standards and had the benefits of local policies.

The opportunity to partner with a single global insurer was as reassuring as it was simple, convenient and cost effective. Over the past couple of decades that is what multinationals have been happy to do. Most of the time, no one bothered to look under the surface.

What the industry, rather conveniently, failed to address properly was the glut of different rules that apply to insurance in each of the hundreds of jurisdictions around the world.

No one really wanted to consider that they could be breaking the law by doing insurance in an unlicensed territory or failing to file their taxes correctly. However, the reality is that many people on both sides of the contract have been slipping up. And it is companies and their directors that could be culpable.

Hype or threat?

Faced with that eventuality, several parts of the industry have started to sit up and take note. But why bring it up now? Directors could feel threatened by fresh pressure from the authorities and possible tax evasion charges. The taxman is after his slice of the pie, so if you are doing insurance in his neck of the woods, and that includes paying and receiving claims, you had better be sure to divvy up the proceeds.

From an insurer’s point of view, apart from avoiding fines, one reason is to gain an edge over your competitors.

A Swiss bank’s insurance arm may have been the first, but now several of the major players have made a lot of noise about new globally compliant insurance programmes. That begs the question: what were they selling before?

Chasing competitive advantage is one thing, but some say the insurers are communicating too much on this issue. Why make such a song and dance about something which for a long time was less than perfect? ‘It could be triggering risks for all of us,’ says one risk manager.

Ever since the fanfare started, the industry has been searching for a solution – one that crossed all the Ts and dotted all the Is. But is there one? And if so, what does it entail? Only a limited number of companies have actually changed their policies in this area. Most are still in discussions. In the main, companies are taking the risk seriously, but they are very confused.

And confused they should be, because the issues are complex and daunting. Nevertheless, this cannot be brushed aside in the hope another department will deal with it. It is an insurance issue – and one risk managers need to be able to give advice on.

Brokers should be able to help, but so far, in many cases, they have failed to cough up much in the way of guidance, although they are starting to do so. Perhaps if the liabilities were transferred to them it would motivate them to do more, says another risk manager. Companies need to consider a number of things when arranging multinational insurance. ‘There is no such thing as a one size fits all solution,’ says Andreas Berger, global head of market management at Allianz.

Businesses are dynamic and the legal landscape is constantly shifting, while local courts’ interpretations may vary from your own. A promise from your insurer that ‘to the best of their knowledge’ the programme is compliant may not be enough. There is a burden of responsibility on the broker and the insured. In the EU, as far as insurance premium tax (IPT) is concerned, an insurer or its fiscal representative is responsible for collecting and discharging the tax. But in the US, Canada, Australia and New Zealand, the local insured or its broker is responsible.

Action plan

“The reality is that many people on both sides of the contract have been slipping up

The first thing to be sure of is that the programme is legal in all of the territories in which it is supposed to operate, so that it will respond in the case of a claim. That means using admitted and non-admitted insurers only in the territories that allow you to do so. And that’s not the end of it. There are some seriously head-spinning tax calculations. And believe it or not, you may even have to pay tax on a non-admitted policy.

Another consideration is to make sure you are allocating premium to where the risk is located, a tricky job and one the risk manager is personally responsible for. IPT is then worked out as a percentage of this.

This also introduces problems for risk managers who want to allocate premium on a ‘punish and reward’ basis. The authorities will only accept a fair and reasonable premium allocation for each of the companies within the group. That means going to the market for a quote. It is not easy for risk managers to award higher or lower premiums depending on how a facility is organised.

Other things to chew over are how to transfer a claim payment into a company in a different country (you may be expected to pay even more tax) and how you are going to pay your premium taxes.

Helen Hayden, group insurance and risk manager for the Prudential, a UK insurance and financial services company, is one person who has been brave enough to tackle this issue head on. In 2006 she took the plunge and went to her insurer to thrash out a solution. ‘It’s time consuming, resource intensive and incredibly frustrating,’ she says.

When it comes to purchasing insurance internationally, buyers have a couple of options: admitted or non-admitted. Generally speaking, most countries prefer insurance to be placed by a locally admitted insurer which follows local customs and is governed by local regulations.

There are quite a few benefits in using locally admitted insurers. Premium payments may be eligible for tax relief and claims can be paid in full without any complications regarding their taxable status. And some policies, such as motor liability or workers compensation, have to be placed locally.

Buying locally is the safest way of complying with local laws and avoiding fines, but it is not always an option. Local insurers benefit from a better understanding of the risks in their country and more experience underwriting them, but they can also introduce some challenges for a corporate risk management strategy.

There is the question of whether a local entity has an adequate rating or is able to provide the right limits. Another issue is that insurance and risk

handling expertise tends to congregate in the big financial centres such as London or New York. There may be insufficient claims handling services locally or they may not be easily accessible. And some territories do not have the specialism in complex areas of underwriting, such as financial lines. These are all things for the risk manager to consider.

Territorial differences

Non-admitted insurance is illegal in many countries. In China an insurer must be licensed by the China Insurance Regulatory Commission before it can write policies in or from that country. In the case of non-licensed underwriting, not only would the contract be void but the insurer could be fined up to five times the level of income they obtained through the activity. In Japan, no foreign insurer without a branch office can underwrite risks there. The penalties for non-compliance include fines and imprisonment for directors. In Indonesia, persons responsible for transacting non-admitted insurance can be imprisoned for 15 years.

A number of countries, such as Canada, allow insurance by unlicensed alien insurers (or non-admitted). Even countries which have a prohibition on unlicensed insurers, Brazil for example, may allow it if the regulator is sufficiently satisfied that there is no local alternative. For that to happen, the risk manager or broker has to go through a process of declinature whereby they approach the domestic market to ask if the capacity is available to write the risk. If the answer is no, an unlicensed insurer may be permissible.

To satisfy these rules and the hunger for insurance expertise and financial security wherever business is located, some of the biggest insurers have gone to the trouble of licensing their own branches or partnering with native insurers.

Setting up locally admitted units can have financial implications for the insurance company, because it must meet local solvency requirements. To offset this, other insurers choose to partner with local carriers instead of licensing themselves. The local insurer fronts the policy, which is then reinsured by the bigger party. In that case the insurer has less control over the sub-unit.

Even the global insurers cannot issue policies everywhere. And where insurance is admitted there can still be problems. Buyers have encountered a situation where the insurer is constrained in what they can issue, the scope of cover being restricted by local regulations. In some jurisdictions the policy needs to be approved by the regulator, which can take time. That means policy wordings might not necessarily replicate what the insured is accustomed to at home.

As a result, some risk managers go for a combination of the two. But a global insurance programme that uses a combination of locally admitted policies and a supporting master policy can be very complicated to administer. ‘Board level support is essential to implement the international programme and ensure its successful operation,’ says Hayden.

Arranging multinational insurance also requires excellent communication between the subsidiaries and the parent to ensure there are no gaps in cover or inappropriate limits where the local unit is left to arrange its own cover. Spotting where you are left exposed can be a challenge. ‘We are working on a project to find the gaps in our coverage. That way we’ll know what we’ve got to rely on London for, and when a claim comes in we won’t be panicking,’ comments Hayden.

“Captive managers should be particularly cautious

Additional issues

But a single global insurance programme is not always the right approach. ‘Global programmes have advantages and disadvantages. People thought it was an advantage to have one partner, one discussion and the solution protects you everywhere against everything. That’s wrong,’ says DVS president Stefan Sigulla, head of insurance at Siemens Financial Services.

Sigulla believes direct relationships with each of the markets where Siemens does business is the best approach to ensure compliance. ‘We go step by step, country by country and we have all local policies which we bring together under a reinsurance programme.’

Competition can be an issue as well. As yet an industry-wide solution is a long way off. Those insurers that have reached a level of compliance that is acceptable to corporate risk managers have spent millions doing so. This handful are claiming one-upmanship over the rest. Buyers are unhappy with this situation. UK risk management association AIRMIC has said publicly it is ‘inappropriate’ for insurers to use compliance as a competitive advantage. Nevertheless, the choice of insurer, which is very important to the success of the global programme, is limited.

Where insurance cannot be provided, even on an unlicensed basis, providers will insure the parent against a loss by its subsidiary. This is the oldest and simplest way of doing things – but not always the easiest. If the subsidiary suffers a loss, the insurer will reimburse the parent. The parent company can choose whether or not it passes the funds on to its subsidiary. It is possible that the parent may not want to rebuild a factory, for example, but may use the funds elsewhere in the group. In some instances, if it wants to reimburse the subsidiary, it could prove difficult. Brazilian legislation will not allow nationalisation of foreign capital from insurance indemnities. Elsewhere, the authorities may treat the insurance payment as a new capital injection and tax it accordingly.

‘Unfortunately this problem still exists,’ says Praveen Sharma, who spearheads the tax consulting practice at Marsh. Even though the policy itself is compliant, the company may run into problems when it comes to distributing a claim payment. Take an example, where a fire occurs in a Russian plant which is a subsidiary of a UK plc, and the insurer responds by paying the sum of the claim to the parent. The UK tax authorities could argue that this is technically income, because no loss has occurred at the parent level and therefore subject to income tax (at 28%). If the parent decides to transfer the money to Russia it could be construed as a capital injection. With no loss to offset it against, the parent could be forced to pay an additional tax.

‘I wish some clarity would be given on this issue, because businesses need to operate on an international basis,’ says Sharma.

Some policies include a tax liability clause, where the insured receives an additional amount up to a certain limit to offset any taxes payable on the income. Describing the master policy payment method, Jonathan Post, XL Insurance’s general counsel for global programmes, says: ‘We don’t think that it is a tax disadvantage.’

Tax is another headache altogether. IPT rates vary between country, and the US has fifty different regimes alone. ‘The calculation is absolutely huge,’ says Hayden.

Before companies even reach for the calculator to do the sums they must allocate the premium to where they think the risk is. The Kvaerner ruling saw to that. Kvaerner was a multinational company that was fined by the Dutch tax authorities for not paying IPT in the Netherlands. According to the ruling, while the non-admitted policy arranged out of the UK was legal, Kvaerner had to pay tax on where the risk was located (the Netherlands) rather than where the premium was paid.

Before that, most of the industry was hardly concerned by overseas taxes. Now, insureds need to consider much more closely what taxes apply to them. The fine was a small one and the ruling only applies to Europe, but it serves as a precedent.

Kvaerner raises another concern. If buyers are trying to allocate tax in a jurisdiction on a non-admitted basis where this is not allowed, they could inadvertently draw attention to their own illegal activities.

Allocating the premium is relatively simple for property insurance, because the risk is easy to quantify. But if you are looking at liability, it can be a much bigger challenge. America has been exporting a litigation culture for some time now, but it’s by no means clear where the biggest risk is.

It may not be a popular topic to bring up at the next board meeting. Risk managers could be admitting to breaking the law and buying something that would not have indemnified the company. But it could be much harder if company directors are arrested overseas and the D&O claim is not able to respond to pay for the lawyers to defend them.

Zurich Insurance, one of the first to move on this, is keen to look forward. ‘What was happening in the market before was best practice at the time. We feel there is now a new set of best practice. I don’t think there is cause for alarm historically, and I don’t think risk managers should be overly concerned by what was provided previously,’ says John Latter, global head of MIP.

Compliance can be a little scary, but companies cannot escape from it. Global companies have to deal with a global legal environment. One hundred percent compliance is probably far fetched, but companies need to be able to show that they are making at least some effort. Captive managers should be particularly cautious. They can shift the workload but not the responsibility. If their captive is writing non-admitted insurance in Russia, where it is a criminal offence, they could be jailed.

Companies need to take a closer look at the territories they are operating in. That means they need a good understanding of the issues themselves. Each risk manager needs to assess their own position. Seeking external advice is a good idea but it won’t resolve all the issues.

Those who have purchased insurance from a market which is not legally acceptable have created two problems. First they have broken the law and second they have no cover.