Insurance Compliance and Tax Considerations for the Multinational Company

June 2014 • Lockton Global® LLP

LOGAN PAYNE, CPCU, ARMInternational Practice

816.960.9617lpayne@lockton.com

L O C K T O N G L O B A L ® L L P

As the events of the past few years have clearly shown,

countries and, increasingly, the companies that operate

inside those countries can no longer operate in isolation. Due

to increased market volatility, enterprising companies have

sought to improve their prospects for revenue growth and

to diversify their portfolios by expanding beyond their home

country borders.

In a KPMG survey of U.S.-based mid-market companies, 48 percent of executives stated they planned to expand globally in 2013, up from 22 percent in 2012. Of those 48 percent, 55 percent planned to expand to emerging markets outside the U.S., while 30 percent were looking to expand to developed markets outside the U.S. Our focus in this white paper will be to discuss compliance considerations, example global program structures to maintain compliance, and key tax considerations

for cross-border programs for these companies expanding outside their home countries.

Compliance is not a new subject for most multinational companies. It has been one of the primary drivers for the purchase of international

Compliance has been one of the

primary drivers for the purchase of

international insurance and local

admitted policies outside the U.S.

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insurance and local admitted policies outside the U.S. What are we really worried about when clients and insurance professionals discuss “compliance”? We’re worried about violating country regulations that vary by province and state. We’re worried about compliance with global and local contracts and compliance with internal company guidelines on accepting or transferring risk. Insurance often underpins contracts and grants the involved parties a level of security and comfort knowing that insurance exists as a backstop to the agreements in the contract. Without compliant insurance, contract uncertainty and resultant lost revenues arise.

Another consideration when discussing compliance is whether claims monies are received in the “wrong” jurisdiction. Simply ensuring the appropriate perils are covered is no longer enough. We must also ensure that the claim money is received in a jurisdiction which recognizes the validity of the insurance contract where a claim is brought. Also of concern are scenarios where insurance cannot pay on behalf of or legally represent the policyholder as a result of local laws prohibiting nonadmitted insurance. This leads to adverse publicity and companies being seen as poor corporate citizens in the jurisdiction of the loss because they have not purchased legally recognized insurance.

Tax considerations, fines, and penalties for nonadmitted insurance are common areas of concern for many companies when addressing compliance. Later on in this white paper, we address the specific area of tax considerations: what they are, example claim payments, and how to address them. “Compliance” can mean a variety of different things to companies, depending on their area of focus and concern. Companies choose to maintain compliance by insuring their risks around the world in two broad categories, nonadmitted or admitted. We discuss these two categories in further detail next.

“Nonadmitted” refers to the status of an insurance policy or insurer. Nonadmitted insurance is arranged outside the regulatory system of the country where the risk is located. Nonadmitted insurers are not licensed by the local supervisory authority to conduct insurance business in a particular country. Global program compliance is often focused

solely on how and where claims monies are paid, but the other ramifications for working with a nonadmitted insurer can be just as critical. Depending on the insurer’s status in country, insurers may not be able to adjust a loss, perform risk engineering activities, defend the policyholder, or pay on behalf of the insured.

Choosing the countries in which to purchase admitted policies can also be a large determinant in a global program’s degree of compliance and how effectively a company can respond to claims. Relying on nonadmitted insurance can lead to additional tax liabilities, complications with receiving claim payment, or unwanted scrutiny from

Global program compliance is often

focused solely on how and where

claims monies are paid, but the other

ramifications for working with a

nonadmitted insurer can be just as critical.

Tax considerations, fines, and penalties for nonadmitted insurance

are common areas of concern for many companies when

addressing compliance.

June 2014 • Lockton Global® LLP

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local regulators. In some countries, purchasing locally admitted insurance is the only way to access government-supported insurance and pools or secure local contracts with government entities, contractors, or lenders. The key for multinational companies is to be proactive in addressing compliance, not reactive. Next, we outline a few ways to structure your global insurance program to be proactive and become, or continue to be, compliant.

Diagram 1.1: Typical Global Insurance Program

Insured Entities Property General Liability Compulsory Auto/EL, etc.

Directors & Officers Marine Cargo

Broad Form Named Insured Master Programs—Excess/DIC

Local Entities or Other

Admitted Total Value at Risk or

Loss Limit

Admitted $2M or Similar

Admitted at Least to Statutory

Requirements

Limited AdmittedAustralia, Brazil, China, India, etc.

Limited Admitted Select African and South American

Countries

Compulsory coverages such as auto, workers’ compensation, or employer’s liability should be covered through the purchase of a locally admitted policy regardless of the structure. Under this global insurance structure, local admitted policies are purchased in countries where nonadmitted insurance is not permitted (or where contracts or operations require local cover), allowing claims support and local payment for covered claims. By issuing a local policy, at least some premium is allocated to the local entity, and premium taxes paid as part of the policy, which represents a step in the direction of compliance. This is a cost-efficient way of structuring a global program as the local admitted policies have minimal limits that keep local premiums and taxes low while still partially complying with local laws.

A potential drawback to this structure is that the master program policy is considered nonadmitted and sits excess of the local policies, not totally addressing the problem of compliance. In the event of a large claim that would exceed the local policy limits, the excess policy would respond, and the nonadmitted insurance considerations would apply again. Furthermore, some local regulators may apply a penalty or additional tax after looking at the low premiums allocated to the local policies and deciding they are inappropriate in light of the size of the local company operations.

Choosing the countries in which to purchase admitted

policies can also be a large determinant in a global

program’s degree of compliance and how effectively a

company can respond to claims.

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Diagram 1.2: “Unrealistic” Global Insurance Program

Property General Liability Compulsory Auto/EL, etc. Directors & Officers Marine Cargo

Admitted Insurance Admitted Insurance Admitted Insurance Admitted Insurance Admitted Insurance

To Full Corporate Limits

One potential response to the “Typical Global Insurance Program” illustrated in 1.1 is to only rely on local policies with limits equivalent to those of their corporate excess tower. In this structure, shown in 1.2, there would be no potential for a regulator to claim the company was relying on nonadmitted insurance or not allocating appropriate premiums. Due to lack of capacity and prohibitive costs of purchasing local policies with such high limits, this is an unrealistic approach to structuring a global program.

The more practical and recommended way to structure a global program is to increase local admitted limits and add a Financial Interest Clause (FINC) to the master policy as seen below in Diagram 1.3. The higher limits on the local policies (although still not completely compliant) would help to mitigate potential large claims going into the excess layers while also creating a more supportable premium and tax bill in each country, in accordance with the size of the exposure. Unlike the “Unrealistic Global Insurance Program” illustrated in Diagram 1.2, the limits are not full limits as this structure still seeks to minimize costs for issuing local policies as much as possible.

Diagram 1.3: Recommended Global Insurance Program

Insured Entities Property General Liability Compulsory Auto/EL, etc.

Directors & Officers Marine Cargo

Broad Form Named Insured

Master Programs—Excess/DICAdd “Financial Interest Clause”

Local Entities Admitted Total Value at Risk or

Loss Limit

Admitted $5M-$10M

(As appropriate for local needs)

Admitted at Least to Statutory

Requirements

Admitted Where Dictated

Admitted Where Dictated

June 2014 • Lockton Global® LLP

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The addition of the FINC seeks to move a program from reactive to proactive. Although each carrier calls the FINC a different name, the overarching purpose is to clarify that the excess coverage applies to the first named insured only in those jurisdictions where nonadmitted insurance is permitted and legal. If nonadmitted insurance is prohibited, this clause outlines that the coverage will only pay the loss suffered by the first named insured (parent company) as a result of the financial interest of the first named insured in the foreign subsidiary. By adding this clause, insurers are seeking to make the excess/DIC coverage compliant with foreign insurance regulations operating in jurisdictions where nonadmitted insurance is prohibited. It should be noted that in order to maintain full compliance all the way up an excess limit tower, the FINC clause should be added to all excess policies that might respond to a foreign claim.

The reality for most companies is that even if they take all these recommendations into consideration and structure a well-thought-out global insurance program, their claims monies will still need to be repatriated or moved across borders at some point. In the next section, we’ll look at the specific tax implications that come into play in the event of claims monies moving across borders and key considerations for companies in this situation.

The variance in regulations between countries, and even states, is one of the difficulties of navigating global insurance programs. In regard to tax, the rules are generally consistent with and based upon the regulatory requirements of the respective state or country. When tax complexities associated with international insurance arise, they are often in situations where nonadmitted insurance is being used and claims payments are received in the jurisdiction of the parent company purchasing the global insurance. Placing local admitted policies can help to mitigate tax complexities and problems, but as shown in the diagrams above, local limits may not always be sufficient, leading to excess/DIC payments and ultimately back to the same tax complications faced when there is no locally admitted coverage.

Since the tax rules vary by jurisdiction, there is not a simple, universally applicable rule set to apply. This necessitates analyzing each jurisdiction of operation to determine how it handles receipt of a claim payment or intercompany transfer of a claim payment. Many countries charge a premium tax on insurance, so if a claims payment is received in a country where no premium tax was collected, it may raise a red flag with local regulators.

WHAT IS A FINC CLAUSE?Helps move global policies toward compliance.

Limits XS/DIC coverage to countries where legally permitted.

Where XS/DIC coverage not legally permitted, clarifies “who is an insured.”

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To illustrate the range of tax considerations that arise between purchasing insurance and receiving claim payments, we use Diagram 1.4, showing a sample company (ABCD Co.) with a common global insurance structure. ABCD, a U.S.-domiciled company, purchases a global property policy protecting the assets of their subsidiary in a country where nonadmitted insurance is not permitted. The first issue is the premium tax that is owed on the premium charged in the U.S. for the risk located in the foreign jurisdiction. The second issue arises from the transfer pricing practices of ABCD. If ABCD follows the common practice of allocating insurance costs to subsidiaries, this may reveal the nonadmitted insurance to local regulators. Additionally, since there must be consistency in transfer pricing, any future claims payments received in the U.S. must also be transferred to the local ABCD Co. entity. Even though a loss may occur in a foreign jurisdiction and impact the assets of the local subsidiary, the claim payment would usually be paid to ABCD in the U.S. This claim payment normally might be recognized as income in the U.S. since there is no offsetting recognition or realization of loss suffered by the U.S. entity, just a diminution of its investment in the subsidiary. The claim payment, now seen as income, may be subject to U.S. taxes as well as foreign taxes in the jurisdiction eventually receiving the claims money. In the foreign jurisdiction, the local entity may be eligible for a deduction as a result of the asset loss suffered, but the deduction may not equal the amount of the income tax in the U.S., causing further friction and lost money. In a very simple way, this serves to illustrate how companies can easily run into tax problems when receiving and then moving claim payments across jurisdictions.

ABCD Co. U.S. Parent

ABCD Co. U.S. Local Subsidiary

Insurer

Diagram 1.4: Example—Movement of Claims Monies

Claim Payment for Local

Country Loss Event

Reimbursement

Payment for Loss

June 2014 • Lockton Global® LLP

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What action steps can be taken in response to a potential tax problem?

The primary action step is for companies to communicate with their international tax department. The practices of the tax department dealing with the movement of money across borders should align closely with how the insurance program is structured. A company’s regulatory standing and global compliance may be jeopardized by a lack of congruence between the company policies relating to tax and insurance.

Another action step is to consider the cost of taxes when determining the amount of insurance to purchase. The limits selected as optimal for the exposures around the world may not consider that claims payments may be taxed several times, as they are paid in one country, then moved into the actual country needing indemnification. This may mean either an increase in limits on the master policy to contemplate the amount lost after taxation or an increase in the limits on local policies to avoid an excess policy needing to respond in a country restricting nonadmitted insurance. Another option would be to change the structure of the global insurance program and move from a nonadmitted position to one with more locally admitted policies. We suggest thinking through the entire transaction cycle—from premium payment to claim payment—to ensure that the position chosen is consistent all the way through and that there are no unforeseen areas where nonconformity with the chosen tax and regulatory position can arise.

The last action step is to integrate all of these factors into your transfer pricing. If a fully admitted global insurance program is chosen (Diagram 1.2) to avoid receiving nonadmitted claim payments and running afoul of local regulators, insurance may not be something that is charged on the transfer pricing between the parent company and subsidiaries. Consistency is the key here to avoid a circumstance where charges on your transfer pricing put a company in a different position from the one it intended.

Compliance while operating or expanding internationally can be a very challenging and daunting

prospect. By defining potential areas of concern and structuring the insurance program accordingly,

companies can move toward a position of compliance and avoid many unforeseen penalties, fines, and

tax consequences for noncompliance.

ACTION STEPSCommunicate with international

tax department.

Consider tax costs when determining limits of insurance to purchase around the world.

© 2014 Lockton, Inc. All rights reserved. Images © 2014 Thinkstock. All rights reserved.

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