DIC/DIL coverage is typically provided under a Master Policy2 to ensure consistent terms and limits throughout the Controlled Master Program (CMP) by providing coverage:
- when a claim is not covered under a Local Policy (DIC); and
- when the Local Policy limit is exhausted (DIL).
In each instance, the claim must be otherwise covered under the Master Policy’s terms, conditions and remaining limits.
Notably, the Master Policy may still afford coverage for foreign losses absent DIC/DIL provisions and/or Local Policies, typically through a worldwide coverage territory, broad definition of insured or some other wording.
When no Local Policy is issued, the Master Policy provides coverage on a ‘primary’ basis. The scope of cover is the same as DIC or DIL, but the difference is that the cover is not triggered by a Local Policy not responding or being exhausted.
In contrast, the FIC reduces the worldwide scope of the Master Policy to cover the parent’s financial interest in its local subsidiaries, as opposed to covering the subsidiaries themselves. Effectively, the loss suffered by the subsidiary causes a reduction in the value of the parent’s financial interest in the subsidiary, for which the parent is indemnified.
Without the FIC, the parent and its local subsidiaries are insured entities under the Master Policy as set forth above. With the FIC, only the parent is an insured entity and beneficiary, and the parent is covered for its own exposures as well as its financial interest in its local subsidiaries’ loss(es), subject to the policy’s terms, conditions and limits.
If the Master Policy contains an FIC for some or all subsidiaries, it will negate the DIC/DIL function, as well as any other inherent global coverage for these entities, and there will be no coverage because they are not actually insured entities under the Master Policy.
While each provision derives from the same circumstances, they are tailored to accomplish entirely different things.
Different solutions for different problems
Multinational clients are inevitably seeking consistent coverage worldwide; however, there is no such thing as an international insurance licence or policy wording. Local laws, wordings and practices vary because they are tailored to each market’s customs and requirements, and the type of operations in a given country.
Against this backdrop, the benefits of DIC/DIL are fairly obvious: the provision functions as a backstop across country differences to facilitate consistent terms, conditions and limits throughout the CMP. Because the foreign subsidiaries are covered under the Master Policy, they have that safety net regardless of whether a Local Policy responds to a given claim (subject to the Master Policy’s terms, conditions and remaining limits).
Because the Master Policy insurer is usually not licensed in the local subsidiary’s country, the Master Policy may cover some subsidiaries on an unlicensed or non-admitted basis, which some countries may prohibit. This in turn may expose the subsidiaries to local regulatory or tax risks, particularly if any local services are provided by the Master Policy insurer. Even where the Master Policy is combined with Local Policies within a CMP, the same risks may be triggered by a DIC/DIL claim for which local handling or payment is sought.
This predicament gave rise to the FIC as a mechanism to obtain coverage without having to purchase a Local Policy, while mitigating the client’s risk of unlicensed or non-admitted insurance. By removing the local subsidiaries as insureds such that the parent is the only insured under the foreign Master Policy, the FIC avoids the local subsidiaries being covered by a locally unlicensed insurer.
The FIC may also prove cost-effective for multinational companies that are concerned with centrally assessing and managing exposures, experience a low frequency of local losses, and/or have well-capitalised, independent local operations.
Despite these potential advantages, the FIC’s removal of local subsidiaries across regulated touchpoints – i.e., purchase, claims handling and payment – carries important limitations that underwriters, brokers and clients (at the parent and subsidiary level) must understand upfront.
And, since DIC/DIL and FIC are often included within the same policy, it is equally imperative for these parties to understand the differences between the provisions, as they impact the coverage offered, potential policy response and tax treatment.
Scope of coverage
Recovery under the FIC is generally limited to the corresponding reduction in value of the parent’s financial interest in its local subsidiary. Coverage under DIC/DIL is typically broader, limited only by the Master Policy’s terms, conditions and remaining limits, and extends not only beyond the parent’s financial interest, but also to local operations that are not subsidiaries.
Any recovery under the FIC is similarly defined by the amount of ownership interest the parent has in the local subsidiary, whereas the actual loss suffered by the subsidiary may not necessarily equal the post-loss reduction in its value to the parent.
When a subsidiary is covered under DIC/DIL, the local claim will be paid under the Master Policy, not the Local Policy. Without a local license, however, the Master Policy insurer may be precluded from locally handling or paying claims. Even where permitted, the practicality of paying the claim locally may be outweighed by the administrative or financial burden of doing so.
Accordingly, where permissible and otherwise feasible, DIC/DIL losses will be paid in the country of occurrence. Where not, these losses will instead be paid to the parent in its home country.
Additionally, in some countries, the Master Policy insurer may legally be required to collect and settle insurance premium tax (IPT) in its home country on the premium allocated to foreign exposures.3
FIC claim payments will only be made to the parent in its home country, and the insurer will not be able to provide local services such as local claims adjusting or payment to local subsidiaries or third-party beneficiaries.
In either case, there is no certainty upfront as to where local losses will be handled or paid.
Upon receiving an FIC or DIC/DIL claim payment, the parent may wish to repatriate these funds to its local subsidiary to compensate for its losses. The capital infusion from the parent to the local subsidiary may trigger tax consequences (in either or both countries).
The local insurance or tax authority may similarly interpret the parent’s internal allocation of DIC/DIL and/or FIC premium to its subsidiaries as an attempt to circumvent local requirements, with the local subsidiary receiving insurance and/or related benefits indirectly through unlicensed carriers.
Of particular note here is India’s Tax Tribunal in the Adidas case.4 To date, no other court, regulator or legal body has addressed or confirmed acceptance of FIC.
Brokers and clients should consult their advisers when it comes to these issues, and more broadly, the decision to forego local policies.
No substitute for local policies
Neither FIC, DIC/DIL or other provision under a Master Policy replace Local Policies.
The Master Policy’s provisions – DIC/DIL or otherwise – may simply not contemplate the type of losses common in the subsidiary’s country. Even where such losses are covered, recovery will be further limited: in the case of FIC, by the parent’s financial interest; in the case of DIC/DIL or other provision, by the terms, conditions and remaining limits of the policy (which may be eroded by local losses in other subsidiary countries).
Further, local insurance services, such as local claims handling and payment and evidence of local coverage are not possible under FIC and may be uncertain under DIC/DIL.
These limitations may have a negative impact on the client’s needs or objectives if/when local losses occur.
Unequivocally, Local Policies remain the most effective option to facilitate compliance, local servicing and payment. Local Policies also transparentize tax liability and settlement.
There is no one-size-fits-all solution; the most appropriate programme for each multinational company is the one that reflects its worldwide exposures, strategies, and preferences. As these aspects will differ from company to company, and evolve from year to year, so will the structure of the corresponding multinational insurance programme.
All stakeholders – brokers, clients, captive managers and fronting insurers, should be well-versed on the benefits and limitations of each option, to ensure they are making informed decisions when protecting their worldwide exposures.
For more information about Financial Interest Clauses, please review our Briefing Paper.