As businesses globalize, the need for comprehensive and consistent overall insurance protection arises. Multinational policyholders look to their brokers and insurers to provide them with seamless worldwide protection for all their subsidiaries and operations on the same terms and conditions. And when global policies are provided, the insurance companies providing that worldwide protection to their policyholders seek to reinsure part of their assumed global exposures on the same basis to their reinsurers.
However, crafting a global insurance policy that provides consistent and comprehensive coverage for an entire multinational corporate organization, including subsidiaries incorporated in countries around the world, is easier said than done. Many local jurisdictions have restrictions that stand in the way of merely issuing a single global policy to insure all subsidiaries. First, not all global insurance companies are licensed in every jurisdiction. Second, some jurisdictions require that only a local domestic insurance company may provide insurance coverage to a local company and that all insurance be placed through a local broker. Other regulatory restrictions, including premium tax collections, have made consistent and seamless global coverage problematic. Yet other limitations, like policy terms, limits, and conditions mandated by the local authorities or under local insurance law, make consistency nearly impossible.
Solutions to Restrictions on Global Policies
There are myriad creative underwriting solutions to placing a global insurance program, including having the global master policy wrap around the local policies and fill in the gaps as essentially a form of difference in conditions and difference in limits insurance policy. Regulatory issues persist, however, where the master policy is not an approved or licensed policy in the local jurisdiction, and the local authorities are less than kind to unlicensed insurance of local subsidiaries or local claims.
In certain jurisdictions, using local licensed insurance companies to front, with facultative reinsurance provided by the global insurer assuming the risk from the local fronting insurer, provides some relief, but very often the terms and conditions of local policies are not consistent with the master policy. This situation is even more complex given the portability issues arising out of the European Union, the required use of a market reform contract in the United Kingdom, and the potential fallout from Brexit.
Financial Interest Coverage
To address these and other issues, a number of creative underwriters have come up with a potential solution to the global policy conundrum.1 This relatively recent development is financial interest coverage.
Financial interest coverage provides insurance protection to a parent company against the risk of damage to the parent's financial interest in its uninsured local subsidiaries. What this means is that, where the local subsidiary cannot be directly insured by the global insurance company under the master policy for licensing, regulatory, or other reasons, the parent is nevertheless insured for its financial interest in that subsidiary. So, if the subsidiary suffers a loss, the parent company is covered for its financial interest in that loss suffered by the subsidiary.
To make this work, the local subsidiary is expressly not insured under the master policy. The financial interest coverage grant in some formulations of this insurance provides that any loss suffered by the subsidiary be equal to the loss suffered by the parent company, which essentially equates to what would have been the loss suffered by the subsidiary if it had been insured for the loss suffered by the insured parent. This way, the risk to the insurance company is the same.
In other formulations, a valuation provision addresses how the parent's financial interest in the local subsidiary is determined. A parent's interest in its subsidiary spans economic, operational, and strategic interests. Should the subsidiary suffer a loss, the parent's interest in that subsidiary will be affected as well. Where the parent is a 100 percent owner of the subsidiary, valuation of the parent company's financial interest in the subsidiary as equal to the loss suffered by the subsidiary makes sense. Where the parent is not a 100 percent owner, then a different or proportional valuation may be required.
Financial interest coverage is considered appropriate and in compliance with local laws and regulations by the underwriters of this coverage because it is insuring the "insurable interest" of the parent's interest and involvement with its subsidiaries. Yet, as far as we can tell, no regulator has formally weighed in on this insurance product and its validity.
The Financial Interest Clause
A global master policy issued to a multinational policyholder will include a financial interest clause where that insurer issues this type of coverage. The clause, generally in the form of an endorsement, will describe in detail the nature of the coverage, the subsidiaries that are specifically uninsured, and the manner in which the parent's interest in those subsidiaries are valued for coverage purposes.
Where a ceding insurer issues a global policy that includes financial interest coverage, the reinsurance contract that assumes a share of those liabilities may include its own financial interest clause or at least a definition of financial interest coverage. This is not to be confused with a financial interest clause in property policies that addresses a party's financial interest in an insured property. An example of a reinsurance clause addressing financial interest coverage follows.
"Financial interest coverage" means coverage provided to the Company for its financial interest in any entity (the "uncovered entity") which would otherwise be covered under this Agreement which is located in a jurisdiction where: (i) applicable law or regulation do not allow the Reinsurer to provide coverage; or (ii) the Company has elected that this Agreement will not cover such entity directly but will cover the Company's own financial interest in such entity.
Where financial interest coverage is triggered, this Agreement will not provide any coverage for the uncovered entity, and the Reinsurer and Company further agree that: (i) the Company has a financial interest in the uncovered entity because it benefits financially from the continued operation of the uncovered entity and/or would be prejudiced by loss to, or damage to, or liability incurred by the uncovered entity in the operation of its business; and (ii) the Reinsurer shall indemnify the Company in respect of any loss to its financial interest, by way of agreed valuation calculated as the amount which would have been payable to the uncovered entity if it had been permitted and agreed for this Agreement to provide cover for such uncovered entity. All other terms, conditions and limitations of this Agreement shall remain unchanged. This Article does not change the limits or aggregate limits of this Agreement.
The financial interest clause transparently conveys the existence of the financial interest coverage and makes it clear how a loss under that coverage grant will be covered by the reinsurer. It also acts as a further assurance to regulators that the global policy is not providing insurance to an entity in a jurisdiction where providing insurance by the global insurer is not permitted.
In the example above, the reinsurer is required to indemnify the ceding insurer for the parent company's damaged interest in its subsidiary in the same amount as it would have indemnified the ceding insurer had the uncovered subsidiary been covered under the global policy in the first instance. Essentially, the coverage does not expand the reinsurer's liability under the reinsurance contract and is revenue- and risk-neutral. Its value is not expanding coverage but providing the ability for the ceding insurer to issue a comprehensive and consistent global policy to its multinational insured.
As with many things reinsurance, the reinsurer may be left to trust the ceding insurer that the agreed valuation is calculated properly. As indicated above, if the parent does not have 100 percent ownership of the noncovered subsidiary, the valuation may not be equal to the subsidiary's loss.
Sanctions and Financial Interest Coverage
One side note worth mentioning is the interplay between the various sanctions regimes and global insurance policies (and the reinsurance of global insurance policies). If a subsidiary cannot be insured because of a prohibition caused by sanctions, query whether providing financial interest coverage to the parent of that subsidiary also violates the prohibition. The likelihood is yes, so both the ceding insurer providing global coverage and financial interest coverage to a multinational policyholder and the reinsurers of that global policy need to be cognizant of whether any of the policyholder's local subsidiaries are subject to any relevant sanctions regimes.
Financial interest coverage is a relatively new and untested form of coverage used to mitigate some of the legal and regulatory issues surrounding the provision of global comprehensive insurance coverage to a multinational policyholder. Reinsurers are being asked to reinsure these risks through financial interest clauses in reinsurance contracts. Financial interest coverage is meant to be risk-neutral because the policy and the reinsurance contract are covering a loss to the parent company generally equivalent to what the loss would have equaled if the subsidiary itself had been covered by the policy. Financial interest coverage and the financial interest clause are recent developments in the globalization of insurance and reinsurance and are worth watching for developments.
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