AIG Multinational Whitepaper How to Build a Multinational Program

AIG Multinational

How to Build a

Multinational Program

Global Solutions Customized

By: David Halperin

Deputy General Counsel

AIG General Insurance

Weighing Worldwide

Insurance Options

Much has been said and written about the complexities of

multinational insurance programs. For those of us who occupy

the multinational space — insureds, carriers and brokers alike

— terms such as “compliance,” “compulsory,” “admitted,” and

“nonadmitted” are bandied about regularly. But what do these

terms really mean, and do they mean the same thing for each

stakeholder? More importantly, do these terms actually help

us collaboratively structure multinational insurance programs?

The expansion of regulatory regimes governing everything from financial

services and taxation, to general business activities and corporate governance

— against the backdrop of interconnected world and regional economies —

requires a thorough assessment of cross-border risks as well as the options

and obstacles inherent in multinational insurance programs.

There is no one right way to structure a program. Rather, each program should

reflect a particular multinational’s preferences, goal and situation, and be

adaptable, year to year, as the organization’s needs change and the global

business climate inevitably evolves.

This paper sets forth fundamental guidance pertinent to multinationals of

any size as they chart a logical, practical approach to insuring

multi-country risks.

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The AIG Philosophy

A Matter of Strategy... and Choice

Notwithstanding the benefits a CMP provides, there may be reasons why a multinational would prefer not to have

a local policy in a given country, and instead rely on a global policy to cover its exposures there.

AIG will accommodate its clients’ preferences, whether it is a local policy in every country with exposure, local

policies only in some countries, or a single global policy. However, in making those determinations we believe our

clients should be well-versed on the potential limitations they may encounter should they choose to forgo local

policies. In particular, multinationals should be aware of the potential pitfalls a lack of local coverage could create

in the areas of compliance, claims, income tax, proof of insurance and coverage.

• It may utilize separate, unrelated local insurance policies

in each country where it has exposure. These policies are

underwritten by carriers licensed in the particular countries

to insure the multinational’s local offices, operations,

subsidiaries, affiliates, assets and/or people. Locally

issued policies are tailored to local industry practices and

regulatory requirements, provide access to local reinsurance

pools, fulfill local contractual obligations, and afford a

vehicle for local claim servicing and local payment of claims,

premiums and premium taxes.

• A multinational may rely on a single global insurance policy

issued in its home country to cover itself and its worldwide

exposures. Global policies are generally issued within the

multinational’s home country by a carrier licensed only

in that country. These policies enable the multinational

to assess its risks and insurance needs centrally, and

provide consistent terms, conditions, limits and umbrella

attachment points for the organization’s operations

worldwide.

• Both local and global policies offer advantages. Fortunately,

multinationals do not have to choose one or the other, but

rather may combine the best of both in what is commonly

referred to as a controlled master program (CMP), which

essentially combines multiple local policies issued in

various countries with a global policy in the multinational’s

home country. The global policy is often a “difference in

conditions/difference in limits” policy, meaning it serves as

a backstop for all of the local policies, providing coverage

if a claim is either not covered under a local policy or the

local policy limit is exhausted (subject to the global policy’s

terms, conditions and remaining limits). Because the global

policy usually has a worldwide coverage territory, it also

covers risks even in countries where there are no local

policies. In a CMP the global policy and local policies are

linked, often through terms in the global policy. Properly

structured, a CMP can provide a multinational and its

worldwide operations with the benefits of both local and

global insurance protection.

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The Building Blocks

Local Policies. Global Policies. Controlled Master Programs.

A multinational has several options for insuring risks around the globe.

Principles of extraterritoriality and international law dictate that

the laws of a particular jurisdiction generally apply to conduct

within its borders or by its nationals. Multinationals have offices,

operations, subsidiaries, affiliates, assets and people around

the world. Because foreign laws generally apply to parties

operating in-country, a multinational’s presence in a foreign

country may subject it to some or all of that country’s regulatory

requirements. Certain countries have laws and/or regulations

that may, with varying degrees of clarity and specificity, indicate

that in-country exposures be covered by a carrier that is

licensed to conduct business in that country.

These mandates may take the form of a prohibition, an

affirmative requirement, or both. They may be specific to

a particular type(s) of insurance, apply only to compulsory

insurance, or apply to all insurance, compulsory or

discretionary. Some of these mandates may expressly state the

party(ies) to which they apply, i.e., brokers, insureds or carriers

resident in the country, whereas others may not. The specific

requirements vary country to country.

If a given country clearly requires local operations to be covered

by a local policy issued by a locally licensed carrier, then a

multinational’s local subsidiary — because it is resident in

that country and thus subject to local regulation — may be at

risk of violating such mandate if it is covered by the parent’s

global policy, transacted outside the country by its parent,

and issued by a foreign carrier. The local subsidiary, as an in-

country resident, may also be required to calculate and settle

local premium taxes itself, and failure to do so could result in

penalties and interest.

A hypothetical to consider:

An Australian-based multinational has a global professional

indemnity policy in its home country that covers the parent

company and the worldwide operations of its affiliates. A

high profile lawsuit has been brought in Europe against the

company’s European subsidiary. The local European regulator

determines that because the local subsidiary is not covered

by a locally licensed carrier, it is violating local regulations,

which prohibit entities or residents from purchasing or having

coverage for local risks from carriers outside the country.

The regulator assesses fines and penalties against the local

operation, and renders the company’s global insurance policy

void in the local jurisdiction, leaving it without coverage for the

lawsuit.

In addition, the local tax authority learns that premium tax

was not paid in connection with the global policy issued in

Australia. Since the subsidiary resides within the tax authority’s

purview, the tax authority sends it an assessment for back

taxes based on the premium it believes should have been

charged for local coverage, plus accrued interest. The local

tax authority also determines that the subsidiary was charged

by its Australian parent company for the portion of the global

policy premium attributable to the subsidiary’s risks, and took

a tax deduction for the premium expense. The deduction is

disallowed, and additional fines and penalties are imposed.

Compliance Questions

When crafting a program for multinational exposures, consider:

• Does local law require the local subsidiary to purchase and/or be covered by insurance from a locally licensed carrier?

• Does local law prohibit the local subsidiary from purchasing and/or being covered by insurance from a carrier not

locally licensed?

• Will the parent company charge the local subsidiary for the allocated premium?

• Will the local subsidiary take a tax deduction for the allocated premium?

• Will the local subsidiary need to pay premium tax in-country?

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Compliance

A Multinational’s Regulatory and Premium Tax Requirements

The laws of a country generally apply to companies operating

within its borders. Global policies are generally transacted

entirely within the home country of the carrier and the

multinational. During the solicitation, negotiation and binding

of the global policy, the carrier does not undertake activities

outside the home country. Moreover, the carrier underwriting

the policy is generally not licensed or conducting its insurance

business outside its home country, and is thus likely entirely

outside the purview of foreign regulation. Simply covering

potential exposures, such as people or legal liability, in other

countries without undertaking activities in those countries does

not by itself subject a carrier to regulation in those countries.

While a carrier may be able to consummate a global policy

solely from its home country, it may not be able to provide

essential insurance-related services locally, because it is neither

licensed nor conducting business outside of its home country.

It may be prohibited by local law from providing claim services

or making claim payments locally. Even if it is not prohibited, a

global carrier may refuse to undertake these activities in foreign

countries so as to avoid creating a nexus that could subject it to

legal or regulatory scrutiny in those countries.

This constraint on localized carrier activity has been recognized

and addressed in the U.S. by the Insurance Services Office,

Inc. (ISO),

which provides standardized policy forms widely

used in the U.S. property-casualty insurance industry. ISO

forms provide for covering exposures in multiple countries. For

example, a standard ISO endorsement entitled Amendment

of Coverage Territory – Worldwide Coverage (CG 2422 10/01)

extends the scope of a general liability policy from U.S.-only to

a worldwide territory. By virtue of this extension, the U.S. carrier

is able to provide for coverage in multiple countries, including

those in which it is neither licensed nor conducting business.

In the event foreign law prevents the carrier from defending or

paying a claim in that country, the endorsement calls for the

carrier to instead reimburse the policyholder. ISO’s commentary

recognizes that foreign laws, including insurance mandates,

may hinder the policy’s ability to respond:

“Because the laws of foreign countries can sometimes interfere

with or complicate recovery of insured losses … if local laws

prevent the CGL insurer from providing the insured with

a defense, then defense costs incurred by the insured will

be reimbursed … If the insurer is prevented for any reason

from paying covered damages on behalf of the insured, the

amount of those damages will be reimbursed … If the laws

of the country in which the insured is conducting operations

require the purchase of specific insurance (e.g., from an insurer

domiciled in the foreign country), then the CGL policy will

function as excess insurance over that foreign insurance...”

1 ISO is a leading source for actuarial, underwriting and claim information as well as policy forms in the U.S. property-casualty insurance industry. See www.iso.com.

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A Word About Financial

Interest Clauses:

In lieu of wording that covers a multinational’s

subsidiaries around the world, some global policies

incorporate a “financial interest clause,” which amends

the policy to cover only the multinational’s financial

interest in these worldwide subsidiaries. The key feature

of these clauses is that the parent company is the only

legal entity actually covered under the global policy. The

purpose of the clause is to avoid the regulatory concerns

that can arise when a policy is not issued locally — if

the local subsidiaries are not actually covered under

the global policy, they are not part of the transaction

and arguably not violating regulatory requirements

applicable to local entities and residents.

However, financial interest clauses are not a panacea.

While technically a multinational’s local subsidiaries

may not be covered, regulators could potentially

view defining financial interest by the amount of

subsidiary loss as an attempt to evade local regulatory

requirements. Financial interest clauses are untested. We

are unaware of any regulators that have opined, officially

or unofficially, that a financial interest clause excuses a

local subsidiary from local regulatory requirements.

A financial interest clause may also give rise to

uncertainty in quantifying a loss. While it is intended to

cover the parent for an amount identical to that which

the subsidiary would have been covered for had it been

an insured under the policy, if not carefully defined, and

the actual loss sustained by the subsidiary arguably

does not equal the actual post-loss reduction in the

subsidiary’s value to the parent, then recovery may be

uncertain. Lastly, even if the financial interest clause

solves any regulatory issues, it may trigger undesirable

or unforeseen tax consequences, regardless of whether

the financial interest clause effectively removes the

subsidiary as an insured.

Claims

The Need to Respond Locally

While this ISO endorsement and commentary is specific to the

U.S. marketplace and to general liability insurance, the fact that

a carrier on a global policy may be unwilling or unable in some

cases to adjust or pay claims locally is a universal concern for

many types of insurance.

Consider how this might play out:

A multinational’s Southeast Asian subsidiary owns a factory that

manufactures widgets. A chemical explosion causes significant

damage to the facility, destroying inventory. While it is too soon

to quantify the extent of the loss, a bevy of loss control experts,

engineers, and investigators will be needed to conduct forensic

analyses and facilitate the release of insurance proceeds vital to

the local operation’s financial survival.

The factory does not have a local property policy in place. Rather,

coverage for the loss is being sought under a global property

policy that was negotiated and purchased by the parent company

in Mexico and issued by a carrier licensed and operating only in

Mexico. Because the carrier’s license and operations are confined

to Mexico, it may not be able to undertake any claims-related

activities in Southeast Asia or retain a third-party to do so either.

The subsidiary may be left to service the claim itself — locating

and engaging all necessary engineers, adjusters and experts,

in-country or elsewhere, to investigate, analyze and adjust the

property damage and time element aspects of its loss.

Additionally, as a result of the explosion 25 individuals sustain bodily

injuries, many of them severe. They are suing the subsidiary, alleging

negligence in maintaining the factory in a reasonably safe manner.

Here again, the factory does not have a local policy in place to

respond to these allegations. Instead, coverage will be sought

under the parent company’s global liability policy, also negotiated

and purchased in Mexico and issued by the same carrier.

Once again, the carrier may not be able to undertake any local

claims-related activities or retain a third-party to do so. The

subsidiary may need to retain local counsel to defend these claims.

Moreover, because of the country’s underdeveloped legal system,

the subsidiary is likely to have difficulty identifying and retaining

appropriate counsel. Due to conflicts of interest and other legal

considerations, multiple law firms may need to be retained.

In sum, due to limitations on the ability of a global carrier to

respond locally, a multinational and its subsidiaries may be in

the unenviable position of responding to claims on their own.

The best way to ensure that a carrier will manage losses and

claims locally is to have local policies issued by a global carrier’s

local affiliates as part of a CMP.

Claims Questions

When crafting a program for multinational

exposures, consider:

• If a loss occurs locally, can the local subsidiary retain

local counsel and other litigation experts to defend a

lawsuit?

• Will the subsidiary be able to retain loss control experts,

engineers, medical providers and other vendors to

assist in the claim adjusting process?

• Will the subsidiary be able to retain investigators, search

for beneficiaries, assist in gathering documentation, or

arrange for housing or other accommodations in the

wake of a loss?

• Will the subsidiary be able to arrange for immediate

medical treatment and evacuation?

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Not only does the absence of a local policy potentially impact

the ability of a multinational to obtain claim services in-country,

but if a claim payment cannot be made locally there may be tax

ramifications as well.

Consider:

A company’s European subsidiary suffers a $30 million property

loss. The loss is covered by a global policy negotiated and

purchased in the U.S. by the U.S. parent company. As no local

policy was purchased the carrier may be unable to remit claim

payment directly to the subsidiary in Europe, and may instead

pay the parent company in the U.S. — a move that has material

tax ramifications.

Since the parent company did not actually sustain the loss,

the proceeds could be taxable income to the parent company.

The highest U.S. corporate income tax rate is 35 percent, which

translates to a potential $10.5 million tax liability. In addition, if

the subsidiary is not sufficiently capitalized to absorb the loss on

its own, necessitating that funds be contributed by the parent to

the subsidiary, the funds could be considered taxable income to

the subsidiary as well. For example, if the subsidiary is subject

to a 25 percent income tax rate under local law, the parent

company may need to provide the subsidiary with $40 million

to fully compensate it for the loss after tax. As a result, the total

organizational tax liability in this example would be $20.5 million

($10.5 million for the parent and $10 million for the subsidiary).

Income Tax Questions

When crafting a program for multinational

exposures, consider:

• Will the claim need to be paid in-country?

• If the global policy cannot respond by paying the claim

locally and must instead pay the parent company, will

the parent incur tax liability in its home country?

• Will the parent need to make a capital contribution to

the local subsidiary; if so, will the local subsidiary incur

tax liability?

• Can the local operation survive if the parent does not

infuse capital to make it whole for a loss?

Income Tax

Tax Liability and Capital

Depending on the nature of a multinational’s local operations,

a local policy issued by a locally licensed carrier may be needed

to fulfill contractual and/or other obligations.

Consider:

A large South American-based pharmaceutical company and its

subsidiaries sponsor clinical trials around the world. Following

one clinical trial sponsored by the parent company in Europe, 50

individuals sustain bodily injury and are on the verge of litigation.

The local subsidiary, which sponsors most of the clinical trials in this

same country, has a local insurance policy that expressly provides

clinical trials coverage. The parent company (and sponsor of this

trial) only has a global policy issued in South America.

The Ethics Committee responsible for approving the clinical trial

requires that, as a condition precedent to approval, the trial

sponsor be insured by a carrier licensed in the country where the

trial is conducted. The parent company did not obtain this requisite

local policy, and now faces potential regulatory consequences

in addition to the individual lawsuits. Additionally, there may

be ramifications for conducting a clinical trial without proper

approval. On top of the financial exposure, both the parent

company and the local subsidiary may face reputational risk.

Proof of Insurance

Satisfying Local Authorities

Proof of Insurance Questions

When crafting a program for multinational

exposures, consider:

• Are local operations required to obtain insurance from

locally licensed carriers?

• Does a contractual counterparty, government entity or

other party need to be shown evidence that coverage

has been obtained locally?

• Will failure to provide evidence of locally obtained

insurance breach contractual covenants or trigger any

commercial, contractual or reputational consequences?

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Coverage Questions

When crafting a program for multinational exposures,

consider:

• Are there particular insurance terms and conditions

local operations need to be adequately protected?

• Are the necessary terms and conditions available only

under a local policy?

The Greater the Exposures, the Greater

the Need for Local Insurance Protection

The fundamental question facing every multinational is whether

or not to utilize a local insurance policy in a given country

for a particular line of business, either on a stand-alone basis

or as part of a CMP. While posed as a yes or no question, the

complexities in answering it are multi-faceted, and involve the

same analytical skills, judgment and risk assessment that risk

managers deploy on a daily basis.

The more significant the risks, the greater the need for local

insurance protection. A multinational should undertake a

comprehensive risk assessment annually to determine whether

a local policy is prudent in a given country for a given line of

business.

A thorough evaluation should encompass the multinational’s

products and services, physical presence, corporate

structure/capital position, lines of insurance and contractual

counterparties.

Ultimately, the risk manager must consider the local assets,

exposures and individuals at risk.

Products and Services

Whether or not a risk manager wants a local policy in a given

country may depend on the products and services its operation

provides in that country. If the local operation manufactures

an inherently volatile or dangerous product, the risk may

be heightened and a local policy may be wise. A consumer-

oriented product or a high profile product that attracts media

attention also indicates higher risk and is more likely to merit

a local policy. The risk manager should also review if and how

products or services are regulated, what regulatory bodies

are involved and whether prior approval is a prerequisite for

conducting business. Lastly, the types of claims and allegations

that have historically arisen in connection with the local

operation are a key consideration.

Physical Presence

The nature and size of the local operation has bearing on

program structure. For example, does the multinational have only

a small in-country sales office, or does it have a large factory or

an extensive auto fleet on the ground, which heightens exposure?

Whether the local subsidiary rents space or owns real property

could implicate different liability considerations, and may also be

important in assessing the risk.

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Coverage

A Global Policy for Local Risks

Without a local policy in place, a multinational could be left

without coverage for certain losses.

An example:

An organization faces a potential directors and officers (D&O)

lawsuit in Europe. All of its D&O exposures worldwide were

insured under a single global policy, which was issued on a non-

European D&O coverage form.

The potential losses from this oncoming lawsuit may not

be adequately covered under the global policy because the

facts giving rise to the legal action are particular to European

companies, and not expressly contemplated in the non-European

form. The standard D&O form in Europe would have covered this

potential lawsuit.

Evaluating the Risks

Company Structure/Capital Position

A subsidiary’s legal structure and local capital position could

portend whether a local policy is warranted. Different types

of liabilities and considerations come into play depending

on whether the parent company has a locally incorporated

subsidiary or a locally authorized branch. When it is the later,

the risk manager may be especially reluctant to expose the

parent company to the foreign risks of not having a local policy.

How the local subsidiary or branch is capitalized and what tax

liabilities may be incurred if a claim payment were received

from the parent company could be factors. A strong capital

position may afford the local subsidiary the flexibility to forgo

a contribution from the parent. Conversely, a weak capital

position could jeopardize the solvency of the local operation,

necessitating capital from the parent and possibly triggering

significant tax liability.

Lines of Insurance

Type of insurance is another determinant. If the line of

insurance is compulsory, such as auto insurance, the decision

to buy local is easy. However, most lines are not compulsory,

in which case the decision may be swayed by whether the

line is third-party liability or first-party, and/or whether it is a

high frequency or high severity line. Moreover, if crucial terms

and conditions are available only in the local marketplace,

purchasing a local policy will be particularly important.

Contractual Counterparties

Whether or not a local policy would be advantageous

(or necessary) could also depend on local contracts and

contractual counterparties. If the local counterparty is a private

sector company and the contractual obligations are innocuous,

the risk of not having local insurance may be minimal. However,

if the contract is with a local government entity that imposes

obligations to carry insurance from a locally licensed carrier, the

need to purchase local may be clear.

The European Paradigm

Freedom of Services Policies

Companies in Europe may have yet another option

to weigh: Freedom of Services (FOS) policies. These

essentially enable a carrier licensed in one member

state of the European Union to cover risks across the

European Economic Area (EEA).

At first blush, FOS policies may appear to be a complete

solution for a multinational’s European risks. A

multinational could obtain a single policy covering all

of its European risks, and the policy would be deemed

admitted throughout Europe by virtue of the carrier’s

FOS rights. However, nothing is that simple; the use of a

one-size-fits-all FOS policy raises its own set of concerns.

While a FOS policy is indeed considered admitted

throughout the EEA, local requirements in each covered

country must still be addressed. For example, the FOS

policy may need to incorporate specific provisions

unique to each covered country and/or may need to

be translated into various languages. Also, as with local

policies, premium taxes will still need to be calculated

and remitted by the carrier in each covered country.

Claim handling may need to be localized as well. So

while FOS policies distinguish European-based risk

programs from those produced elsewhere and may have

some appeal, they must be carefully considered and

smartly executed.

A Final Note

The debate and discussion over structuring multinational programs will continue. What really matters, however,

is what the various options mean to each particular stakeholder — and the implications they have for a particular

multinational’s insurance program. We believe that the best protection will always be the risk manager’s ability to

make well-informed decisions in covering his or her company’s unique exposures, at home and in every jurisdiction

in which it operates.

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2 The EEA consists of Iceland, Liechtenstein and Norway plus the 27 countries that comprise the European Union (Austria, Belgium, Bulgaria, Croatia, Cyprus, Czech Republic, Denmark,

Estonia, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, Netherlands, Poland, Portugal, Romania, Slovakia, Slovenia, Spain and Sweden).

US0385 0824

The AIG Global

Network

At AIG, our ability to provide local policies and

service the needs of our multinational clients is

virtually boundless. We have licensed carriers

worldwide, that are able to provide local coverage

in over 200 countries and jurisdictions through AIG-

owned operations, AIG licenses and authorizations,

and network partner insurers, keeping clients safe,

compliant and protected across borders.

Even more important than our geographical reach

are the experience and servicing capabilities that

come with it. We have more than 500 multinational

insurance professionals dedicated to underwriting

and servicing global programs, and can draw on

our claims professionals located around the globe

to serve our clients wherever they operate. Our

member companies issue more than 52,000 local

policies annually for over 8,000 clients.

Our multinational clients and brokers reap the

benefits of in-country underwriting, claims

expertise and resources accumulated over

decades. A knowledge of local practices and

customs is ingrained in our operations. We have

forged long-standing relationships with local

professionals, such as law firms, engineers,

adjusters and regulatory bodies, to serve our

clients’ local needs. Our local policies provide

access to our network, and all of the capabilities

that come with it.

Biography

David Halperin is Deputy General Counsel, AIG General

Insurance. In this capacity, he oversees the Legal function for

the AIG Multinational business, among other things, working

with regional and country counsel and other stakeholders

around the world. Additionally, he works on other key

initiatives and cross-border issues integral to the mission of

AIG General Insurance.

Prior to assuming this role, Dave was Deputy General

Counsel for AIG’s Global Product areas and was also

responsible for overseeing the WorldSource, Aviation and

Warranty Divisions of the company.

He joined AIG in 2001 as Assistant General Counsel of

Risk Management.

David earned a B.A. from Colgate University and a J.D.

from Rutgers School of Law.

AIG General Insurance

1271 Avenue of the Americas, New York, NY 10020

[email protected] | www.aig.com/multinational

Nothing herein should be construed as providing legal or tax advice and is not intended to be relied upon or used for the purpose of making any legal or tax recommendations to another person or entity.

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