Global liability coverage
Article 7 minute read

Global liability coverage

28 July 2020

Global directors and officers liability (D&O) insurance coverage guarantees the attention and focus of the board – especially when their group captive is participating on the programme - on a direct or reinsurance basis.

Aside from the more obvious key strategic considerations around arm’s length, non-indemnifiable and ‘insured versus insured’ claims, in determining appropriate involvement of the group captive, there are further key considerations to ensure compliant implementation and administration of the insurance programme.

Most commonly, captives participate in side B and C coverage of multinational D&O insurance, and when it comes to considering the compliance of their programme, the Insurance Premium Tax (IPT) rates and application themselves, are straight forward. A relatively modern non-traditional class of insurance, D&O is rarely referenced in local tax legislation, and therefore doesn’t generally trigger different treatment to the local default tax rate. For example, within EU/EEA classifications of non-life insurance, for the purposes of IPT compliance, D&O falls within class 13, general liability. Coverage does not tend to attract any of the parafiscals, additional charges, levies or compulsory pools to add to the complexity involved in tax treatments applicable to other lines of business such as property damage.

However, on a global D&O programme, whether written on a direct or reinsurance basis, there are considerations in the structuring of the programme and policies, to be addressed, as they can impact the tax due in addition to determining who is responsible for reporting and settling the taxes in each territory. 

Location of risk

Tax treatment globally will differ dependent on where the risk and subsequent coverage is identified. Directors and officers often have responsibilities wider than the jurisdiction in which they are physically located. Support from insurance partners and brokers, in conjunction with understanding the group structure, will determine where and how coverage is required. Risk transfer pricing considerations are also a factor here. The resultant programme structure will drive potentially differing tax consequences, further considered below.

Freedom of services

For EU/EEA based captives, passporting allows direct underwriting, with the insurer responsible for collection, reporting and settling of the various premium taxes to the local authorities. A direct write captive therefore must assume or outsource responsibility for understanding local tax rates and their application, and ensure where appropriate, the costs are built into insurance premiums to avoid erosion of underwriting profits. Although under the umbrella of EU/EEA defined legislation, when it comes to insurance premium taxes, each member state can apply its own, unique tax regime on insurance. It is important that the captive is fully conversant of the differing rates, tax points, payment and reporting deadlines to ensure compliance in all territories.

Non-Admitted versus reinsurance

In North America, a key area for a global corporate with D&O exposure, captives can no longer benefit from the regulatory passporting benefits available in the EU, and very different IPT considerations arise. The captive could choose to partner with a fronting insurer, providing locally issued policies, then reinsured into the captive, or conversely, include north American entities on a direct write, non-admitted basis. 

Fronted policy

Insurance taxes in the US are myriad. As with the regulation of insurance in the US, taxation is at the discretion of the state and can even be at a county or municipal level. In addition, retaliatory taxes (an additional tax where the insurer’s state’s insurance tax rate differs to the tax rate of the state they are selling in) and surplus lines tax (if written on a surplus lines basis) can come into play. Fortunately for captives underwriting US business on a reinsurance basis, all of this is the concern of the fronting insurer.

Typically, insurance premiums paid to a non-US insurer are subject to 4% FET, and reinsurance premiums at 1%.  There are a number of jurisdictions that hold a treaty with the US allowing for an exemption from FET. Depending on the captive’s domicile, it may be possible to avoid this extra cost. Entering into a closing agreement with the IRS, which identifies an insurer’s eligibility for the exemption, is an option sometimes taken to provide certainty. This can, however, create additional administrative burdens.

If FET is due, the IRS will normally hold the entity making the payment liable to account for the tax, but almost any party involved (insured, policyholder, broker or insurer) can be held liable.  The captive should, therefore, understand if FET is due and, if so, who is paying it, so that they or any other parties to the transaction, do not get an unexpected tax bill further down the line. 

US FET is unusual in that it taxes reinsurance transactions, but it is not alone. The use of a local policy will pass all local tax compliance issues to the local fronting insurer. This doesn’t albeit avoid erosion of underwriting profits when premiums haven’t factored in additional taxes on reinsurance premiums.

Non-admitted coverage

When writing direct non-admitted business, tax considerations change again, with compliance obligations often falling to the local policyholder or insured entity. Many countries will tax insurance through a VAT or GST regime, and in the absence of a local supplier, the local policyholder may need to account for these through their broader VAT or GST declarations.  This should not represent a significant burden to the local policyholder’s tax department.  Alternatively, withholding taxes, in lieu of income tax being paid by a local insurer, may be deducted from the premium payment and settled locally.

In Canada, again the programme structure will drive tax compliance requirements. Presence of an authorised broker, in the province the policyholder or insured is located in, will determine provincial sales or insurance tax due and any local policyholder filing obligations. 

It is important to mention, when considering Canada, that insurance taxes of potentially 50% in Alberta, can kick-in when the business is written on a non-admitted basis, and starkly contrasts the rate of 4% applicable to admitted insurance. Varying sales and insurance premium taxes in each province will likely be due from the local policyholder, creating potential monthly compliance obligations. 

Canadian federal excise tax will be due regardless of the province in which the local insured entity is located. Whilst certain coverages such as life, sickness or marine can benefit from an exemption, a D&O premium is likely to trigger the excise tax. Premiums paid to an overseas insurer by a Canadian entity, or where the contract is entered into on behalf of the Canadian entity, require the Canadian resident entity to account for 10% excise tax on the premium, making the relevant declarations and payments to the tax authorities. Legally the responsibility does not lie with the overseas captive.

Clear dialogue between the captive and insureds is important to avoid this annual declaration being missed.  

Financial interest clause

Financial interest clauses (FINC) continue to be used to the effect that the parent company is the only entity insured, covering its financial interests in its subsidiaries rather than the subsidiaries themselves. Again the captive will need to weigh up the pros and cons of this approach including regulatory considerations, cost implications and impact on any claim settlement. The FINC is unlikely to be suitable for side A business, as the parent company will have no financial interest in the individual.

The most common practice for IPT compliance with use of a FINC, is to apply to the whole premium relative to the financial interest clause in the domicile of the parent company. The IPT regime of this domicile is where tax liabilities are subsequently filed. But as this type of arrangement has been tested very little, if at all in in the tax courts, a tax office could take a different view, considering the substance of the arrangement is actually one of insurance in the jurisdiction of the subsidiary.

Inevitable complexity

A single territory D&O policy tends to be one of the easier coverages from an IPT perspective. Global programmes, by their nature, cover many jurisdictions, multiplying the complexity. This is further compounded by the many different ways there are of covering the risk. It is inevitable that a captive is going to cover multiple jurisdictions in a variety of ways, due to the nature of the size and complexities of their parent. A good awareness of, and preparedness for, the IPT consequences as the programme is being designed enables the captive, its parent, and its insurance partners to focus on their key objectives rather than IPT.

Need more information? Make an enquiry with our IPT team.

This article was originally published by Captive Review.

Written by

Karen Jenner

IPT Client Engagement Director Accounting & Tax

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