The IRS May Tax Your Next Claim Payment and Other Reasons to Review Multinational Insurance
Any time a company takes its business across borders, things can get a little complicated from both an operational and legal/regulatory standpoint. In the midst of sorting out the physical and financial logistics of an expansion, one critical component can easily fall off the radar: multinational insurance.
Relying on a U.S.-based global policy may not be sufficient when other countries require coverage be purchased from locally-licensed insurers.
“If you have an insurable interest in another country, you should be buying insurance locally so the policy is consistent with local insurance regulation and tax law,” said Alfred Bergbauer, Head of Multinational Underwriting, The Hartford. “Whether or not your policy is locally-admitted has significant implications for what your insurer can and can’t do on your behalf in the event of a loss.
“The vast majority of insureds and their producers fail to recognize these implications.”
Here are five unpleasant consequences of not using locally admitted insurance that multinational companies frequently overlook:
1. The IRS may tax you.
U.S. insurers that are unlicensed in a foreign country may face restrictions on how they can legally disburse claims payments into that country. Instead, they may have to reimburse insureds directly in the U.S. The Internal Revenue Service could view that influx of cash as income rather than payment of an insurance claim. As such, the amount could get taxed as income (up to 21 percent).
“Under such a scenario, you could, effectively, receive as little as 79 cents for every dollar of the claim,” Bergbauer said.
“If the loss occurred outside of the U.S., the IRS could view the claim payment on a U.S.-based policy as a taxable event.”
2. The country where the loss occurred may tax or penalize you.
The law of the land where the loss occurred may also not recognize the disbursement as a claim payment since it may not recognize the insurance policy as legal. Accordingly, there may be taxes or penalties that attach to the subsequent payments made through an unlicensed insurer.
“China, for example, has a rule that applies a financial penalty of up to five-times the amount of money paid through an unlicensed insurer. Depending on the claim amount in question this could cause potentially dire results for a company that utilizes unlicensed insurance to cover losses in that country.”
On small losses, losing a chunk of the claim payment to fulfill tax obligations and penalties may not cause more than a hiccup in a company’s cash flow. On major losses, however, tax and penalties could become multiples of the claim payment and become a significant balance sheet event.
“Because of the way the insurance is structured and the taxation and penalties that can be applied, a company can get themselves into deep financial trouble and not be able to cover their obligations,” Bergbauer said.
3. Your insurer can’t effectively manage your claim.
“When an insurer is providing coverage for a client where licensing is required and they’re not licensed, that alien insurer may not be able to adjust a claim on behalf of a client. It may not be able to send in a third-party adjuster, or hire legal counsel. It may not be able to represent a client in a court case. For future claims, it may not be able to pay a first party claim for property, or pay a third party a claim,” Bergbauer said. “A lot of people don’t know that, so when a claim happens, it is the customer’s obligation, responsibility and duty to manage that claim within the market where they have the laws.”
In other words, the insurer will not be able to fulfill the obligations that their client expects them to fulfill. When the value of an insurance policy rests in the payment and administration of a claim, the failure of an insurer to deliver on these promises can come as a shock to clients and sow distrust and anger.
“Companies are typically ill-equipped to manage the complexities of a claim themselves, and will understandably get angry with their broker and their insurer for not being aware of these implications or not providing any education on them,” Bergbauer said.
4. Regulatory non-compliance may result in legal action.
To extend coverage to insurable assets overseas, a common practice undertaken by some carriers is to change the jurisdiction of a policy to state that it responds globally. While that may suffice as a legal contract in the U.S. where the policy is issued, it may not be recognized as a legal contract compliant with insurance and tax regulations in other countries where licensing is required.
“Policies from an insurer that is not locally licensed in that country may be prohibited by law,” Bergbauer said.
“Depending on the country, there are ramifications like taxes, fines, seizure of goods, disruption of business activities, and even jail time for executives.”
Though the laws haven’t changed much over the past 30 years, enforcement of them has.
“Regulators globally have started doing spot audits to look at insurers, brokers, and insureds and specifically looking for evidence of unlicensed insurance in their jurisdictions,” Bergbauer said. Tax and insurance authorities are increasingly collaborating on this front, both within individual countries and across borders.
“There is a strong practice of bilateral and multilateral agreements between regulatory authorities where there’s a known trade across borders. Continental Europe is very active, so is the Asia Pacific,” Bergbauer said.
5. Your corporate reputation will suffer.
In addition to the financial consequences of unlicensed insurance, companies also earn a reputation as a poor global citizen. Many healthy economies are built on the backbone of fixed investments by insurance companies and tax revenue associated with premium transactions. When corporations attain policies from unadmitted carriers, they essentially rob the country that’s hosting their business of revenue.
“Companies found guilty of breaking the law can easily end up on the front page of business publications, and it’s all part of the public record,” Bergbauer said. “So the stakes are high, not just from a business or insurance performance perspective, but from a broader reputational impact.”
Bergbauer suggested that the best way to avoid these unpleasant surprises is to work with a broker and an insurer who understand all of these implications, are willing to educate clients about the risks, and take the time to discuss all options for insurance program structure.
“Some brokers are looking for the most competitive price, and they buy insurance based on premium,” he said. “But in reality, insurance is a sophisticated financial instrument. The way you structure your program should fit within your own risk tolerance, asset management, tax structure and cash flow characteristics. It’s worth taking the time to run through worst-case scenarios and determine how you want your insurance to respond.” &