FINC clauses and their limitations

What is a FINC clause?

A global insurance programme, usually only offered by large international insurers, is designed to protect the policyholder and all of the companies in its group from claims all over the world. It consists of a global or master policy covering all of the group’s operations, combined with local policies for specific companies in non-admitted countries or jurisdictions (i.e. where the global insurer is not licensed to conduct business).

A global policy is designed to respond either in excess of a local policy or policies or from the ground up. However, when loss is suffered by companies in non-admitted countries or jurisdictions there can be issues for insurers in paying the insurance funds to such companies.

Not all insurers have the capacity to provide global insurance programmes that include local policies. Instead, they offer policyholders worldwide cover through a single insurance policy covering the policyholder and the companies within the group.

Problems can arise when losses are in excess of local polices or when local policies aren’t purchased. A Financial Interest (FINC) clause can be added to a policy and is designed to try and protect the policyholder’s financial interest in a subsidiary or affiliated or connected company (all referred to as a ‘subsidiary company’ for the purposes of this note) in those circumstances. The insurable interest arises from the policyholder being adversely affected by a loss of the subsidiary company. FINC clauses in policies generally state that insurers will pay loss to the policyholder where insurers are legally prohibited from paying loss to a subsidiary company.

It is hoped that FINC clauses will allow the policyholder and relevant subsidiary company to avoid regulatory and tax issues, and be a cost effective way for multinational companies to manage their insurances – without the need for many local policies.

However, there are a number of possible issues with FINC clauses to be aware of (this is not an exhaustive list, there may be others):

1. If the insurance funds are provided by the policyholder to a subsidiary company to make it whole for that loss then tax issues can arise. That payment may have local tax consequences for the subsidiary company i.e. it may be treated as corporate income by the local tax authority, or they may impose local insurance taxes and penalties as insurance wasn’t sought locally. Even if the claims proceeds are retained by the policyholder outside of the country where the claim/loss arose the tax authorities may still be able to pursue a tax payment against the subsidiary company.
2. A payment to the policyholder under the FINC clause can also give rise to taxes in the policyholder’s country where the tax authority may take the view that they did not suffer the loss and tax the loss funds at a higher rate than IPT.
3. The amount of insurable loss recoverable under a FINC clause may be restricted by the percentage ownership that the policyholder has in the local operation. Words can be included in the FINC clause to seek to protect around this limitation.
4. FINC clauses have not been tested widely in claims scenarios so there remains a lot of uncertainty around their operation.
5. Practically speaking, FINC clauses do not provide for local insurance servicing or claims and would not seem appropriate for subsidiary companies with high claims frequency or severity, and where the subsidiary company is not appropriately capitalised.
6. For insurance programmes that have multiple insurers per layer and/or various layers be aware that if some insurers don’t follow the FINC clause this can also cause issues in terms of there not being a mechanism for the policyholder to facilitate payment to the local subsidiary.

FINC clauses and D&O insurance

FINC clauses are fairly limiting with respect to D&O insurance. There is also a distinction to be drawn in how they apply to A and B Side claims. We will leave C Side securities claims aside, as it tends to be the policyholder that is the listed company and FINC clauses are less of an issue.

A Side claims are where indemnification of the individual director, officer or other insured person by the company is legally prohibited (or otherwise not required by contract or by the articles of association, charter, by-laws or operating agreement of the company - depending on the policy language) or where the company is financially not capable of providing
indemnification. The insurer pays the loss directly to or on behalf of the insured person.

B Side claims are made by the company against the insurer and are claims for reimbursement to the company for amounts they have spent or disbursed in defending their directors and officers. The company pays the amount to or on behalf of the individual insured pursuant to a legal indemnity and then recovers that amount from the insurer.

A Side claims do not result in a loss to the company. FINC clauses provide for the payment of loss to a subsidiary company in a non-admitted country. They don’t say that the A Side loss of the insured person in a non-admitted country can be paid to the policyholder. In other words, FINC clauses do not change an A Side claim into a B Side claim. This distinction is key. It is worth also noting that there can be conflicts between a director, officer or other insured individual and the policyholder or subsidiary company in the group and practically speaking that individual insured would not want their loss paid to the policyholder or subsidiary company on the basis that entity may then pay it the funds – as it simply may not pay the funds on. FINC clauses therefore do not work for Side A claims.

The position on this has become more relevant in light of Brexit. A number of European countries have legal systems that do not allow for broad based indemnification of directors and officers. It is not something that most of us have had to consider, as the EEA was automatically covered as ‘admitted’. However, if the EEA is now ‘non-admitted’, it is something that needs to be taken into account. FINC isn’t the magic solution. A Brexit-proof EEA compliant solution is definitely the preferred route in that it provides locally admitted insurance and provides for full cover whether a claim is an A or B Side claim.

Even if insurers do agree to pay what is an A Side loss to the policyholder under a FINC  individual insured and the policyholder or subsidiary company), it is then a question of the policyholder moving funds from one country to another. It could then come back to a question of that subsidiary company facilitating indemnification of its directors and officers i.e. is the subsidiary company legally permitted to indemnify that individual.

There could also be tax implications for both the policyholder and the subsidiary company (in having to account for moving funds from one balance sheet to another) (see above) and for the insured person in relation to the indemnity they received.

This commentary represents general guidance on FINC clauses and is not meant to be exhaustive. Other aspects may also exist which are not addressed here. Howden are not providing legal advice and you should look to obtain specific legal advice in respect of how the matters that are the subject of this commentary may impact you.

If you have any questions in relation to the above please contact your usual Howden representative.