So, why exactly would you need a fronting or local policy? You have your Professional Indemnity Insurance (PII) covering you globally, after all. Why pay for more cover than you need?
There are many great reasons – regulatory compliance and ease of local trading, to name two. We'll be explaining more on this today in the hopes that you'll be better armed with the information you need to make the right decision for your business and the clients you serve.
Your PII may not be enough
You'll be aware that as an international firm, your PI policy will respond to claims made against you anywhere in the world. Complications arise, however, when you are contracting for services in a foreign jurisdiction with a third-party 'in-country' client.
Although the PI policy responds to claims emanating from those in-country clients, your global insurers often aren't locally licensed. This can cause issues, especially if the client contract dictates otherwise.
A global insurer that is not licensed in an overseas jurisdiction may result in your insurers having to pay the parent company via a Financial Interest (“FINC”) clause (subject to the terms of your policy). This could mean you are subject to additional taxes or restrictions (movement of capital) in transferring this claim payment to the overseas entity. Additionally, your local directors may be in breach of local legislation by not purchasing local cover and therefore can incur penalties in the way of fines or, at worst, imprisonment!
Admitted versus Non-admitted territories
Some territories allow your global insurers to provide direct coverage to the overseas entity even if they are not locally licensed (“admitted” policies). However, many restrict insurance cover being provided by a non-locally licensed insurer, making the global policy “non-admitted” in that territory.
In the pre-Brexit EU, UK insurers can be licensed under Freedom of Services (FoS) legislation. However - and especially as Brexit looms - it could well be that the FoS is no longer available to firms utilising UK domiciled insurers.
To that end, it's important to understand the regulatory principles that apply - and any possible solutions for both the EEA and those outside of Europe.
What is Fronting?
The application of fronting is the use of a locally licensed insurer to issue an insurance policy to your overseas subsidiary on behalf of an insurer of a global programme without the intention of bearing any of the risks.
The risk of loss is transferred (usually 100%) back to the global insurer via a reinsurance agreement (reinsuring the local “fronting” insurer) for a small fee. Any limit is, therefore, part of the overall global programme limit and, ideally, should upon the same terms where permissible.
This means that there is a locally licensed policy available in the overseas territory and the local insurer is the one to pay any claim to a local claimant upon the proviso that they are reinsured by the global programme. A neat, cost effective solution to managing risk.
Why Fronting?
In short, the insured receives a policy that's issued by a locally licensed insurer, allowing local insurance certificates to be issued (often required in contract) and tax deductibility on global insurance premiums. It's easy to arrange and allows you to rely on the extent and security of your global insurers.
Fronting facilitates the payment of insurance premium tax to local authorities. Even better, associated costs are relatively low when compared to the cost of a local policy; typically the fronting fee is 5%-15% of the local premium otherwise payable, subject to minimums.
Issues with Fronting
Recent years, however, have seen insurers in some jurisdictions become increasingly reluctant to participate in fronting arrangements without taking a percentage of the actual PI exposure. .
Local insurers usually provide arrangements for global insurers involving small indemnity limits, and may be unwilling or unable to issue high limits of indemnity. Further complications arise from the in-country entity being only insured to the limit fronted. You may, for example, be taxed on the additional percentage of claims remittance over and above the amount of the claim.
Lastly, the market security of the local insurer may not be to a comparative standard to the insurers of the global policy.
What is a Local Policy
A pure “local policy” operates slightly differently. In many territories, fronting is not permitted, leaving local policies as the only option.
They are, essentially, policies of first response. They operate on a standalone basis and should be administered in conjunction with a global programme to avoid issues around coverage disputes.
Local policies are intended to respond in the normal fashion in the event of a claim with your global policy sitting DIC/DIL (Differences in Conditions/Differences). In essence, the global policy sits over and above any local policy while compensating for gaps in local coverage.
Why a Local Policy?
For one, fronting isn't always permissible in certain territories; a true local policy gives more surety around “in-country” claims and is a more compliant way of meeting local laws.
Locally prescribed wordings, terms and conditions are also more easily incorporated into local policies. If they're arranged correctly, your global policy can still interact and sit on a DIC/DIL basis. This ensures there are zero gaps in your coverage.
However, just as with fronting, there are also issues with local policies that you should be aware of.
Issues with Local Policies
Arranging a local policy means that the control usually enjoyed by your global programme can be lost - claims might have to be dealt with locally on the terms and conditions of the local policy. Whether culturally or legally this might be a very different approach to what is traditionally enjoyed.
Local terms and policy conditions can also be more restrictive than would be the case under a global policy. They also may cost more, with the added challenge ensuring the allocation of local premiums is managed adequately.
Lastly, placement needs to be managed carefully. It's important to ensure you're compatible with the overarching global policy; technically, the local insured is being covered separately – any policies must be suitably endorsed to avoid issues around integration.
Don't 'OverFINC' it
In tandem with any other solution, it's also possible for you to have a Financial Interest Clause (FINC) on your PII policy.
The goal of a FINC is to indemnify the parent Insured in respect of any entity in which the Insured has a financial interest, thereby clarifying the intent of the placement in any territories whereby non-admitted insurance is not permitted.
Whilst an attractive solution simply by virtue of ease and cost, you should be aware that it means that an Insured may have to negotiate the payment of funds from their parent company to another territory, thereby making any claim payment subject to taxes and exchange rate issues.
Not every FINC clause will be the same and not every global territory will be subject to the same rules.
If you'd like more advice and clarification on local and fronting policies, please get in touch with your Lockton advisor who can guide you through to your best possible solution.