They may change form, but taxes and regulations never really go away. How, then, do risk managers handle the compliance challenge?

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Compliance is an area that looms large for risk managers, and perennially so.

The issue of regulation and tax compliance is always raised during discussions about international programmes. But how important is 100% compliance, and where are the potential hot spots?

“The big compliance topic continues to be tax,” says Tony McHarg, head of multinational and alternative risk, Asia-Pacific, at AIG. “Authorities are always looking for additional revenue sources, so tax is certainly an area that needs focus.”

McHarg cites China’s recent expansion of value added tax (VAT), which will inevitably lead to complex collection and administration issues.

“New country-by-country reporting requirements will result in increased scrutiny by tax authorities around the globe and invariably lead to increased audits and administrative burdens,” he adds.

Praveen Sharma, managing director, global practice leader, insurance regulatory and tax consulting at Marsh, says that before addressing any regulatory and tax compliance issues, multinational companies (MNCs) must first consider the need to enter into an insurance arrangement at all.

“The question that the MNC must ask is, what is the value of insurance to the MNC? In this respect, it should go through a thorough evaluation of whether the insurable risk is either legally or contractually required in a particular country.”

Sharma says that following such a consideration, an MNC should determine its group and entity-level risk appetite and risk tolerance.

“Finally, the MNC should evaluate its expected or potential maximum loss, or EML/PML, that falls outside its risk appetite and risk tolerance limits and it would then wish to transfer to the insurance markets.

“If the EML/PML is significant, then a local policy with appropriate limits should be put in place.

“Such a local policy with limits equal to the EML/ PML would ensure that the premiums and taxes, and eventually claims, are paid in country – in the agreed currency – to the local loss-making entity, that would not only be compliant but also mitigate any potential adverse corporate income tax costs.”

To ensure that the MNC manages the ‘3C’ principle – total cost of risk, widest possible coverage and as far as possible compliant – the master policy with difference-in-condition and difference-in-limit (DIC/ DIL) clause should still be considered, says Sharma, as it would cover the MNC for catastrophic losses that could not be foreseen, such as a ‘sleep-easy policy’.

He adds: “The MNC should be aware that if it focuses purely on being ‘100% compliant’, then it could compromise its objectives on managing the total cost of risk and coverage, as it will only arrange local policies to full limits with local insurers and no master policy.

“Consequently, the DIC/DIL issue will not be addressed and could leave the MNC uninsured for certain types of events. Such a practice would go against good corporate governance of managing the risks to its assets and people.”

Sharma says the global insurance programme of the MNC, particularly for product liability and business interruption risks, must follow its internal business model. “In this respect, the risk manager should work closely with representatives from the MNC’s tax and finance departments to understand the internal business and inter-company arrangements to assess which legal entity within the MNC could suffer a loss beyond the risk appetite and risk tolerance limits.

“The risk manager should also work closely with its risk advisers and global insurers to understand the insurance regulations of the countries in which the loss-making legal entity or operation is based.”

The next stage towards achieving a greater degree of compliance, Sharma explains, would be to ensure that the premium allocation methodology for the master and excess policies are not only on a “just and reasonable” basis but is also “equitable, robust and defensible”.

“At present the regulatory and tax authorities in many countries are reviewing, modifying and tightening their respective laws and regulations, and therefore it is imperative that the risk manager obtains relevant and timely information to ensure that the global insurance programme is structured in accordance with the insurance and tax regulations.

“Finally, the risk manager should ensure that it goes through hypothetical claim scenarios at renewal stage, to ensure that the global insurance programme will respond according to the expectations of the MNC and that again there are no surprises for the MNC.”