You may think you know it all when it comes to covering your operations, but think again. Your innocence may astound you

Multinational companies (MNCs) often develop a set of template commercial contracts and operating policies specifically for their business operations and expansions in China. These templates are normally tailored from a PRC law perspective, based on the MNC’s offshore headquarters templates. However, it appears that many MNCs in China tend to use the same insurance provisions and policies that their headquarters use, without tailoring the insurance policy requirements and standards specifically for their China business.

 MNCs may require products like personal accident coverage without knowing the ground rules.

MNCs may require products like personal accident coverage without knowing the ground rules.

In a recent transaction involving the Chinese subsidiary of an MNC that wanted to engage a Chinese engineering consultant, it only took a few days for this company and the consultant to agree upon the major terms of the consulting agreement. However, the execution of the agreement was delayed for two months, simply because the parties were not able to agree on insurance terms and the company had little discretion to modify the insurance language in the MNC’s template for consulting services agreements. We believe that many MNCs encounter the same problem in China.

Unexpected problems

Not surprisingly, this happens to many MNCs that have global policies for insurance, which require their suppliers – including suppliers of goods and service providers – or contractors to procure insurance coverage according to the types of insurance and minimum amounts set forth in the globally applicable policies. Some MNCs require their suppliers and construction contractors to take out employer’s liability insurance, public liability insurance, professional liability insurance and business automobile liability insurance, along with additional types of insurance depending on the nature of the contract (such as collective casualty/personal accident insurance for construction workers and aircraft liability insurance for construction contractors). The typical amounts of insurance required are in the range of US$1 million.

These policies may have worked well in the US or other developed countries, but some MNCs may find it difficult to implement these standard insurance policies in China. Very often, the business teams of these MNCs may have little or no authority to modify such policies and they end up waiving many of the insurance requirements for their contracts after difficult negotiations that ironically result in no insurance coverage at all. Alternatively, some MNC contracts with suppliers may contain minimum coverage requirements that mirror the requirements applicable in other countries, but the business units often do not confirm whether such insurance obligations of the suppliers are enforced or not.

At the other extreme, some MNCs turn to arrangements other than insurance for protection. In lieu of insurance, they require their suppliers to provide a performance bond issued by credible banks to ensure performance of a contract, or they may retain a portion of the contract price (5% to 10%) during the warranty period. They rely heavily on the process of selection of reliable suppliers and believe indemnity clauses in a contract backed by a bond or retainer provides them with good protection. Such arrangements may work well in some cases, but will prove inadequate when serious accidents happen.

Many MNCs are weighing the impractical insurance coverage provisions and the risks of zero insurance coverage protection, and are seeking practical solutions.

Source of the problem

There are multiple things that can cause difficulties for MNCs trying to implement their standard insurance policies in China. To begin with, MNC policies for insurance may not have been fully localised or customised for use in China, which causes various problems. The required amount of insurance may be unusually high for certain types of insurance. Take business automobile insurance, for example. It may be difficult to get coverage in an amount higher than RMB1 million (US$157,000) in China. Requiring at least US$1 million in compensation for automobile accidents appears unreasonable or unusual for Chinese suppliers or contractors, considering that damages awarded for car accidents are much lower than in the US.

Compensation for death or injury from car accidents in China is linked to per capita income.
Compensation for death or injury from car accidents in China is linked to per capita income.

In China, the compensation for death or injury from automobile accidents is linked to the annual disposable income of urban residents, or the annual net income of rural residents per capita in the victim’s area for the preceding year. For example, if an automobile accident causes the death of a Beijing resident in June 2012, the compensation for the death will be RMB658,060, (US$103,000), which is 20 times the annual disposable income of Beijing residents per capita for 2011 (RMB32,903). Other damages or losses could also be available to the victims or their families, such as emotional distress compensation, which usually ranges from RMB50,000 to RMB100,000. The level of compensation for death or injury varies from region to region. Outside Beijing, compensation for a death may be much less, since the annual disposable income of urban residents, or the annual net income of rural residents, can be much lower. For example, the compensation for death of urban residents in Hubei province is just RMB367,480 for 2012. Automobile owners in China are also required to take out compulsory motor vehicle accident liability insurance, which can be used to cover compensation for death or injury caused in automobile accidents first, and the shortfall can then be covered by business automobile insurance. Given the above, requiring at least US$1 million in compensation for automobile accidents appears unreasonable or unusual in China.

Another factor is that insurance products may have different names or functions in China. The coverage of public liability insurance is one example. Public liability insurance is a policy designed to cover a business when it is legally liable to pay compensation for personal injury or property damage occurring to members of the public within the geographical boundaries specified in the policy, and caused by an occurrence connected with the business or its products. In some countries, public liability insurance usually includes product liability – which protects a business against injury to customers, and damage to their property, as a result of a product it sells or supplies – and is known as public and product liability insurance, or alternatively, public liability insurance can be extended to include product liability insurance.

We have seen insurance provisions regarding public liability insurance in some MNC contracts requiring coverage of product liability. This provision may work in countries like Australia, but not in China, because public liability insurance in China does not cover product liability, and public liability and product liability are usually covered by different policies. Therefore, requiring suppliers in China to obtain public liability insurance in order to cover product liability will cause confusion and may result in no coverage for product liability.

On the other hand, historically Chinese suppliers and contractors are unwilling or reluctant to procure insurance. Many Chinese companies do not fully understand or appreciate the importance of insurance, and some Chinese companies will even ask MNCs to pay for their insurance. In their view, insurance is not part of the standard practice in China – for example, employer’s liability insurance is much less common in China than in the US – and unnecessary insurance will increase their costs and reduce their profit margin. Therefore, the ratio of those having insurance coverage is surprisingly low in China. For example, reportedly only 9% of construction projects are insured in China. So in this light, it is not surprising that Chinese suppliers or contractors push back on the insurance requirements of MNCs.

Reportedly as few as 9% of construction projects in China are insured.
Reportedly as few as 9% of construction projects in China are insured.

Due to their lack of experience, Chinese companies also often claim that certain types of required insurance are not available in China, although such insurance or its equivalent can be found. A good example may be professional liability insurance. MNCs often require their service providers to obtain professional liability insurance if professional services are involved. Few Chinese insurers are able to offer such insurance, and the insurance, when available, is mostly limited to traditional professions such as design, legal or accounting services. Most Chinese companies are not aware that professional liability insurance may extend to professionals other than designers, lawyers and accountants. Since the development of the Chinese insurance market is uneven, some insurance available in first-tier cities may not be available in second- or third-tier cities – another reason that some Chinese companies claim the required insurance is unavailable.

To make matters worse, while most Chinese suppliers or contractors are inexperienced in insurance matters due to lack of relevant training, some MNC employees in China negotiating contracts do not fully appreciate the significance of insurance, or understand what is exactly required under the policies as well as the reasons for these requirements. As a result, they cannot effectively convince Chinese suppliers or contractors of the necessity of insurance, or assist them in locating the correct products from the right insurance companies.

Take expert advice

Delays in reaching an agreement on insurance will adversely impact the business of MNCs. First of all, the negotiation process may be prolonged. Second, without the right to modify the policies, or by not knowing how to revise insurance language, the business teams of MNCs often have to waive the requirements, resulting in no coverage for their corporations in China, although their operations in China may be covered by insurance carried by their headquarters.

To solve these problems, many MNCs have realised that their global policies need to be customised for use in China. It is necessary to revise the insurance language based on insurance products available in China, and to use the correct terminology. It is equally important to set the required amount at a reasonable level, considering the practice in China. Instead of requiring contractors to procure employer liability insurance at a minimum amount of RMB8 million for a limited number of employees involved in the performance of the contract, it may be more appropriate to require compensation of RMB200,000 to RMB500,000 for each employee.

A good local insurance team will ensure your asset is covered.
A good local insurance team will ensure your asset is covered.

MNCs having a problem with their insurance policies in China should seek the assistance of insurance brokers and experienced lawyers. Experienced brokers can not only advise on what types and amounts are usually used in China, but also from which insurers the required coverage can be obtained at the most favorable rate. With the help of lawyers, different templates can be developed for contracts as needed, which can significantly assist in negotiations between MNCs and their Chinese suppliers or contractors.

Some MNCs have only one template for all kinds of service contracts requiring, among other things, professional liability insurance without exception when professional services are involved. In some circumstances, it is desirable to prepare different templates for different service providers. For example, when the design institute engaged to prepare drawings has obtained professional liability insurance and a consulting firm is engaged to review and provide comments on such drawings, it may not be a good idea to require the consulting firm to have the same professional liability insurance as the designer, since the consulting firm only has secondary liability.

Our suggestions to MNCs regarding their PRC insurance policies are:

  1. Locate a reliable and experienced broker to assist in selecting insurers and determining the types and amounts of insurance coverage;
  2. Categorise the commercial contracts into different groups based on the nature and amounts of the contracts, and work with legal counsel and/or an insurance broker to allocate specific types and amounts of insurance policies to each group of contracts;
  3. Establish a feedback system where the business team reports to the head office in China regarding the implementation of insurance policies in each region, and for each business;
  4. Have a locally based insurance coordination team to examine and supervise the implementation of insurance policies, and update the insurance policies in China.

David Livdahl is a partner, chair and chief representative at the Beijing office of Paul Hastings, and has served on the official arbitrator panel of the China International Economic and Trade Arbitration Commission since 2000. Jenny Sheng is a partner at the Beijing office and Daniel Qin is an associate with the firm in Beijing