As the sale of offshore products become more mainstream, investors should consider which jurisdiction offers them the best protection
Cross-border, commonly known as 'offshore' life insurance products, have been a feature of the UK investment market for the past 20 years or more.
However, for much of this period, such investments have not always been considered by a significant number of UK resident investors, despite their recognised tax advantages. While there has been interest in the UK in cross-border products, coming from both mass affluent customers as well as truly high net worth UK resident individuals, such products have been seen as representing a niche market.
These mass affluent clients are advised by UK intermediaries, who identify their tax planning needs as part of a general fact-find advice process.
In more recent years, however, a number of factors have driven growth in offshore sales and have resulted in a much wider appreciation of the benefits of 'offshore' investments and single premium cross-border life business into the UK growing by more than 30% per year between 2003 and 2005.
The factors, which have driven growth, can be summarised as follows:
• The restriction or removal of many tax management programmes by HM Treasury, leaving life insurance-related tax planning as one of the few mainstream avenues for legitimate tax mitigation.
• Discretionary asset managers utilising portfolio bonds to provide an efficient 'tax wrapper' for their client's existing collective investments.
• The recovery in stock market performance, a desire for greater asset diversification and the growth in alternative investments.
• The increasing number of people whose wealth exceeds UK inheritance tax relief thresholds.
This growth would not have been possible without consumer and adviser confidence in the cross-border jurisdictions from which these propositions are manufactured. Today individual companies tend to compete more on their service levels, financial strength and technical expertise rather than seeking to exploit differences in regulatory practice or jurisdictional arbitrage. Despite this, differences with regard to regulatory regimes which apply between jurisdictions are still evident which, while broadly neutral in totality, are nevertheless interesting to compare.
An increasing number of major financial services groups have driven the growth of cross-border business sold in the UK, by establishing cross border life companies in Dublin, who now compete with the long standing players in Luxembourg, Guernsey and the Isle of Man. What was once a very niche sector has now become a more mainstream business activity relevant to many different groups of investors. As the cross-border market into the UK has developed, much of the traditional resistance to this form of business has been addressed:
• cross-border is too expensive - reduction in yield comparisons show that cross-border propositions are now highly competitive in this area. The cost of cross-border products into the UK is not the issue it once was.
• Administration and service levels are poor - companies have invested substantial amounts in administration technology and the outsourcing of specialist functions to third party administrators while at the same time retaining the personal touch required by advisers in this market segment. The maturing of the sector has ensured that staff handling this business are now generally more experienced and better trained. While there is always room for improvement, compared to 10 years ago, the difference is quite noticeable, with companies such as Prudential International investing substantial sums in enhancing the overall adviser and customer experience.
• Technical support is patchy - the role of product providers in providing technical support to advisers has now extended beyond decision trees and advice on which forms to fill in. Today life companies have differentiated themselves by employing technical personnel who are likely to be ex-HMRC employees or tax professionals. These technical experts are typically involved in supporting adviser activity and the development of new propositions and estate tax planning solutions.
Points to consider
When assessing consumer protection frame-works offered by a jurisdiction, there would appear to be a number of measures to consider:
• The minimum solvency margin requirements and the financial reporting requirements imposed on the life insurance firm.
• The segregation of policyholder assets and liabilities from the life company's shareholder assets.
• The requirements relating to the external management or custodianship of policyholder assets.
• The existence of any formal policyholder compensation scheme triggered in the event of a life company becoming insolvent.
• The provisions in place relating to the winding-up of a life insurer and any preferential treatment for policyholders.
Ireland, Luxembourg and the Isle of Man all operate minimum solvency margin regimes for consumer protection purposes, however the solvency margin requirements for companies based in both Luxembourg and Ireland are higher than those that apply in the Isle of Man.
The approach of the three offshore jurisdictions to the segregation of assets and liabilities is broadly comparable. The high proportion of unit-linked business associated with cross-border business largely ensures that life company and policyholder assets are managed and accounted for separately as a matter of course.
Luxembourg requires that custodianship of policyholder assets is placed with an approved third party custodian, usually a major bank. Although neither the Isle of Man nor Ireland prescribes such a requirement, both regulators have the power to require assets to be placed with a third party custodian if they consider that an insurer is in danger of becoming insolvent. So, despite Luxembourg's apparent 'advantage' with regard to the custodianship of policyholder assets and liabilities, in reality the measures in all three offshore jurisdictions provide an equivalent level of 'flood defence' in the event that a product provider gets into financial trouble.
In Luxembourg, policyholder protection is addressed via the custodianship regulatory requirement to appoint a custodian bank, while the Isle of Man has a policyholder compensation scheme in place.
However, investors can probably draw most comfort when they purchase a policy from a company that is both part of a strong financial services group and is subject to a robust regulatory framework.
In addition, where a UK resident purchases a policy from an EU or EEA-based cross-border product provider, for example based in Dublin, they can avail of the UK Financial Services Compensation Scheme (FSCS). The FSCS applies to any policyholder of an EU/EEA cross-border insurance provider if it has completed all EU freedom of service notifications and the policyholder is habitually resident in the UK when affecting the policy.
The FSCS is the UK's statutory fund of last resort for customers of authorised financial services firms. This means that FSCS can pay compensation if a firm is unable, or likely to be unable, to pay claims against it. FSCS is an independent body, set up under the Financial Services and Markets Act 2000 (FSMA).
Ireland and Luxembourg have both implemented the EU directive on the winding-up of insurance undertakings, whereby on the winding up of an insurance company any obligations under insurance policies have first call on the assets making up the technical provision or reserves of the company, as well as other assets. The Isle of Man is not subject to EU directives but includes similar winding up requirements within its Insurance Act 1986. Again, the pattern is broadly neutral across the three jurisdictions.
Based on this high level review of consumer protection measures as they relate to UK resident investors, it is difficult to state categorically that any of the three offshore jurisdictions are 'better' than the others.
Many of these protection measures are only triggered on the occurrence of the 'nightmare scenario' of product providers becoming insolvent, but with the financial strength of the parent companies standing behind many of these cross-border companies, and their wish to avoid the reputational fallout of a failed company, this is unlikely.
It is therefore pleasing to note that as the cross-border life sector becomes more mature, the three main jurisdictions supplying the UK market are of a high standard, and that competitive advantage is now being driven by commercial rather than regulatory considerations.
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