Both Luxembourg and Dublin have developed strong cross-border life assurance business. But Dublin is gaining an edge over its continental counterpart, being particularly attractive to UK investors
The offshore life assurance market has traditionally been dominated by three financial centres. While the Isle of Man has been the major player, Luxembourg, and latterly Dublin, have developed as centres for European cross-border life assurance business.
The two centres both offer attractions to investors. However, for UK investors the advantages of Ireland largely outweigh those of Luxembourg, which is reflected in the fact that Dublin is home to three major life insurers selling back into the UK - Prudential, Norwich Union International and Scottish Equitable International.
Luxembourg has successfully developed as a financial centre because of its favourable tax and legal regimes. Like Switzerland, Luxembourg has banking confidentiality and the interest earned on savings is not taxed at source, although this will change with the implementation of the European Union's Savings Tax Directive in 2005. It has been well placed to capture a significant portion of the cross-border financial services market because of its skilled and multilingual workforce and location in continental Europe.
The first driver of Luxembourg's finance centre was the development of holding companies. The 1929 law made them attractive vehicles for non-domestic investors because profits and capital gains tax were not subject to tax. Luxembourg has subsequently become best known for banking and investment funds. There are 176 banks in Luxembourg, most of which are subsidiaries of international groups.
The future for the banking sector has been partly clouded by the Savings Tax Directive but it won an important victory in being allowed to retain confidentiality, which is one of Luxembourg's main attractions.
The Grand Duchy is the leading centre for offshore funds. It has been estimated that more than 50% of all offshore funds and over 60% of those distributed cross-border in Europe are domiciled in Luxembourg. In the first half of 2003, assets under management in Luxembourg domiciled funds grew by 3.79% to e876.5bn (£604.78bn) at the end of July 2003. Luxembourg passed hedge fund legislation at the end of 2002 to try to attract a greater number of alternative investment funds.
The use of Luxembourg by life insurers took off in the late 1980s through the free provision of services cross-border in Europe. It has been estimated that between 1980 and 1990, life assurance premiums grew by an average of 14.7% a year and then by 48.3% a year from 1990 to 2000. There has, however, been a downturn in the number of cross-border life insurers over the past couple of years, due largely to mergers. James Ball of Deloitte & Touche says the number has fallen from 61 in 2001 to 52.
Gaining the edge
Luxembourg once had the edge over Dublin as a centre for life assurance but, according to consultants Boal & Co, Ireland overtook the Grand Duchy in cross-border life business in 2001 and maintained this lead in 2002. This was achieved by Dublin growing its premiums by 22% in 2002.
According to Boal & Co, total new life business in 2001 in the Grand Duchy was e5.4bn, of which e5.1bn was cross-border, but this represented a decline of 10%. There were only three life assurance operations set up in Luxembourg between 1999 and 2001.
By contrast, Dublin made a relatively slow start in developing a cross-border life assurance sector. But by 2001, total cross-border business in Dublin had grown to equal the domestic Irish market at e5.6bn and, between 1999 and 2001, there were 19 life assurance start-ups.
The International Financial Services Centre (IFSC) was set up by the Irish government in 1987 with the Finance Act establishing a special 10% corporate tax rate. From the end of 2002, financial services companies could no longer claim the 10% rate unless they had set up before 1998, which will continue until the end of 2005. Other companies are subject to a 12.5% rate.
More than a quarter of IFSC companies are involved in insurance, including captive and reinsurance as well as life assurance. The fact Dublin is the only English-speaking common law jurisdiction in the eurozone has made it attractive to insurers. Many UK-based intermediaries prefer to invest in Dublin because it offers a highly educated English-speaking workforce.
Like Luxembourg, tax benefits are one of the main attractions of Dublin to insurers and their investors. It has low corporation tax rates, no withholding tax on most interest and dividend payments and tax-free investment income to life policyholders. This enables investors to enjoy gross roll-up through their life policies. They only pay tax on their gains when assets from policies are cashed in or there is a chargeable event.
Dublin is also attractive because of the generally lower costs. This is helped by the fact that the outsourcing of administration is accepted practice in Dublin. In Luxembourg, it is unusual for outsourcing of administration to be permitted by the regulators. Confidentiality laws, a major selling point, also make it harder to outsource administration, particularly outside the Grand Duchy.
Another advantage of Dublin is the greater investment flexibility it offers. Clients can invest in hedge funds and non-Ucits funds through insurance policies as long as certain liquidity criteria are met. Furthermore, all the money in an insurance policy can be invested in a single asset.
By contrast, in Luxembourg, depending on the amount invested, you may not be able to invest more than 20% of a policy's assets in money market or deposit funds while funds domiciled in the Channel Islands cannot comprise more than 2.5% of a policy value in the Grand Duchy. External funds invested in by insurance policies have to be open-ended and must be approved and subject to ongoing supervision by the Luxembourg regulators. Therefore, insurance policies in Luxembourg cannot invest in unregulated funds such as hedge funds and most closed-ended funds.
The Ucits III Directive will allow greater use of derivatives and fund of funds through Luxembourg insurance policies, but Dublin has the advantage of already allowing more flexibility.
This appeals to UK investors who are seeking a wider array of funds than ever before. Whereas there are only about 2,000 unit trusts from which investors can choose in the UK, there are more than 15,000 offshore funds, excluding hedge funds.
The greater choice provides enhanced investment freedom for investors, which in turn can improve the construction of their portfolios through greater diversification and access to the best fund managers anywhere in the world. The wider range of funds available through offshore bonds makes it easier to tailor a portfolio to meet their particular investment objectives and risk profile.
This demand for a wider range of funds is reflected in the growth of multi-manager funds in the UK. These have expanded because of the difficulty for intermediaries and investors in keeping track of the movement of fund managers.
Manager of managers (Mom) funds grant individual mandates for each asset manager to follow through segregated accounts. The money is managed according to the specific wishes of the Mom, so it can be a more effective and transparent way of diversifying the portfolio. The Mom will know the investment approach and holdings of all the underlying fund managers.
Another advantage of the Mom approach is that the funds can gain access to institutional asset managers that are normally inaccessible to retail investors in the UK.
Policyholder protection is usually attributed to the Isle of Man as a unique selling point. However, an EU-wide scheme is under discussion. In Luxembourg, insurers are required to place policyholder assets with a third-party custodian, usually a bank. But Dublin has the same minimum solvency margin requirements as the UK. If an insurance company in Dublin becomes bankrupt, policyholders have priority to assets over all other claimants.
Ireland relies on the statutory appointed actuary within its regulatory framework, so its regulatory approach tends to be more 'hands-off' than Luxembourg's. Companies design and price products, calculate reserves and manage their businesses within a regulatory framework that relies on professional actuarial responsibility. This has enabled life insurers to design more innovative products and to bring them to market more quickly. Certainly the regulatory approach is lighter than in the UK and Luxembourg but stringent enough to protect investors.
Luxembourg offers confidentiality and investor protection but its regulatory framework can be restrictive. Dublin, however, enjoys an advantage through greater flexibility and product development potential, as well as increased fund choice. Innovation is only good if you can follow it up quickly. Dublin provides the flexibility to do that. Having a lower cost base also makes it on average 20% cheaper than Luxembourg.
Both Dublin and Ireland offer attractive benefits as financial centres, but the former offers more advantages to UK investors.
Despite a relatively slow start, Dublin has now overtaken Luxembourg in attracting new life assurance business.
Dublin has generally lower costs, helped by the fact that, unlike Luxembourg, outsourcing of administration is accepted practice there.
‘Important to have an anchor’
Report to be written by TPR
Lack of innovation for solutions
Some 2,000 consumers affected