Offshore with-profits providers may have to change the way they work once the UK Government introduces changes that give greater transparency to policyholders
Many offshore life companies offer with-profits funds in their product range either as a standard life insurance bond, or on a capital redemption basis, with both offering gross roll-up. These funds are usually reinvested or reinsured back into a UK parent company's fund. As a consequence, they share in the fortunes, and more recently the misfortunes, of the onshore parent funds.
Many of the changes implemented through the various UK Government reviews will have a knock-on effect on offshore with-profits providers. Current Financial Services Authority (FSA) consultations will see the introduction of the requirement for all UK providers to produce and allow policyholders access to a Principles and Practices in Financial Management (PPFM) document. This document must contain information relating to the management of the fund in areas such as investment strategy, exposure of policyholders to business risk, bonus and smoothing policy, charges and expenses, surrender value bases and how the inherited estate is managed. When implemented, UK providers will be required to produce this document and it is likely to be extended to the EEA product providers selling with-profits business into the UK. As a result of market pressures, this will probably include offshore business written through the Isle of Man and Channel Islands.
The UK market for offshore products in 2002 is estimated to be around £3bn, including business written in or from the Isle of Man and Channel Islands markets. Of this, it is estimated between £500m and £600m went into with-profits investments.
However, it is a common misconception most of this comes from mainland UK. In reality about 80%, or around £450m, is sourced from Isle of Man and Channel Islands distributors.
In 2001, the whole UK and islands market for offshore with-profits was worth £1.1bn. This represents a significant downturn of 40% in the market.
The current market for offshore with-profits in the UK and islands is not UK resident/domiciles as many commentators believe, but more typically UK expatriates or offshore trusts with UK connections. These niche client needs are being met via distributors based in the Channel Islands and Isle of Man.
For the UK resident/domiciles the tax deferral planning arguments are generally less persuasive for this type of cautious investment when compared with an onshore 'pay tax as you go' with-profits fund. Some sales, however, do come from UK distributors and there are limited market opportunities in mainland UK, although this is restricted to some of the UK banks selling to their non-UK resident or non-UK domiciled customer bases.
Onshore sales of offshore with-profits are principally attractive to the UK inpatriate (UK resident, non-UK domicile) who only pays UK income tax on income earned in the UK or remitted into the UK. Generally, offshore bonds provide advantages for all overseas income, mitigating income, capital gains and inheritance taxes (IHT).
As house prices have risen, more UK domiciles based both overseas and in the UK are potentially caught by IHT at the current threshold of £255,000. It is the offshore providers that have exploited the tax-planning opportunities in this market segment most successfully, by using specialist trust and investment bond structures, either as a packaged product or an added trust feature to existing investments.
With-profits may be an investment option that suits older, more cautious investors in this area of financial planning. However, in both scenarios it is the product solution and not the fund (with-profits) that satisfies the client's need.
Distribution in Isle of Man and Channel Islands markets is dominated by the large offshore banks offering financial advice to their UK expatriate customers. The investment profile of these clients is often risk averse with, for example, retired people looking to supplement their pension income at minimal risk to their capital. For this reason, for many years with-profits funds have been a compelling argument and an easy sale, as it suits the distance sales process used and pays handsome levels of commission.
However, the most common use of offshore with-profits is the trust and company management market based principally in the Channel Islands. This market has different needs in terms of product structure, remuneration and positioning. With-profits has a place in this market as trustees are required to invest clients monies with due care and attention, which suits the perceived low to medium-risk profile of with-profits.
The product providers in these markets cannot rely on a with-profits fund link alone to be successful as the whole product and service proposition needs to be correct.
The trust market, however, has more need for multi-currency options to match the underlying trust or company currency denomination and for the little understood capital redemption structure to deal with inter-generational wealth transfer. Trustees also look for low commission or fee-type structures to maximise their client's investment potential and match their own fee-driven charging basis.
Due to the international nature of their clients, both market segments require a flexible but robust business acceptance policy that needs to be clearly communicated by the product provider.
For providers to be truly successful in these market segments for with-profits or any other form of offshore investment, they need to provide all the requirements to satisfy both the bank and more specialist intermediary distributors. This can be said of the market leader CMI, whose Global Investor and Capital Investor both link to the sterling, US dollar and euro with-profits funds, with the Capital Investor providing a capital redemption structure. CMI's range of in-house trusts and trustee services appeals to UK domiciles looking to mitigate their IHT liabilities.
There has been an approximate 40% downturn in offshore with-profits investment between 2001 and 2002. However, the need for cautious low-risk investments in the current bear market shows no signs of decreasing. When considered in the context of falling interest rates and market volatility, there are few substitute products available ' so where is this money going?
Increasingly offshore banks are placing their clients in guaranteed or capital protected type investments. But these are not without their critics; the FSA is consulting on strengthening the marketing rules around so-called precipice bonds which may be the next mis-selling scandal waiting to happen.
Some companies are starting to restructure their with-profits funds into more 'Sandler friendly' structures with the aim of increasing transparency and protecting consumers' assets. However, in the offshore arena the actions of the onshore parent are likely to drive any changes to the structure of the with-profits fund. Although Scottish Equitable International's onshore parent has introduced a Sandler-friendly with-profits structure, this has not yet been extended to the Dublin company.
Some firms have tried more innovative approaches, for example, Scottish Life International has introduced the 'Safe Combination' feature on its offshore bonds. Safe Combination uses automatic switching to give investors the opportunity to 'gamble' with their profits while protecting their original capital investment. However, the success of this unique product feature is not guaranteed unless the whole market proposition, such as pricing, service and fund choice, is correctly aligned.
Another feature of this market in recent years has been the 'gearing' of with-profits investments via bank loans. At times of high bonus rates, many clients were encouraged by their intermediaries to gear their with-profits investments, sometimes up to four times, to earn potentially higher returns. Similarly to the precipice bond issue in the UK market, geared with-profits may become a major offshore mis-selling scandal.
This gearing factor accounts for some of the high new business figures recorded in previous years, distorting the 'true market' for with-profits. Recent falls in bonus rates have reduced the demand for this type of investment and banks are becoming more cautious on allowing this type of loan. This may account for a fair proportion of the 40% downturn and as a result, current business figures may more accurately reflect the actual level of demand in the market.
Although there has been a downturn in the sales of offshore with-profits in the UK and islands' markets this does not necessarily reflect a downturn in demand for this type of product.
Many investors are still looking for protected low-risk investments, especially in the current bear market. With-profits funds satisfy many of the needs of cautious investors. Much of the recent flight from with-profits in favour of guaranteed or capital protected funds may be attributed to the bad press with-profits has received in the UK. However, changes in the fund structure will be required to ensure the future marketability of the concept. Current UK regulatory changes aiming to increase clarity and transparency will affect offshore with-profits funds as they are usually reinsured back into a UK parent's fund.
Many investors in offshore with-profits are trust or company structures based in the Channel Islands. This market sector has very specific needs in terms of product and pricing structures. Offshore with-profits providers need to be sensitive to these needs to be truly successful in this market. Just having a with-profits fund is not enough.
In previous years the true size of the market has been distorted by high levels of gearing. However, as a result of falling bonus rates, many banks have reviewed their gearing policy and have either restricted or withdrawn altogether from this type of lending, leading to a decrease in offshore with-profits sales.
The current market for offshore with-profits in the UK and the islands typically comprises UK expatriates or offshore trusts with UK connections.
Some companies are starting to restructure their with-profits funds into more ˜Sandler friendly' structures with the aim of increasing transparency and protecting consumers' assets.
The need for cautious, low-risk investments in the current bear market has shown no signs of decreasing.
Joined as head of strategy, multi asset, in June
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