Originally published in Business Brief, June 2011
Christopher Anderson, Partner at Carey Olsen in Guernsey, notes the growing trend for insurance/investment hybrid structures which enable investors to gain exposure to insurance risk through non-insurance financial instruments, often referred to as insurance linked securities.
In the current economic climate, good investment returns are hard to come by. However, as they say, necessity is the mother of invention and, in such a hostile environment investors often become innovative in seeking the returns they or their stakeholders demand.
The uncorrelated returns which insurance can provide is attractive but investors are unable to gain exposure to insurance risks directly without being an authorised insurer. Carey Olsen has advised on the establishment of a number of insurance/investment hybrid structures which enable investors to gain exposure to insurance risk through non-insurance financial instruments (often referred to as insurance linked securities).
Guernsey's array of cell company options and its in-depth expertise in both the finance and insurance sectors make it perfectly placed to host such structures. Often those structures take the form of an insurance securitisation (or insuritisation as they are sometimes referred to). Securitisation is the conversion of an income stream into capital. This is achieved by selling the rights to the income stream to a special purpose vehicle (SPV). The SPV funds the purchase price to acquire the income stream through the issue of bonds or loan notes. Payment of interest and repayment of capital under the bonds is linked to the income stream. If the income receipts falter for any reason, the bondholders will suffer, through lower or no interest payments, and, in extreme situations, they may lose their entire investment.
Securitisation began in the mortgage industry in the US. Banks discovered they could sell to investors the monthly interest payments they received from their mortgage books. The investors received regular income from the underlying mortgages and the funds raised through the sale of the income stream to investors provided additional capital which enabled the banks to make further loans.
As investors' appetite for securitised products has grown a variety of underlying assets have been securitised in this way. Carey Olsen recently advised on the securitisation of a book of European life insurance policies. The structure followed that described above. A cell of a Guernsey incorporated cell company extracts the income stream from the life insurer through an insurance contract. That income stream, and the risk associated with it, is then transferred to an SPV (a non-cellular Guernsey company) under an ISDA documented derivative contract. The SPV issues bonds to investors; payments under the bonds are linked to receipts from the underlying life insurance policies. With its blend of insurance and investment expertise Guernsey was the ideal location for both the insuring cell and the bond issuing SPV.
As ever there are a number of external issues affecting Guernsey's insurance industry. On 25 January 2011 the Guernsey Financial Services Commission announced that the authorities in Guernsey had no plans to seek equivalence under Solvency II. Within a European context, adopting Solvency II provides regulatory equivalence with EU member states. However the benefits of such equivalence are outweighed by the increased burden on Guernsey's captive industry. Guernsey already complies and will continue to comply with the highest standards of insurance legislation such as those set by the International Association of Insurance Supervisors and endorsed by the G20.
Opting out of Solvency II could make Guernsey a more attractive jurisdiction for captive insurers than those jurisdictions subject to the legislation. As well as the EU member states, this includes Bermuda which has publicly stated that it will be voluntarily adopting the Solvency II regime. This is an opportunity for Guernsey to attract new business from the EU as well as migrating existing captives from other offshore jurisdictions which are adopting Solvency II. Migrating an existing insurance company into Guernsey is straight forward. Guernsey has had legislation permitting companies to relocate to Guernsey for over ten years and a large number of company migrations into Guernsey have taken place during that time. The process involves close liaison between the transferring and transferee jurisdictions but can usually be achieved within a matter of weeks.
The other major external issue currently looming is the proposed changes to Guernsey's tax regime – an issue which is also affecting the islands of Jersey and the Isle of Man. In May 2011, the Jersey Council of Ministers announced that they would repeal those elements of Jersey's corporate tax regime which were deemed harmful by the EU Code of Conduct group. No part of Guernsey's tax regime has ever been deemed harmful by that group but, given the similarities between the regimes in those islands, Guernsey has viewed these developments with interest.
Although Guernsey is yet to make any formal decision in relation to any changes to its tax regime, it is considered likely that in future the tax system will be based on "territoriality". That is to say that only income with a source in Guernsey will be subject to tax in Guernsey. Throughout all of the discussions concerning the tax regime review, the States of Guernsey have continually stated the need for any revised regime to ensure that Guernsey remains competitive. Guernsey's insurance industry remains confident that any change will not affect its position as the premier European captive domicile.
For more information about Guernsey's finance industry please visit www.guernseyfinance.com.
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