Investing offshore can offer investors tax savings when compared to an onshore investment and as you would expect, larger amounts are generally invested offshore to benefit from larger tax savings.
Naturally, this leads to investors and advisers putting more emphasis on provider security and policyholder protection, and some clients still perceive a greater risk with investing offshore.
This is not necessarily the case as it will depend on the provider and jurisdiction used.
It is fair to say that most people are more comfortable investing in the UK, but this doesn’t necessarily mean that investing offshore carries more risk if investing in similar funds.
There will always be risk at fund level and, yes, offshore can offer access to a broad range of funds, but we are not looking at investment risk; this is manageable irrespective of the provider and the jurisdiction, UK or otherwise.
A provider that effectively manages risk, coupled with a jurisdiction whose government understands the needs of investors, can offer protection over and above that available in the UK to UK investors.
There are a number of areas to consider when looking at policyholder protection.
In addition to any statutory protection that may be available from the regulator or government in the chosen jurisdiction, as an adviser, when recommending a provider it is also important to consider how that provider manages insolvency risk, provider risk and jurisdictional risk.
The larger the investment, the higher the priority these factors are.
The requirement for effective management of these risks will be a key consideration in deciding not only the provider, but also the jurisdiction.
So what are some of the key ways of reducing risk for investors?
Insolvency risk
This refers to the pressures on the provider’s balance sheet and how it is managed.
In a perfect world when looking to invest money, the provider will only write investment business and carry a matched liability in its long-term business fund.
The long-term business fund is ring-fenced and used to meet the provider’s obligation to its policyholders.
By matching the liabilities, the fund will hold £1 in the fund for every £1 of liability, clearly demonstrating sufficient funds to meet the liabilities.
In reality, many providers write other types of policies or have legacy business that requires them to manage the potential liabilities, making it impractical to match each on a one-for-one basis.
This legacy business could take the form of guaranteed business, such as capital redemption policies, annuities, protection policies and with profits.
All of these carry additional risk and require careful management against company reserves in order to minimise the effect on the provider’s balance sheet.
This is where the financial strength of the provider reflects the ability to meet the solvency requirements of the regulator.
Another way of easing the burden is the charging structure of the products.
By avoiding the use of initial charges or establishment fees, the reliance on new business revenues disappears, meaning less reliance on new business, as well as the temptation to write unprofitable business purely to increase assets under management, or increase market share.
Provider risk
Advisers may recommend a provider as being suitable because it does not write business in specific areas, but what if that provider changes strategy and decides to enter new markets and focus on other, risk-based product areas?
This could leave investors in a riskier situation and potential chargeable gain to surrender and reinvest with a new provider.
A provider can include restrictions in its constitutional documents, detailing the type of business it will write.
In reality, most providers will not as they want the flexibility to develop in new markets, which therefore increases risk, but a provider can impose such restrictions.
For peace of mind, a clause could be included stating that the provider can only change the types of business, if:
- there is a material change in law, regulation, fiscal or regulatory practice that adversely affects the company and its policyholders; and
- the company’s lawyers confirm that such changes require the licence or constitutional documents to be amended.
Irrespective of where new business is targeted, many onshore and offshore providers carry a legacy book of risk-based business.
Jurisdictional risk
There are two elements for this this type of risk:
Firstly, regulators, such as the Insurance and Pension Authority on the Isle of Man or the Central Bank in Ireland, ensure the assets within the long-term business fund are ring-fenced on winding-up.
These assets are only available for meeting the liability of the company, attributable to its long-term business, referring back to the importance of matched liabilities on the balance sheet.
Secondly, there are the jurisdictions in which the provider will transact business.
For example, it is not uncommon for a company to write business only for UK-resident individuals, trusts, companies and partnerships.
This reduces the chance of litigation for mis-selling or unauthorised selling of policies and manages the potential chance of a breach of local regulatory requirements that can occur with multi-jurisdictional offerings.
Statutory protection
The final layer of protection is the statutory protection available in the jurisdiction in which the provider is based.
For most UK investors, investing offshore is through providers based on the Isle of Man, or the Republic of Ireland.
Both offer tax-efficient investing with the only tax, within an investment, being withholding tax, such as the 10% rate on UK dividend income.
This can make them very attractive for investors, but many people wonder what the differences are.
The Isle of Man has, for many years, been recognised as a strong centre for offshore financial services and the Government of the Isle of Man, Tynwald, recognises this.
It has implemented policyholder protection measures similar to the UK but, given the international nature of its business, the protection applies to investors wherever in the world they are based.
Should an Isle of Man provider fail then policyholders will receive up to 90% of the value of their investment.
As a comparison, Ireland does not offer a policyholder protection scheme.
The Central Bank of Ireland has strong solvency requirements to help manage providers and reduce exposure to risk.
These requirements will be overtaken by the Solvency II requirements as it is implemented across the EU.
For UK investors, there is some peace of mind as advice given by a UK-based adviser, in the UK, to an investor that is habitually resident in the UK should be covered by the UK policyholder protection scheme, irrespective of where the adviser is based.
This could potentially put a strain on the UK scheme in future years and, in turn, on UK-based advisers who fund it through a levy.
So, if the Isle of Man offers strong policyholder protection measures, why consider
Ireland?
Well, where a UK policyholder nominates a discretionary investment manager (DIM) to manage the underlying investment, they will charge a fee.
The provider will then appoint the DIM.
The invested assets are owned by the life company and therefore the contract for services is between the Irish-based provider and the UK-based DIM.
Under the EU VAT directive, there is a VAT exemption for managers of special investment funds and it is up to each individual member country to define what a special investment fund is.
The Irish Revenue Commissioners’ long-standing belief is that this exemption may apply to the services performed by a third party in respect of investment and the administrative management of a fund.
This includes mandates given to DIMs by Irish-based insurance companies.
Because of this exemption, the fees for a DIM should be lower through an Irish-based provider compared to a similar arrangement through the Isle of Man.
There is an argument about fiscal neutrality, but this is likely to take many years to resolve.
So to summarise, where an investor is concerned about policyholder protection, which is generally more of a factor for larger investments and, in turn, high net worth and institutional clients, it is important to look how these areas of risk are managed.
By combining effective risk management and imposing restrictions in the company’s structure, as well as its constitution, an investor can have peace of mind, knowing that the level of policyholder protection will be high from day one, and continue thereafter.
Rather than constantly looking in the rear view mirror at what might come back at them, they can concentrate on the road ahead.
