Offshore life assurance bonds provide a way to achieve greater tax efficiency for high net worth individuals (HNWIs), particularly in high tax jurisdictions such as the UK.
Their primary use is to act as a tax "wrapper", allowing assets to be housed within a life assurance policy.
The European offshore bond market is primarily centred on the Isle of Man, Ireland and Luxembourg where many insurance companies have offshore units.
The most significant benefit of an offshore bond is tax deferral. Housing a client’s assets within this investment wrapper means that no tax is to be paid annually – taking away the burden of yearly capital gains and income tax charges.
A private client can also withdraw an income from the assets, when encased in the bond, with an allowance of 5% of the original investment per year.
However, tax does have to be paid eventually, at the point when the benefit is taken out of the insurance policy.
Steve Lawless, global head of banking distribution at Old Mutual Wealth, says tax deferral is also beneficial for banks: "The bank with the underlying assets can manage the money purely in terms of buying exactly what they want, when they want, without worrying about timing and tax payments."
What can be wrapped?
In terms of assets that can be wrapped within an offshore bond, there are limitations depending on where the client is domiciled.
In the UK, wealthy individuals are restricted to wrapping collective investments such as mutual funds.
Although most countries allow for collective investments to be wrapped within an offshore bond, there are some jurisdictions that will allow clients to have direct holdings such as equities or corporate bonds, for example.
Luxembourg Insurer, Lombard International, differentiates itself by offering its clients the ability to structure "unquoted assets" within its offshore bonds service. The insurer employs a team of 15 specialists for on-boarding and maintaining non-traditional assets.
Jurgen Vanhoenacker, marketing and wealth structuring at Lombard International, says:
"Some countries allow for non-traditional assets like private equity funds to be structured within an offshore bond. Apart from these home country restrictions, we need to respect the Luxembourg investment rules as well. Depending on the size of the client, the latter allows greater flexibility as long as the assets are securitised and transferable.
"It is important to highlight that many countries require a full discretionary management of the portfolio and do not allow any investment influence from the policy holder. The UK is a clear example of this."
Lombard’s use of structuring non-traditional assets is the exception rather than the rule. In most non-Luxembourg offshore bonds, clients will be restricted to collective investments.
The restrictions on the type of assets that can be held mean that offshore bonds may be a less efficient solution for UHNWIs with a larger proportion of direct investments. Michael Leahy, international wealth director at Prudential, says that although there are some cases of ultra wealthy individuals using offshore bonds, the majority are within the £1-20m space.
Sam Instone, chief executive of UK-headquartered financial services organisation, AES International, says offshore bonds were originally designed as tax efficient savings vehicles for people based in the UK or other high tax jurisdictions and continue to offer very real tax mitigation benefits to people in that position.
However, Instone argues offshore bonds have been hijacked by those who use their complex, opaque structure to hide large commission payments – "at very real detriment to consumers".
Instone says: "There are regulatory pressures though which are making them less attractive to sell in some corners of the globe. In Hong Kong and Singapore, for example, new regulation introduced this year has made it a requirement for all commission payments to be disclosed.
"When consumers are made aware of the huge commission payments, effectively their money, which would be handed to the product vendor, they are significantly less likely to buy the products. This has had the effect of slowing their sale in some countries, but also of pushing offshore bonds into new markets which are less well regulated and where the consumers are less wise to the true costs."
Cross border focus and costs
Where the UK has offshore structures predominately based in the Isle of Man and Ireland, Luxembourg’s focus is more centred on cross-border HNWIs.
Offshore bond structures based in Luxembourg tend to be more expensive in terms of fees; however they can be advantageous if the policy holder wishes to liquidate their assets in a jurisdiction with a lower tax liability.
The demand is certainly present; Lombard International, one of the larger providers in Luxembourg, has $75bn in assets under administration. Leahy, Prudential, suggests that insurers in both Ireland and Luxembourg will write EUR15bn in offshore life assurance policies in 2015.
The costs of placing assets within an offshore bond, however, have become competitive in recent years as more insurers enter the market.
From the insurers’ perspective, the commercial benefits are beginning to weaken. Leahy says the provision has become "more commoditised in recent years",
Prudential is stepping back from offering "vanilla" offshore bond solutions due to the price of the insurance wrapper being driven down significantly.
"We’ve stepped back, as a commercial decision, and we focus more on the bespoke end of the market where we can add more value."
Passing on wealth to the next generation is one of the key concerns for HNWIs, and offshore bonds are an attractive option for wealth succession.
Leahy says that offshore bonds can have advantages in jurisdictions where there are forced heirship regulations, including France and the Middle East, where Shariah law restricts the passing of assets.
According to Lindskog, another advantage is where multiple lives can be assured on the life insurance policy: "It’s what’s known as a last survivor basis – so you could have six lives assured and the plan continues until the last of those six people die."
Liskog adds that the policy can also be split up into segments and given to children to be used, for instance, when they attend university.