The Chancellor has announced the Treasury is consulting on a new regulatory and tax framework for the insurance linked securities (ILS) business to increase UK competitiveness in the global reinsurance business
ILS are an alternative form of risk mitigation for insurance and reinsurance firms which, unlike conventional cover, offer insurance and reinsurance firms a means of transferring risk to the capital markets. Use of ILS has grown very significantly in recent years, with estimates suggesting the market is likely to be worth $87bn (£70bn) by 2019.
At Budget 2015, the Chancellor announced that the government would work with the London market and the UK’s regulators to develop a new competitive corporate, tax and regulatory framework for ILS vehicles, also called insurance special purpose vehicles (ISPVs).
There was a consultation earlier this year on the issues which closed in April 2016. The Treasury reports that the responses to this indicated that a ‘protected cell company’ (PCC) corporate structure was appropriate for a new ILS framework; that a bespoke approach to the taxation of ISPVs would be needed; and stressed that a robust but streamlined supervision of ISPVs from the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA) would be key to the success of the regime.
In the Autumn Statement, Philip Hammond announced there is now to be a second consultation which sets out the government’s proposed regulatory framework for ILS. It includes two sets of draft regulations: the Risk Transformation Regulations 2017 which will introduce the PCC as a new corporate structure for multiarrangement ISPVs (mISPVs), and propose a new regulated activity of insurance risk transformation under the Financial Services and Markets Act 2000; and the Risk Transformation (Tax) Regulations) which set out the tax treatment of ISPVs.
Separately, the PRA and FCA will be consulting on their approach to the authorisation and supervision of ISPVs in the UK.
Ben Reid, executive director in EY’s specialty insurance practice, said: ‘The insurance industry will welcome the Chancellor’s confirmation to publish regulations to develop the ILS market in the UK, which is expected to allow (re)insurers and brokers operating in the London insurance market to develop and issue new products, supported by alternative capital. It will be an important growth opportunity for the industry.
‘To be successful, this new market must be complementary to other global ILS centres, and to meet the new requirements of global insurance buyers, London’s world renowned reputation for product innovation should be harnessed.’
New corporate structure
The consultation says the proposed UK PCC regime is designed to meet Solvency II requirements through a strict segregation of risk transfer contracts, while also providing an administratively efficient means for managing multiple deals from one ISPV.
The PCC will be able to issue securities on behalf of the cells, whether equity or debt instruments, in order to fund the insurance risk they take on. A PCC will be a private company limited by shares, and the directors’ duties will be no different to those in relation to a conventional company incorporated under the Companies Act 2006, with appropriate modifications. The consultation asks for views on the extent to which this provides a suitable framework for PCCs.
The current accounting framework includes a separate schedule for insurance companies. The consultation is seeking views on the extent to which this provides a suitable framework for PCC accounts; or whether modifications to the Large and Medium-sized Companies and Groups Regulations 2008 are needed in order to make these applicable to PCCs.
The audit requirements for PCCs will follow the Companies Act approach, with necessary modifications to make these applicable to PCCs. Some respondents to the orginal consultation raised concerns that publishing statutory accounts for each individual cell could force the PCC to publish market confidential information, so the latest consultation asks for feedback on whether a reduced disclosure regime is appropriate. It also considers whether there need to be any changes to the insolvency regulations with regard to PCCs.
Bespoke tax regime
There is to be a bespoke taxation regime for ILS in the UK. This will include exempting the insurance risk transformation of ISPVs from corporation tax; a complete withholding tax exemption for foreign investors; and UK investors being taxed as normal according to their facts and circumstance.
The Treasury says that exempting the ISPV’s core insurance risk transformation activity from corporation tax is necessary to compete with jurisdictions where ISPVs are currently located. It also argues that imposing a withholding tax at the level of the ISPV would also make the UK less competitive than jurisdictions where ISPVs are already established, and would be inconsistent with treatment of the ISPV as a conduit.
The government’s proposal is to fully exempt debt and equity payments made from an ISPV to investors from withholding tax. UK investors would be taxed as normal on their investment income, with overseas investors taxed according to the regime in their home country.
In order to counter potential abuse of the new regime, the consultation document says the tax treatment will be strictly limited to ISPVs. It will be contingent on regulatory rules being met and vehicles receiving authorisation from the PRA and FCA.
The Treasury states that the tax advantages given by the regime will be fully switched off if an ISPV is used as part of a tax avoidance scheme. The proposed ILS tax treatment should only be available where there has been genuine transfer of risk to an ISPV. This will mean that existing traditional reinsurance cannot be routed through ISPVs to achieve outcomes which are not in line with the intended policy approach.
The PRA and FCA have published a joint consultation paper which covers the authorisation of ISPVs and mISPVs, how the PRA will expect key Solvency II requirements to be met; and how the senior managers insurance regime will apply to ISPVs.
The Treasury consultation closes on 18 January 2017.
The joint PRA/FCA consultation on new regulatory and tax framework for the insurance linked securities (ILS) business closes on 23 February 2017.
