Private banks and HNWIs are continually on the look out for ways to lift tax burdens, especially in a low yield environment where gains are already modest. Offshore life assurance bonds present an attractive option, enabling tax to be deferred and allowing portfolio gains to be compounded. John Schaffer finds out more about these bonds that are growing in popularity
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Tax-efficiency has always been an important area of focus for private banks and clients. However, tax avoidance has come under a harsh spotlight for private banks and their wealthy clients in the last couple of years, leading to hefty fines and reputational issues for several lenders.
In an increasingly demanding regulatory environment where aggressive tax strategies are being continually scrutinised, private banks are looking to insurance companies to issue offshore bonds as they provide a transparent tax efficient solution for their clients’ portfolios.
Offshore life assurance bonds are particularly relevant 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.
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By GlobalDataThe 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 that 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."
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.
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, tells PBI:
"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.
Dion Lindskog, head of life and pensions products at Royal Bank of Canada (RBC), says that although RBC advises on using the instrument for the majority of its private banking clients, he suggests they shouldn’t put all of their assets within the bond. "Typically we recommend that clients hold some assets personally to use their tax allowances. For example, in the UK there’s a capital gains tax allowance of £11,100, and there’s a new £5,000 a year dividend allowance coming into play next year. Clients would need to hold assets personally to take advantage of these allowances," he says.
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.
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 tells PBI that as 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, giving control over when the policy is surrendered." Lindskog adds that the policy is normally split up into segments. This can be useful, for example, when parents want to help their children with university costs, segments can be given to the child. The segments can then be encashed by the child using their tax allowances meaning that there is often little or no tax to pay.
Despite there being varied opinions around the commercial benefits of offshore bonds from the insurers’ perspective, their popularity among HNW clients seems to be on the rise. This presents opportunities to further develop and customise these products.
