Insurance linked securities framework will maintain London's 'reinsurance hub' status

Out-Law News | 29 Nov 2016 | 12:31 pm | 3 min. read

Creating a new regulatory and tax framework for UK insurance linked securities (ILS) businesses will help to "maintain London's position as the most important global hub for reinsurance" post-Brexit, the government has said.

It has published its draft proposals for the framework for consultation, with the intention of placing final regulations before parliament in the spring. The UK's financial regulators are also consulting on their plans for authorising and supervising insurance special purpose vehicles (ISPVs), the vehicle through which a new regulated activity of 'insurance risk transformation' will take place.

In his written foreword to the Treasury consultation, economic secretary Simon Kirby said that it was "clear that the UK does not currently have a fit-for-purpose corporate, tax and regulatory framework" enabling it to compete in the global ILS market.

"I believe that with the right framework, the UK can make a major contribution to the continued growth and development of the global ILS market," he said. "By supporting innovation within a trusted and robust regulatory environment, the UK is perfectly placed to become a global leader in the alternative risk transfer market."

ILS offer insurers an alternative to traditional reinsurance as a form of risk mitigation. An ILS arrangement enables an insurer to transfer large and complex risks, such as catastrophic risks arising from natural disasters, to the capital markets rather than to a reinsurer. The use of ILS has grown "very significantly" in recent years to around $70 billion in value, or about 12% of the overall reinsurance market, according to the Treasury's consultation paper.

The UK government first announced its intention to develop a competitive corporate, tax and regulatory framework for ILS vehicles as part of the 2015 Budget. In March 2016, it consulted on its draft proposals for an ISPV regime overseen by the Prudential Regulation Authority (PRA). The new consultation provides the detail of that regime, as well as an accompanying "bespoke" taxation regime.

The new ISPVs will be set up using a 'protected cell company' (PCC) corporate structure. This type of arrangement, which is already recognised by English law, would enable the ISPV's assets and liabilities to be strictly segregated in order to comply with the Solvency II regulatory framework, while at the same time making it administratively efficient to manage multiple deals through a single ISPV.

A PCC would be a private company limited by shares, but would be registered with the Financial Conduct Authority (FCA) rather than Companies House. Directors would have the same duties as directors of a conventional company incorporated under the 2006 Companies Act with appropriate modifications. The PCC would be able to issue equity and debt securities on behalf of its cells in order to fund the insurance risk that those cells takes on; however, those shares would be non-voting shares given the need for ISPVs to be operated "in a way which delivers reliable protection for cedants".

The Treasury intends to develop a bespoke tax regime for UK ILS activity, according to the consultation. This would include exempting the insurance risk transformation of ISPVs from corporation tax and a complete withholding tax exemption for foreign investors, while UK investors would be taxed as normal "according to their facts and circumstance". The corporation tax and withholding tax exemptions are necessary for the UK to compete with the jurisdictions in which ISPVs are currently located, according to the consultation.

ISPVs will continue to be dual-regulated entities once the new framework has taken effect, expected in spring 2017, according to the FCA. However, they will also have to apply for authorisation for the new regulated activity of insurance risk transformation. The PRA and FCA expect to be able to assess "straightforward" applications within six to eight weeks, according to their consultation.

Insurance expert Nick Bradley of Pinsent Masons, the law firm behind, said: "The ILS market has grown over the last decade or so such that it has now become an important part of the established reinsurance market, for catastrophe risks and, on the life side, mortality and morbidity risk. For London to retain its place as a global hub for reinsurance it is vital that it has the elbow room within the regulatory and tax regime to innovate."

"It will be exciting to see the UK, and London in particular, take its place in this market. The Treasury, the Bank of England and the regulators deserve credit for recognizing the opportunity, and hopefully this exciting initiative will enable UK PLC to put in place an effective regime which is both attractive to investors and reinsurers," he said.

The Treasury consultation closes on 18 January 2017; while the joint FCA and PRA consultation closes on 23 February 2017.