A surge in sales of so-called ‘insurance wrappers’ reflects big business opportunities for private banks, but experts caution against using generic non tax-compliant offshore spin-offs. Maryrose Fison finds a growing market for these unit-linked life policies for high net worth individuals.
The rising popularity of insurance wrappers among global insurance companies over the past six months has revealed a growing market for tax-efficient unit-linked life policies for high net worth individual. Using generic offshore wrappers, however, could do more harm than good.
Insurance wrappers ‘wrap’ an investment portfolio into an insurance contract with a written-in guarantee to pay the value of underlying assets upon encashment.
As governments across Europe hike up taxes, the tax-deferring quality of insurance wrappers is becoming more appealing to investors in the higher income tax bracket.
Wrappers: A vehicle for avoiding taxes?
The term “wrapper” has gained a bad reputation of late, with some seeing it as vehicle for avoiding taxes. But insurance wrappers issued by regulated, tax-compliant life companies are capable of reducing tax charges in a perfectly legal way and enhance a private bank’s service proposition to wealthy clients.
John Barnett is chairman for the UK Chartered Institute of Taxation’s (CIOT’s) capital gains tax and income investment committee. He says the favourable tax deferral arrangement available through insurance wrappers was inscribed in a series of regulations specifically designated for insurance contracts known as the Income Tax Trading and Other Income Acts 2005 regulation (Part 4, Chapter 9).
Barnett adds that offshore insurance wrappers operating under the EU Freedom of Services regime, and specially regulated in the jurisdictions of their policyholders, could offer valuable incentives for clients looking to maximise their long-term growth.
Valuable long-term incentives
Among the options were withdrawal options that are not always possible on conventional bonds with a lock-in period and higher compounded growth.
“Every year you could take up to 5% of the original investment back without triggering any tax charges,” he explains, adding that this could be done for 20 years and withdrawals could be carried forward from previous years where no money was taken out. Moreover, offshore insurance wrappers could increase the end return by eliminating corporation tax.
“If [the insurance wrapper is issued by] a UK insurance company, it will pay corporation tax. If it is an offshore insurance company, it will not pay any tax on that,” he says. Illustrating the point further with a theoretical example, he shows how £100,000 ($156,000) could grow in an insurance wrapper.
“Let’s say you are getting a 5% return [in the insurance wrapper] – you would get £5,000 in the [insurance] bond after year one,” says Barnett. “If it was a UK insurance company, the insurance company would be paying broadly 20% corporation tax – which would equate to £1,000 – so the next year you would have £104,000 to reinvest, whereas the Singapore wrapper would have £105,000 to reinvest.
“If you then take 5% of that, you can see that the compounding effect over time will mean that in 10 years the Singapore company might be worth more than the UK policy.”
Barnett warns that the price for corporation tax exemption on some products could outweigh the additional compounded growth: “Because they’re more specialist products, by the time you’ve taken the fees off, the compounding effect may be eroded.”
Not immune to abuse
The products are also not immune to abuse and Barnett says it is essential to check the issuing insurance company is regulated by the tax regime in the country in which the holder is resident to avoid potential theft of assets and criminal and civil tax penalties.
Obligations for disclosure could also vary from jurisdiction to jurisdiction, he adds, citing the UK’s use of disclosure documents as one example.
UK insurance companies are obliged to issue clients and the UK’s customs and tax department with Chargeable Events Certificates – documents which outline the future tax charge which will be due. Offshore companies have no such duty.
This gives rise to potential for accidental error (in the case of unsophisticated investors who do not understand the tax-deferring quality of the product) or willful abuse on the part of investors deliberately failing to disclose the assets.
Wrapper sales up more than 40%
Johannes Pfister, head of legal and compliance at European insurance group Baloise Liechtenstein, says his firm has seen a substantial rise in the popularity of the products.
Sales of the products issued in Liechtenstein, which Baloise operates under the EU Freedom of Services regime for Italian, German and Austrian residents only, rose from CHF4.6bn ($4.6bn) to CHF6.6bn.
This represents a valuable mechanism for private banks wishing to add value to their high net worth customers, to retain assets under management.
“[It is] an opportunity to strengthen the relationship with a client because you can still have the relationship on the portfolio management side,” says Pfister.
The firm has “Pension Plus” products for Italy, Germany and Austria and Pfister says it now intends to roll out the UK version “Pension Plus UK” as soon as December.
Swiss Life Holding AG also saw substantial growth in this segment over the first half of this year. The half yearly results showed sales of gross written premiums, policy fees and deposits received almost doubled to CHF3.1bn from CHF1.6bn.
Experts warn general use of offshore products could have potentially catastrophic consequences for investors as some offshore jurisdictions set up tax-compliant arrangements with host countries using the EU Freedom of Movement regime.
John Stone, founder and chairman of Luxembourg-based Lombard International Assurance, says offshore insurance wrappers may not comply with the regulations and tax rules in an investor’s home jurisdiction.
To ensure private bank clients do not lose out through unscrupulous or non-tax-compliant offshore products, he advises using onshore insurance policies which could still offer the tax deferral option to those reluctant to be stung by higher income charges of 40% or 50%.
“The great advantage from the bank’s point of view is that they do keep the management of the assets and so it is a win-win situation,” Stone says.
“The client is happy because he keeps his investment management service with the bank but has now got their assets within a legitimate tax-compliant structure which will mitigate their potential tax liabilities.”