Current issues in insurance
Briefing note - Insurance-linked Securities
20 Dec 2017
On 4 December 2017, a new set of regulations came in-force which will allow Insurance-linked Securities (“ILSs”) to be written in the UK. Insurance companies now have an exciting new set of tools in the box to manage their capital and risks.
Insurance-linked securities allow insurance and reinsurance companies to transfer their risks to the capital markets, as an alternative to the traditional reinsurance market. It does this by using insurance special purpose vehicles (“ISPVs”) to accept insurance risk and transforms them into capital market instruments, such as debt or equities. Investors can then invest in these instruments for an appropriate rate of return.
In recent years, there has been enormous growth in the use of these instruments in the non-life sector. However, to date, they have mainly been written off-shore – in jurisdictions such as Bermuda, Guernsey and the Cayman Islands. So in order to retain London’s status as a global centre for reinsurance, the UK government has pushed through a new set of regulations intended to attract this business to the UK. It is hoped that the new rules, combined with the expertise and regulatory oversight of a leading financial centre such as London, will not only attract this growing business to the UK but extend it to areas that have, up till now, been largely untapped, particularly the transfer of life insurance risks.
The new regulations
Parliament has approved two sets of regulations, the Risk Transformation Regulations 2017 and the Risk Transformation Tax Regulations 2017. Together, these set out a framework that
- Introduces a new regulated activity “risk transformation” and sets out the rules for the issuance of the securities.
Introduces the concept of Protected Cell Companies (“PCCs”) that enable multiple transactions to be written efficiently and in a cost-effective way. PCCs are specialised multi-arrangement ISPVs comprising a “core” and any number of “cells”. The core is the administration function for the ISPV and each new risk transformation transaction will be written in a new cell. The assets and liabilities of the cells are ring-fenced so that all the transactions are segregated.
Sets out a bespoke and competitive tax treatment for ISPVs, allowing them to compete with the existing off-shore locations. The vehicles will not be subject to corporation tax or withholding tax, providing that they remain qualifying vehicles and continue to be authorised to perform risk transformation activities.
Provides for the PRA and FCA to apply a new, streamlined authorisation and supervisory regime for insurance special purpose vehicles issuing insurance-linked securities.
Ensures only appropriately sophisticated and institutional investors can invest in these instruments, as they are relatively complex.
Although these vehicles already exist on some off-shore locations, it is envisaged that investors and issuers will draw significant comfort from the rigour and expertise of the UK financial system.
The new regulations opens up many exciting opportunities for insurance companies to transfer their risks and raise capital (for example, to enable them to write new business) directly from the capital markets. In the short term, it gives them additional options to when deciding looking to manage their risks and capital. In the medium to longer term, the capital markets may provide more capacity, structuring options or better price than the reinsurance market.
We believe that investors can be attracted to this market as these investments can provide better returns than other, more straightforward returns, investments. And some types of insurance risks, such as longevity risks, are generally stable and well-understood within the industry. As insurance risk is fairly specialised, however, investors may need significant levels of education and support to understand the specific risks.
How Hymans can help
The team at Hymans Robertson has significant experience in designing, authorising and reporting on these structures. This, combined with unrivalled experience in longevity transactions, makes us uniquely placed to work with insurance companies and investors to implement these exciting new structures.
If you wish to discuss these further, please contact Theresa Chew (firstname.lastname@example.org).