By Kareline Daguer, Director, PwC
For the last two and a half years the government – HM Treasury and HMRC - and the UK regulators (PRA and FCA) have worked closely with the London Market Group to develop a set of detailed regulations designed to implement a new ILS regime in the UK. ILS is not new by any means; the ILS market is strong in jurisdictions such as Bermuda, Ireland and Gibraltar. The new UK regime is built on the provisions of Solvency II for Insurance Special Purpose Vehicles (ISPVs), but it has some added key features that might help make the UK an attractive ILS market.
There are three innovations to the regime:
1. Protected Cell Companies (PCCs) - The new ILS regulation introduces the concept of PCCs into UK law. It will allow single or multiple ILS deals to be undertaken from the same regulated entity, whilst ring-fencing the assets and liabilities of each deal. This will provide flexibility and agility to those wanting to set up a vehicle to strike more than one single deal.
2. Regulation – It is expected that a PCC with a single cell structure might get authorisation within eight weeks, which is in line with other jurisdictions. Authorisation of a multi cell structure will take longer (up to six months). But these vehicles will be able to obtain a Scope of Permission (SoP) to allow them to enter into deals within the boundaries of the permission without requiring pre approval. Any new deal within the SoP needs to be notified to the PRA within five working days of the transaction taking place.
3. Tax - There are two key aspects of the tax regime: SPVs will not be liable for corporation tax on profits relating to the ‘insurance risk transformation’ activities subject to certain conditions, and no withholding taxes should apply to interest payments made to foreign investors (UK investors being taxed as normal), so that they are taxed in the same way as if they invested directly, avoiding double taxation.
The key question is whether these innovations go far enough to shift some of the ILS market into UK vehicles or to encourage more players to set up structures under UK law. Neon recently announced that it was the first UK firm to set up such a vehicle under the new regime, raising capital to support a $72m collateralised quota share reinsurance transaction that will underwrite a portion of one of Neon’s Lloyd’s syndicates.
2017 was possibly a watershed year in the ILS market, with many heavy losses. However, the investor community seemed resilient and, although new issues might be negotiated at improved terms, investors still seem willing to invest in new transactions.
The success of the new regime will largely depend on two elements. The first and most obvious is the overall demand for these asset classes and the terms required by investors to buy into them. The second relates to regulatory requirements and tax benefits.
The PRA clarified the meaning of fully funded (for the risk transfer to be effective the maximum risk exposure needs to be fully backed by assets at all times). These transactions must initially be fully funded with real assets. Other regimes allow the use of contingent assets and limited recourse. Whether application of the fully funded requirement in the UK coupled with some beneficial tax arrangements can make the regime more attractive than its main competitor (Bermuda) will only become clear over the next few months and years.
Whether the UK remains in a Solvency II environment after Brexit will also have an impact, as it might allow the PRA to further flex its requirements. Whatever happens, I believe the LMG ILS taskforce deserves to be congratulated on the birth of the new ILS regime. It must have taken considerable skill and determination to make it happen in the current political climate.
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