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London ILS work about innovation & leveling the playing field: Hearn


The work being undertaken by the London Market Group (LMG) and HM Treasury to make London an attractive hub for insurance-linked securities (ILS) is all about ensuring that London remains at the forefront of innovation in insurance and reinsurance and that a level playing field exists.

Speaking this morning at the LMG Forum in London, Steve Hearn, Chair of the London Market Group, gave an update on some of the items being worked on by the LMG’s ILS focused industry task force and explained some of the rationale behind it.

London is targeting becoming a domicile for ILS vehicles and funds, Hearn explained, with much of the work underway being about leveling the playing field between London and other ILS domiciles.

Hearn explained why the LMG is focused on ILS business, explaining the need for London to continually innovate and remain at the forefront of insurance and reinsurance developments.

“In part, it is back to the “i” word again.  This is an area of our industry where we have people looking to provide innovative new solutions to customer need.  But it is not an area of the industry that London is pre-eminent in.  It is vital for our future as the centre of excellence that we nurture and retain expertise in this area,” Hearn explained.

Innovation and expertise are two areas that London has lost out in the early development of the ILS market. While London has some of the most professional ILS fund managers in the business, it has lost out on the structuring, domicile and transactional side of the business.

On expertise, there is a clear need for London to be able to support ILS business in order to ensure that the expertise does not all head offshore.

Hearn continued, explaining the importance that human capital plays in the LMG’s thinking on ILS; “Key to our requirements from the work is to ensure that the intellectual capital deployed to manage funds and construct trades is resident in London.

“We do have an interest in the funds themselves being domiciled here – but mainly to ensure that those human experts are more tied to our centre.”

But it’s not just about innovation and expertise, the UK Treasury is keen to have more re/insurance business in the UK which of course has tax implications. Hearn explained that this is where the work becomes more nuanced.

“You will not be surprised to learn that the Treasury is keen to have anything taxable happen here.  And therein lays the crux of the issue we have,” Hearn said.

Hearn explained that ILS business is largely transacted and domiciled in lower tax domiciles, such as Bermuda, Cayman and Guernsey, adding that; “Understandably, our Government does not feel it is in a position to offer this sort of incentive to business to locate here.  But we do need to do something to compete.”

So a number of proposals are underway, which will help to level the playing field and make London more attractive as a location for ILS business in the future.

The first is on creating a structure that can be used to transact ILS or collateralised reinsurance and allow fund managers and investors to invest in the structures, so providing an alternative to special purpose vehicles or insurers and the protected or segregated cells offered in other domiciles.

“Firstly we need to make changes to UK corporation law so that ILS vehicles can be set up here.  Currently it is not possible to create the sort of protected cell structure that the special purpose vehicles need.  So that is something we can address – albeit that it will need primary legislation and so will take a little time to complete,” Hearn said.

A second proposal is focused on leveling the playing field on tax, a major issue that could stall any ILS transactional business coming to London.

Hearn explained; “We are also looking at ways in which the vehicles themselves can pay out on maturity prior to any tax being sought.  In the absence of a claim event, most ILS structures see a return of 100% of the capital to the original investors once the specified period of the deal has finished.  So under this proposal, the vehicles themselves would not attract any tax, but the investors would on any gains they had made.”

What this would mean is a level playing field for the majority of investors, if allocating capital to a London located ILS structure.

“This would make us competitive with the zero tax regimes in that investors there are subject to tax on profits in their home countries.  So an overseas investor could provide funds to a UK domiciled ILS vehicle and pay no more tax than he would if investing in a Bermudian vehicle.  That gets us somewhere near a level playing ground without the Government having to compensate at all on rates,” continued Hearn.

It’s interesting, as this proposal comes at a time when taxation is high in the public mindset in the UK and the public is extremely focused on ensuring that business undertaken in the UK pays its way in terms of tax. The LMG’s solution, to make tax payable on gains, rather than business transacted would ensure that profit is taxed, which tends to be the core issue in the public agenda, so this could be an acceptable way to address this issue.

But perhaps most important to London is the need to continually demonstrate that it is an innovative hub for insurance and reinsurance business, and that means being attractive to ILS players as well.

“The industry is keen to explore the idea of bringing more of this business to London.  Participation in the Task Force has been widespread and volunteers have come forward without the need to prompt.  And everybody sat round the table is adamant that if we were to achieve the changes being discussed there is a genuine enthusiasm to redomicile some existing business, but, more importantly, to ensure that London gets a significant share of the exponential growth this part of our industry is expected to experience over the next five years,” Hearn said.

This is interesting, implying that some members of the ILS task force have said they would bring existing structures to the UK if the playing field can be leveled, making it attractive to do so. That would be a quick win for London, if after enacting new legislation and getting the structures ready it can immediately attract some business to the city.

Hearn explained why this is so important; “That would be London back at the forefront of innovating insurance.  Where we should and need to be.”

It’s interesting, as the LMG task force has been focused on collateralised reinsurance business, but Hearn’s comments make it clear that the work being proposed would also make London attractive as a catastrophe bond domicile as well, suggesting a broader attempt to target ILS business (which makes sense).

The LMG is all about keeping London relevant in a changing insurance and reinsurance marketplace and being ready to embrace and welcome ILS business to the city is a key part of this. As ILS innovates and other domiciles improve their facilities for ILS as well, London may find it has some keeping up to do for the next few years.

That should encourage the kind of continuous innovation which is going to be an essential trait of a successful insurance and reinsurance hub in years to come and will actually benefit all of the ILS domiciles as they increasingly compete for business.

Also read:

London re/insurance market needs true innovation: DAC Beachcroft.

Collateralised reinsurance focus for London (LMG) ILS task force.

London has to fight its corner on ILS: Michael Wade, Cabinet Office.

London ILS task force participants revealed, holds first meeting.

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