The great offshore bond debate
Some say offshore bonds are the expat-focused, financial services industry’s Marmite product: people tend to love them or, well, they normally recommend something else to their clients.
Below, James Fernyhough and Helen Burggraf attempt to make sense of the debate.
In the expat-advisory world, offshore bonds often divide opinion. Proponents say they are, or at least can be, a convenient, tried-and-tested way of giving expat clients tax-efficient, safe access to a wide range of investments.
Critics, however, argue that they’re expensive, opaque products actually designed for high-net-worth UK residents, and not really intended for expats at all.
In the last few years, growing consumer awareness of commission and its role in the selling of all manner of investment products, including offshore bonds, has hit their reputation in some quarters. This has particularly been the case in the wake of the introduction, in the UK, of the so-called Retail Distribution Review (RDR) rules, which banned the use of commission. (See table, below, which shows the drop in the combined sales totals of single and regular premium offshore bonds, in the UK only, after 2008).
Current data is unavailable, but one industry source said UK sales have continued to slide, and now stand at around £3.5bn worth a year. However, the latest data possibly may reflect the fact that fewer life companies are members of the Association of British Insurers than previously, which compiles the statistics from its members.
RDR actually took effect at the end of 2012, but had been under discussion for years beforehand. The precipitous drop in sales in 2009, though, is thought to reflect a combination of the market’s preparation for RDR’s coming into force, and the impact of the global financial crisis, which hit towards the end of the previous year.
Still, when these trends are added to the rise of platforms, which present advisers and their customers with an alternative investment option to offshore bonds, and it would seem that the life companies could be finding themselves in increasingly challenging waters.
Some argue that it is not necessarily all doom and gloom for the industry, however. According to a survey earlier this year by Canada Life, which markets offshore bonds in the UK, 36% of UK advisers said they expected to recommend offshore bonds more to their clients this year than previously, as a result of the UK Government’s reduction in pension contribution limits, which came into effect in April.
What’s more, for some life company providers, business appears to be booming, although not necessarily in the specific area of offshore bonds, as conventionally designed and, still, marketed to UK individuals.
Rather, new types of insurance-based savings products are being used, typically targeting high-net-worth individuals in search of a safe place to stash their wealth.
Lombard International Assurance for example – the Luxembourg-based life company that used to be an arm of UK life giant Friends Provident – has been growing rapidly since it was acquired by Blackstone private equity in October 2014. Last year Blackstone integrated it with a US-based insurance company, Philadelphia Financial, and the company has said it wants to bring its insurance-based wealth management products to a global audience. (See last week’s profile here.)
In March, it unveiled a new product specifically for US expats living in the UK and Germany. Called “Wealth Passport – UK Hybrid Policy”, it combines a UK life insurance policy with a US deferred variable annuity contract.
Lombard is actually one of a number of life companies based in Luxembourg that take advantage of a particular feature of that country’s regulatory structure – known as the “Triangle of Security” – to market a particular type of single premium bond and similar wealth products to high-net worth individuals keen for a safe and tax efficient place to park their money.
Another Luxembourg-based insurer which is also growing and expanding internationally with a “new model” of investment product is International Wealth Insurer, which shifted away from traditional life insurance about five years ago.
It recently revealed it was expanding into the UK market, having already established a presence in Belgium, France, Italy and Switzerland.
Below, International Investment looks at what advisers and life companies say about the use of offshore bonds to address certain common personal financial planning issues.
According to AES International chief executive Sam Instone, offshore bonds were designed to fill a very specific purpose. “They were originally aimed at UK higher rate tax payers who wanted to take advantage of the tax-friendly treatment of life insurance,” he says, adding that expats “don’t need them” for tax purposes, because they are not UK tax residents.
And he is blunt about the reason he believes advisers sell them to expats: commission, which he says in the murky offshore regulatory environment can be as high as 12%.
Old Mutual’s head of offshore financial solutions Phil Oxenham, meanwhile, maintains that offshore bonds have evolved considerably since they were first introduced.
“With an offshore bond, you’ve got a well-structured product,” he says. “Often they’re from places like the Isle of Man, where they’ve got good regulation, policy holder protection, and they’re explained well, and so on.
“[In contrast], in a lot of [expat] markets, the local choices of investment products may not meet your requirement, or they may not be understandable to you; they may not even be written in a language that you’re familiar with.
“And so there’s a gap there that often, the offshore bond is able to fill.”
What’s more, Oxenham says, the usual alternative to an offshore bond is for a client to hold a disparate portfolio of stocks and shares, unit trusts, and so on, which present issues of administration, paperwork and the fact that “each time you trade or want to move” assets around “there may be anti-money laundering requirements” to address.
Canada Life’s Neil Jones agrees that the convenience of an offshore bond makes it much easier for expats to administer their tax affairs, regardless of where they reside, than if they were using an onshore investment in a country other than the one they live in.
“If you have an onshore investment, you’re going to be liable to UK tax,” he says. “Take an investment bond, as the prime example. You pay UK tax within the investment itself. If you are resident somewhere like Singapore or New Zealand or Australia, say, you don’t really want to be paying UK tax.
“Most jurisdictions will have double taxation agreements which will stop things being taxed twice, but because it’s actually within the life fund, you don’t necessarily get a credit for it.
“So the idea is, you pick a tax-efficient jurisdiction – the Isle of Man, Channel Islands, that sort of thing – where you would hold the investments, and then instead of having pots of money in different countries subject to different tax rules, you have one that’s basically a tax advantageous jurisdiction, and then if you’re in Singapore, all you’ve got to worry about is Singapore tax. It’s just a lot easier to administer.”
Chris Lean, a Czech Republic-based adviser and pensions specialist with the Czech Republic branch of Wiltshire, England-based Aisa Direct Ltd, agrees with this argument from a convenience standpoint. But he stresses that it doesn’t change the fact that many offshore bonds are constructed in such a way as to make it possible for advisers to charge what he says are unreasonably high commissions.
And he is particularly critical of the whole idea of front-end loaded commissions, which he says are often “hidden or not disclosed”. He thinks these should quantified, at the very least, and agreed by investors at the point of recommendation.
“Ongoing annual fees are often based on the larger of the original amount invested, or the fund value,” he says. “If the fund value falls, the fees are still based on the original investment. The investments could have annual investment fees of up to 4% to 5% per annum in the first few years, meaning funds will struggle to get positive growth.”
Lean says that “double-dipping” from investment funds can push total commissions into double figures, seriously compromising returns and increasing exit penalties.
Life companies strongly refute such criticisms, and stress that it is the advisers who choose such upfront commission to be charged, not the life companies.
At Canada Life, for example, since the introduction of RDR in the UK, the company has ceased paying commission altogether, regardless of whether the products are sold to UK residents or expats. This is largely because all of its products are sold through UK-regulated advisers.
“Our offshore bond wrapper has a totally transparent charging structure, allowing the IFA to choose his preferred commission model, including being able to accommodate nil commission models if that is the IFA’s choice,” adds an FPI spokesman.
Old Mutual, however, does continue to pay commission on products sold offshore, local regulation permitting. Unlike some advisers and life company executives whom International Investment spoke to, who argue the fee-for-service model that the UK and Australia have adopted is the future of financial advice globally, Oxenham believes other jurisdictions are taking a more critical view of RDR and its Australian counterpart, FoFA.
The problem with banning commission, he says, is it makes advice unaffordable for many people.
“How do you ensure that customers continue to get advice? Because there are some customers that might be comfortable still paying commission, or paying for the advice out of the product. And it could be the only way that they could afford to get advice,” Oxenham says.
“Maybe it’s better that they do get advice, [rather] than go it alone and risk making mistakes themselves.”
If this sounds self-serving, it is worth remembering that the UK Financial Conduct Authority’s Tracey McDermott recently acknowledged the validity of this argument.
Oxenham insists that Old Mutual and the advisers who distribute its offshore bonds clearly disclose their fee structure.
As for the charge that commission encourages advisers to recommend products because they pay high commission, rather than because they are appropriate for the customer, he says: “If the customer and adviser have reached an agreement on the cost of the advice, whether it be a monetary amount or a percentage, then whichever product they go for, it should be the right product.”
Oxenham’s assurances do not, however, placate Instone or Lean, who remain concerned that, in the regulatory Wild West of some offshore jurisdictions, commission paid by life companies encourages many advisers to do the wrong thing.
Another issue facing offshore bonds is that financial platforms, which are widely in use in the UK and such countries as Australia and the US, have begun to take hold in the cross-border international market, and some say they are beginning to pull ahead of the bonds in terms of the technology they are able to offer advisers.
Such companies as Praemium International, Platform One International, Novia Global, Ardan and Singapore’s iFAST Financial have improved the platform industry’s range of offerings for advisers and their expatriate clients in recent years, and are increasingly seen as a rival to the life companies, with which constituent companies some also work together in looking after the portfolios of individual clients.
Lean, for example, says many advisers will recommend using offshore bonds without having compared them to the investment platform alternative, which may in fact offer an equal or better solution, at a lower cost to the client.
Canada Life’s Neil Jones, meanwhile, has an entirely different and more collaborative view.
“We have an ethos that we like to be easy to do business with,” he says.
“So if somebody says to us, ‘Right, we want to hold our money on the Transact platform,’ we’ve got agreements in place with Transact so that people can go to our offshore bond and we send the money to Transact, and then they can manage it on the platform.”
Cost-wise, Jones says customers who make regular transactions within their bond, administering it through a third-party platform can make it considerably cheaper, as you don’t have to pay the transaction fee every time, which in Canada Life’s case is £37.85 a pop.
For investors who prefer to set and forget, however, he says it may not be worth paying the additional platform fee.
Old Mutual’s Phil Oxenham rejects the argument that platforms have superior technology to life bonds.
“We’ve got a system that supports the life products called Wealth Interactive. I would say the technology and functionality that’s available through that is comparable to any [pure investment] platform,” he says.
This story originally appeared in the monthly magazine edition of International Investment. To subscribe to International Investment magazine, click here.