On 8 December 2017, the UK's Insurance Linked Securities ("ILS") regulations entered into force. The regulations create a framework for the establishment of an ILS market in the UK and are the culmination of a commitment by the government first announced in its 2015 budget.
ILS offers an alternative to reinsurance as a form of risk mitigation by enabling an insurer to transfer risk to the capital markets. In other prominent ILS jurisdictions, such as Bermuda, it is often used to transfer catastrophic risks arising from natural disasters. The UK Treasury has cited research that the market for ILS could be worth as much as $87bn by 2019.
The regulations (namely, the Risk Transformation Regulations 2017 and the Risk Transformation (Tax) Regulations 2017) set out the framework for carrying on ILS business in the UK. Some of the key changes to UK law include:
Corporate structure: The creation of Protected Cell Companies ("PCC") which will be used to enter into multiple collateralised reinsurance transactions. A PCC will be a private company limited by shares that comprises of a "core" as well as individual "cells". Each individual cell will have no legal personality and will be established to support specific ILS transactions; however its assets and liabilities will be ringfenced from those of the core and other cells.
Insolvency: A modified insolvency regime for PCCs by excluding company voluntary arrangements, voluntary liquidations and receiverships. In addition, the administration procedure for individual cells reflects the principle of segregation as it is applied as if the cell has separate legal personality to the core and the other cells.
Regulation: There is a new regulated activity of "insurance risk transformation" in the Regulated Activities Order and there is a simplified governance and reporting regime for PCCs. There is also a tailored fast-track process whereby authorisation of "straight forward" applications takes between 6 to 8 weeks from submission.
Tax: PCCs carrying on ILS business will be subject to a bespoke tax regime. In particular, certain PCCs will be exempt from corporation tax and there will be withholding tax exemptions for investors.
The Prudential Regulation Authority and the Financial Conduct Authority published their rules and guidance relating to ILS on 1 November 2017. This will enter into force on the same date as the regulations.
William Hogarth, Legal Director in the Corporate Insurance group, commented that: "The news that Parliament has approved the regulations is a great step forward. London is in a strong position when it comes to attracting ILS business as it is home to some of the world’s best and brightest insurance talent, whose knowledge, experience and ability to innovate is unparalleled. London also has a thriving community of brokers too and can draw on a huge amount of capital.
ILS investors used to operating in jurisdictions such as Bermuda will need to get to grips with what London has to offer. A key sticking point is likely to be the speed-to-market facilitated by the efficiency of regulatory approvals; if London can genuinely compete with the established ILS markets in this space then the sky is the limit for the UK to become a hub for ILS business."
Research for the article was contributed by James Penfold, Associate.