The sophistication of the insurance products offered through Dublin increased with the recent establishment of Ireland's first insurance securitisation vehicle, a US$200 million property catastrophe note offering successfully issued on behalf of SCOR, Paris.

Insurance securitisations traditionally have been domiciled offshore with the Cayman Islands and Bermuda commanding enviable positions in this complex marketplace. Both jurisdictions established the expertise and infrastructure to easily accommodate these transactions. An absence of tax in these countries avoided any special taxation issues for the special purpose company or vehicle(SPV).

However, given that insurance securitisations are intended to be tax neutral, there is no need to locate the SPV in a tax haven. Indeed, there is a growing desire to locate these facilities on-shore and, of late, vehicles have been domiciled in the Netherlands and the United States. One of the main reasons for the move onshore is the possible imposition of a withholding tax on a premium payment to a tax haven.

Ireland has emerged as a significant player in the financial services market following the success of the International Financial Services Centre (IFSC), which attracted many of the world's leading banks and financial institutions, together with large corporates. Banks, treasury operations, shared service centres, insurance and reinsurance companies are established in Dublin.

Asset-backed securitisations have been transacted through Dublin for many years, and expertise in this business has been built up within the leading Irish legal and accounting firms. One other contributing factor to this success has been the willingness of the Irish government to facilitate financial services through legal and tax changes. This expertise and willingness to facilitate business encouraged SCOR to securitise certain of its windstorm and earthquake risks through an Irish SPV. Some of the more important issues which had to be addressed included tax, legal and regulatory issues, as detailed below.

Taxation

As Ireland has a comprehensive tax system including corporation tax, income tax, capital gains tax, stamp duties and value added tax (VAT), many issues required clarification to understand the tax treatment of the insurance securitisation under Irish tax law and, ultimately, to ensure the efficiency of this deal through Ireland. Although complex in nature, the issues were satisfactorily resolved. Following is an outline of the main technical issues addressed:

Corporation tax

  • The normal rate of corporation tax in Ireland is currently 24%. This will reduce to 12.5% from 1 January 2003. However, any taxable profits of the SPV over the three year term of the retrocessional agreement will be taxed at a fixed rate of 25%, which is the rate applied to passive income in Ireland. Representations are being made to the Irish Revenue to bring the profits of the SPV into the normal tax regime (24% reducing to 12.5%).

  • From an accounting perspective, an SPV formed to undertake an insurance securitisation does not normally generate a profit. Income arises from two sources, namely reinsurance premium from the reinsured and investment income from the investment of the proceeds of the notes sold. This income is used to fund the expenses, which mainly comprise the interest paid to the noteholders and any swap expense, together with the administration expenses of the SPV. Normally, the premium is priced to generate a break-even position for the SPV.

    Tax treatment, however, does not necessarily follow accounting treatment. One of the most important issues requiring clarification was the corporation tax treatment of the SPV in Ireland. Here it was necessary to ensure that the expenses of the SPV were deductible against the income. To achieve this, the SPV had to be regarded as “trading” under Irish tax law.

    Irish tax law has specific legislation dealing with securitisation. When drafted this legislation contemplated asset-backed securitisations, such as mortgage receivables. The Irish Revenue has now clarified that insurance securitisations qualify under this legislation. Activities carried out by a qualifying Irish securitisation company are deemed trading, provided such activities take place on an arm's length basis. As such, the reinsurance policy is treated as a qualifying asset under the legislation.

  • It is worth noting that payments made under a swap agreement (entered into by the SPV converting the interest yield on the investments to a spread to LIBOR) are treated as tax deductible for corporation tax purposes. The corollary is that any receipts by the SPV under the agreement are taxable. There are no Irish withholding taxes on any such swap payments.

    Income tax

  • Noteholders (who are not Irish resident) are not Irish income tax in respect of the interest on the notes.

    Withholding tax

  • Another important tax issue was Irish withholding taxes on interest and dividends paid by the SPV. Noteholders and shareholders outside of the European Union or in a country with which Ireland does not have a double tax treaty suffer withholding tax at 22% on the interest (paid in the ordinary course of business) or dividends paid. Noteholders and shareholders resident in the EU or in one of the countries with which Ireland has a double tax agreement (DTA), of which there are approximately 30 in force, do not suffer any withholding tax.

    Capital and stamp duty

  • Capital duty of 1% is charged on the consideration received in respect of the issue of ordinary share capital. In practice, the issued share capital is kept to a minimum.

    Additional shareholder funds can be paid in by means of a capital contribution on which capital duty is not charged.

  • Irish tax law provides an exemption from stamp duty on the issue or transfer of securities (the notes) by a qualifying securitisation company where the proceeds are used in the course of the company's business.

    VAT

  • The SPV activities are treated as VAT exempt under Irish tax law, and as a result no VAT is chargeable on the premium billings. VAT is suffered on taxable services purchased by the SPV such as audit and legal fees, but a portion of it may be recovered in the ratio of premium from non-EU risk underwritten by the SPV to total risk underwritten.

    To summarise:

  • The SPV in Ireland is taxable and will suffer some taxation;

  • However, the legislation is favourable to insurance securitisation vehicles and if they are properly structured, the tax suffered can be minimal;

  • There should be little or no corporation tax as the profits of the SPV should not be material;

  • Stamp duties and capital duties can be reduced to negligible amounts;

  • There are no withholding taxes on interest or dividend payments provided the recipient is resident in an EU member state or in a country with which Ireland has a DTA;

  • The recipient of the interest on the notes or dividends on the shares will not be liable to Irish income tax (except for any withholding tax referred to above) unless they are Irish tax resident;

  • Some VAT may be suffered on taxable services purchased.

    All in all, Ireland has created a favourable tax environment for insurance securitisations. Coupled with EU membership and an extensive double tax treaty network, Ireland is ideally placed to attract securitisation SPVs.

    Legal

    The SPV was incorporated in Ireland as a public limited company with “real” shareholders independent of the reinsured. Traditionally, these SPVs have been owned by charitable trusts.

    The notes were offered to qualified institutional buyers as a private placement by means of a confidential offering circular. They were not listed on any stock exchange.

    Bankruptcy issues under Irish company law were considered, in particular the protection of the noteholders' funds from an event outside that covered in the retrocessional agreement, such as a lawsuit against the company.

    The shareholders had to understand that their investment was at risk. Although remote, the risk would be from an event outside the retrocessional agreement. If there is a loss under the retrocessional agreement, the rights of the noteholders to the return of their funds is reduced by the amount of the loss, thus protecting the shareholders from underwriting losses.

    Liquidation issues had to be addressed, in particular the repayment of noteholders' funds prior to the appointment of the liquidator at the end of the retrocessional contract. The preferential rights of creditors in liquidation were also reviewed.

    Aside from the specified issues above, the SPV structure in Ireland is broadly similar to a Cayman or Bermuda structure.

    Regulatory

    The SPV needed the ability to transact reinsurance business in its objects clause. This immediately brought the SPV into the realm of Ireland's regulatory authority, the Department of Enterprise Trade and Employment (DETE).

    The Insurance Bill 1999 has placed a formal requirement on reinsurance companies intending to establish in Ireland to notify the DETE using a prescribed format. The information required includes details of the capitalisation and solvency, the shareholders, directors and management, and details of the business to be written. The SPV needed approval from the DETE before it could be established or commence trading. The regulator was supportive of this project and approval was forthcoming.

    Conclusion

    The driver for the transaction was the purchase of cost effective, multi-year catastrophe cover for the reinsured. Key considerations were stable pricing and very importantly, the access to new, fully collateralised reinsurance capacity in the capital markets, which the reinsured had never previously accessed. The prestige and experience of successfully completing this deal have added to the resources and capabilities of the reinsured.

    The desire to locate the SPV in an EU jurisdiction was very strong, and Dublin was chosen for its infrastructure. SCOR must be congratulated for the determination to tackle previously uncharted waters and for proving Dublin's ability to facilitate insurance SPVs.

  • Tim Hennessy is a senior vice president of Marsh & McLennan Companies and is deputy branch manager of Marsh Management Services (Dublin) Limited, the company appointed to administer the SPV. He is an associate of the Institute of Chartered Accountants in Ireland, the Institute of Taxation in Ireland and the UK Institute of Risk Management.