Jamon y Queso (Ham and Cheese) – Offshore Annuity Planning Options for Non-Resident Aliens

Overview

I have been active in private placement life insurance since 1999. Over that course of time, while the offshore private placement life insurance industry was getting its start in the late 1990s, Sun Life of Canada introduced an offshore retail variable annuity to non-resident aliens (NRA or non-U.S. citizens and residents). The company had great success while most of the offshore life insurers focused on private placement insurance products struggled. Why?

First, the private placement life insurance industry was largely focused on hedge funds as the underlying investment option. Second, the companies struggled for distribution of their products. Meanwhile, Sun Life sold fully commissionable variable annuities through stockbrokers and other financial service professionals and banks. It does not matter how attractive a product is if salesmen will not sell it! The salesman must be paid!

During this same timeframe, retail life insurance agents on the East Coast and West Coast sold fully commissionable life insurance products to NRAs who were unable to purchase life insurance within their own markets denominated in U.S. dollars and with high retention limits. Additionally, the American products were much more competitively priced. A typical sales scenario might have involved a former private banker turned life insurance salesman. The NRAs purchased coverage that was otherwise unavailable in their home jurisdiction. The salesman received a good commission and client received coverage that the client would otherwise not have had access. America, the land of opportunity!

During this time frame, a market for Swiss annuities emerged. In many cases, the annuities purchased with offshore funds. The annuities were denominated in Swiss France. The policy was denominated in a stable currency from a stable carrier in a stable jurisdiction with a conservative investment return along with asset protection benefits. Since the U.S. Government turned the Swiss’ world upside, the Swiss annuity has fallen off of the product landscape.

This executive summary will provides an overview of new product options emerging in the offshore marketplace for NRAs. The fixed or non-variable investment option is exciting because many NRA do not want market volatility with their “rainy day” or “nest egg” funds that are offshore. At the same time, these investors want the ability to hedge against currency risk with multiple currencies or an equity indexed annuity, with some level of investment guarantee and the traditional income contingency options of an annuity.

What is an Annuity?

A simple explanation of the difference between life insurance and an annuity is that a life insurance policy protects the insured’s family in the event of dying too soon while the annuity protects the annuitant in the event that he lives too long.

An annuity is a financial instrument that requires a premium paid to an insurance company in return for a promise to pay a certain amount for either a specific period of time or over the lifetime of an individual An annuity contract might provide for multiple payments for a period of time following the issuance of the contract – an immediate annuity. Alternatively, the annuity contract might delay future payments until some future time period – a deferred annuity contract. Immediate annuities provide for payments within a career.

An annuity contract has an owner or policyholder that has control over the policy rights; an annuitant which is the measuring life for annuity payments, and a beneficiary.

Fixed annuity annuities provide a crediting rate for the annuity based upon the investment performance of the insurer’s general account assets. Most life insurer general account investments are restricted by statute. Most investment guidelines found in insurance statutes limit insurance investment to fixed income assets – investment grade corporate bonds and mortgages.

An additional factor in investments is the risk based capital ratio used by financial rating agencies to measure the financial solvency and claims paying ability of a life insurer. These tests look towards liquidity and the quality of bonds and mortgages held by the life insurer. Most life insurer’s have very little exposure to the equity markets. As a result, the crediting rate for a fixed annuity is conservatively tied to the yield on mid-term investment grade bonds. In the current low interest rate environment, crediting rates have been very low.

Variable annuities provide a pass-through of the investment performance of investment sub-accounts that are similar to mutual funds. The insurance company makes these investments on behalf of the policyholder through sub-accounts or insurance dedicated funds held in separate or segregated accounts. These assets are segregated from the claims of the insurer’s creditors unlike assets in the insurer’s general account. The policyholder receives a direct pass-through of the insurance dedicated fund’s investment performance.

The insurance company is treated as the owner of the investment assets and included on the insurance company’s balance sheet as separate or segregated account assets. The insurance company receives a reserves deduction for any investment income received and credited to variable annuity contracts. The investment income is credited to the policy.

The Offshore Fixed Annuity

A Bermuda-based carrier has combined the best of product options in developing a sophisticated offshore fixed annuity. The policy is issued by a carrier that is a Bermuda segregated company. This status means that the policyholder’s assets are not subject to the claims of the life insurer’s creditors or the policyholder’s personal creditors under Bermuda law. Effectively, the policy is similar to a variable policy in that regard. The policy is strictly available for non-U.S. citizens and residents.

The policy’s minimum premium is $50,000. The carrier may issue a rate guarantee of two-twelve years. The rate guarantee is contractual. The policy may be denominated in the following currencies – (1) U.S. dollar (2) Euro  (3) Great Britain Pound (4) Swiss Franc (5) Japanese Yen (6) Singapore Dollar. The policy may be denominated in a combination of these currencies. The policy function on a deferred or accumulation basis or as an immediate annuity with an annuity over a period certain or term of years.

The same carrier will also issue an equity indexed annuity with the ability to participate in the upside of major stock indexes around the world. The ability to denominate the policy in multiple currencies may be accomplished while participating in the upside of various stock indices from around the world. The policy is not subject to principal volatility, i.e. you cannot lose your money.

From a planning perspective, the policy allows the NRA to accumulate Flight Capital offshore using the guarantees of an annuity contract while hedging against currency risk or stock market volatility. The statutory protection of the Bermuda insurer provides a layer of asset protection that many foreign banks may not enjoy for large sums of money. The NRA may also use the policy to informally fund an offshore retirement structured as a defined benefit or defined contribution arrangement. Furthermore, the policy should replace the expensive and sometimes inefficient use of a retail life insurance policy. However, if the NRA needs life insurance, he should purchase permanent coverage. There is nothing wrong with that. Nevertheless, the annuity is a better accumulation vehicle for an accumulation objective.

Summary

This product is an important product for NRAs with offshore funds or NRAs looking to develop a source of wealth outside of their home jurisdiction. The product perfectly complements the goal of accumulating and protecting offshore funds in a tax efficient manner. Almost without exception, life insurance and annuities receive tax-favored treatment around the world.