On March 1 2016 the government published a consultation paper announcing proposals to reform UK law as it applies to insurance-linked securities. This is part of a strategy to allow London to retain its status as a 'specialist insurance hub' and to participate more actively in the growth of alternative risk transfer transactions.

The consultation paper seeks views from the insurance industry on a number of key issues. The consultation phase is scheduled to run until the end of April 2016. If the government decides to proceed, it plans to produce draft legislation by the end of 2016.

Summary of proposals

The paper makes some radical suggestions. The most striking is the proposal to amend UK company and insolvency law to allow the use of 'protected cell companies'. This type of corporate structure has existed for many years in several of the jurisdictions which have been the most active in the alternative risk transfer market. The paper proposes that use of UK protected cell companies should be limited to insurance-linked securities transactions, but if it is adopted there will be wide interest in expanding it to allow application for many other types of transaction.

There is a clear intention to address the perceived regulatory and tax disadvantages of the United Kingdom. The government proposes a swift authorisation process, relatively simple ongoing governance requirements and an exemption from UK corporation tax for the issuers of insurance-linked securities (meaning that shareholders in the issuer would be taxed on their income from it, in the same way that they would be if they were investing in an investment fund).

The government acknowledges that not all difficulties can be easily overcome. In particular, interest payments on insurance-linked securities would still be subject to withholding tax rules where they are made to a jurisdiction not covered by an appropriate tax treaty. Although several exceptions exist, they would not always apply, and the government does not consider that a new exception for insurance-linked securities can be made, at least in the near future.

Although radical in some respects, the proposals are cautious and practical in others. In particular, the government proposes that only 'qualified institutional buyers' should be permitted to buy or trade in insurance-linked securities. This restriction reflects the government's expectation that only knowledgeable and sophisticated investors are likely to be interested in buying these securities. It avoids the need to design a specialist investor protection regime, as might be necessary if a wider pool of investors were permitted.


Insurance-linked securities are financial instruments whose values are determined by events which cause losses to insurers. They allow insurance and reinsurance undertakings to transfer the risk of certain events occurring to the capital markets, as an alternative to using traditional reinsurance. They are therefore considered to be a form of 'alternative risk transfer'.

Insurance-linked securities transactions are beneficial for two main reasons:

  • they provide insurers with access to greater reinsurance capacity than the traditional reinsurance markets can offer, thereby enabling them to provide more insurance at more competitive prices and giving them more options to lay off risk in order to manage their capital requirements. This will be particularly important given increased capital requirements under Solvency II, which will continue to increase as transitional measures taper off; and
  • they allow risks to be spread more widely among global investors, rather than concentrating risk in the traditional reinsurance sector. This reduces the likelihood of several reinsurers becoming insolvent at the same time because between them they have accumulated too much exposure to a particular event. From the perspective of investors, insurance-linked securities are seen as largely independent from the financial markets and thus can enable investors to achieve diversification.

Since its beginnings in the 1990s, the international market for insurance-linked securities has increased substantially, with securities currently in issue estimated at around $60 billion. The performance of other structured financial products during the financial crisis – most notably the subprime collateralised debt obligations – had a detrimental impact on the use of insurance-linked securities, but the market has now strengthened considerably once again.

The best known type of insurance-linked security is a catastrophe bond (often called a 'cat bond'), which provides cover for one or more specified natural disasters, such as an earthquake or hurricane. The risk is passed to the capital markets by the issue of bonds to investors. The bonds pay interest and principal as normal if the relevant event does not occur. If the relevant event does occur, the interest and principal payments on the bonds are reduced – either partially or in full – so that money can be redirected to the insurer to cover the losses it has suffered as a result of the event. Investors receive payment only from what is left after the insurer has been paid.

As the insurance-linked securities market has developed, the applicable terms and conditions have become more sophisticated and innovative and the types of event covered have widened.

  • Pay-outs to the insurer need not act as an indemnity for the insurer's actual loss, but may instead be determined by reference to an independent index or parameters relating to the insured event (such as the strength of a hurricane). These types of pay-out trigger provide more certainty for investors, making the bonds more marketable. However, this comes at the cost of introducing basis risk for the insurer.
  • The relevant event need not be a large-scale natural disaster. It might instead be a river flooding more than expected or a general increase in mortality rates.

The development of more sophisticated insurance-linked securities terms and conditions has become the market norm, and rating agencies now look for the inclusion of multiple cumulative pay-out triggers for insurance-linked securities as part of their rating criteria.

This development conflicts with the European Insurance and Occupational Pensions Authority's (EIOPA) 2015 warning that the reinsurance provided by the insurance special purpose vehicle (ISPV) must properly transfer risk, and that the extent of the cover provided by a risk transfer transaction should not result in any material basis risk (a requirement now reflected in Solvency II). EIOPA has also previously pointed out that the complex and non-standardised nature of insurance-linked securities transactions and the difficulty in assessing the underlying risks may lead to investors being wary of such instruments, thus leading to an illiquid market.

It is essential to balance all of these competing concerns in order to ensure a successful insurance-linked securities transaction.


The key to an insurance-linked securities structure is to place an intermediate company between the insurer and the capital markets investors (referred to by the government as an 'ISPV'). The ISPV performs three functions:

  • Reinsurance – the ISPV provides reinsurance to the insurer on agreed terms. In order to perform this function, it must obtain appropriate regulatory authorisations to carry on reinsurance business and comply with applicable reinsurance regulations on an ongoing basis. If the specified event occurs, it makes a claim pay-out to the insurer.
  • Bond issuance – the ISPV issues bonds to capital markets investors whose terms allow interest and principal payments to be reduced in the event of a pay-out under the reinsurance. In order to perform this function, the ISPV must comply with applicable securities regulation in jurisdictions where the bonds are issued. It also must be able to pay interest and principal to investors with minimum leakage of cost and tax.
  • Investment of assets – during the life of the transaction, the ISPV invests the assets it has received from the insurer (in the form of the reinsurance premium) and investors (in the form of payment for the bonds). The investment return generates a further source of income from which to pay interest and principal on the bonds or reinsurance pay-out if the specified event occurs.

The structure is shown in the following diagram.


It is a regulatory requirement under Solvency II that from the outset the ISPV be "fully funded" to the extent necessary to enable it to discharge all of its obligations under the reinsurance agreement. In addition, bond holders must accept that payments to them are 'limited recourse', and that they will receive payment only to the extent that the ISPV has assets available after any reinsurance pay-out has been made to the insurer.

The United Kingdom is perceived as falling behind in the insurance-linked securities market, as few insurance-linked securities transactions have involved securities being issued from ISPVs based in the United Kingdom. Nevertheless, UK insurers have made use of insurance-linked securities transactions involving ISPVs based in other jurisdictions.

The government's consultation paper proposes reforms which are intended to make the United Kingdom more attractive for these transactions. The main aim is to transform the law so that UK and international insurers will be attracted to ISPVs based in the United Kingdom for their insurance-linked securities transactions.

Government proposals

The proposals can be divided into six main categories.

Protected cell company reforms
The government proposes to introduce amendments to UK company and insolvency law to allow 'protected cell companies' to be created. A 'protected cell company' is a single legal entity with a number of 'cells' whose assets and liabilities are legally ring-fenced from one another. Each cell will be able to enter into a separate insurance-linked securities transaction. Because of the legal ring-fencing, the insurer and investors that deal with one cell will be unaffected by losses that arise for a different cell, and each cell will be able to be wound up individually while other cells continue to operate.

This is a radical development for UK company and insolvency law, which until now has largely followed the traditional model that all of a company's assets are available for all of its liabilities, subject only to priority created by statute or security interests. It is a model that has been available for many years in the leading insurance-linked securities jurisdictions (including Bermuda and Guernsey). UK law already has one example of the proposed model in the form of umbrella open-ended investment companies, and it will be interesting to see how far the government follows the regulation that applies to them, as they are not mentioned in the consultation paper.

The main advantage of the protected cell company model is that it allows multiple transactions to be entered into without having to set up a new company and go through the regulatory authorisation process each time. The government refers to an ISPV used in this way as a 'multi-arrangement ISPV' (mISPV).

Use of a protected cell company can also reduce operating costs, as the same set of directors and the same service providers can be engaged to take responsibility for all of the cells, and a single set of reports and accounts can be used for the company as a whole.

Authorisation process reform

The government proposes that new ISPVs will benefit from a fast-track process for obtaining the necessary authorisation to act as a reinsurer. It suggests that ISPVs could receive authorisation within six to eight weeks of application.

This would compare favourably with the process for ordinary insurers, for which the regulator has up to six months from the date of application. The fast-track authorisation process would give insurers and investors greater certainty about when their transaction would be entered into and avoid significant delay.

In combination with the protected cell company reforms, this will be a major improvement to existing law. The government proposes that once a mISPV has been established and authorised, further transactions by additional cells would no longer require the new cells to be authorised. Instead, the regulator would be notified of the proposed transaction shortly before it is executed. In the absence of the regulator objecting, the transaction could then be executed without any further authorisation process.

Governance and reporting
Solvency II rules allow a more simplified governance and reporting regime for ISPVs than that which applies to ordinary insurers. As there is not much latitude in the application of these rules, the consultation paper merely clarifies that the United Kingdom will apply them.

The government has said that it would expect the ISPV to have a minimum of three board members: a chair, a chief executive and a chief finance officer. A chief actuary may also be required, although the government is consulting on whether this is necessary.

Permitted investors
The government has proposed that only qualified institutional investors should be permitted to invest in insurance-linked securities issued by ISPVs established in the United Kingdom. This reflects the expected market for these securities, and avoids the need to consider the introduction of rules to protect less sophisticated and knowledgeable investors.

Withholding tax
Interest payments from ISPVs established in the United Kingdom will be subject to withholding tax if they are made to investors in jurisdictions that are not covered by a tax treaty. Given other ongoing projects where this issue is relevant, the government does not consider that it can make an exception from withholding tax for insurance-linked securities.

This will not be a problem where investors are based in the United Kingdom or other countries where a tax treaty allowing full withholding tax relief applies, or where the quoted eurobond exemption applies, or where the recently introduced private placement exception applies. However, it is potentially a significant drawback if it is intended to market the insurance-linked securities to investors based in other jurisdictions in circumstances where none of these exceptions can be relied on.

Corporation tax
An ISPV will be funded by an initial equity injection represented by shares issued by the ISPV to its shareholder. The shareholder may be the insurer itself, or another company in its group, or it may be a third party.

Because Solvency II rules impose no capital requirement on ISPVs (beyond the requirement to be "fully funded"), this equity injection is unlikely to be significant in most cases. However, it might be significant in particular cases, and the shareholder would expect ultimately to extract a profit from the ISPV. The government has considered how tax law might affect this profit.

Under ordinary corporation tax law, the ISPV would incur UK corporation tax on its profits and the net profits would be distributed as income on which the shareholder (if a UK company) would not be taxed. The government proposes to reverse this position for ISPVs. The ISPV would be exempt from UK corporation tax, but the shareholder would be taxed on the income it receives from the ISPV.

This would be significant where the investor was in another jurisdiction, since no UK corporation tax would apply and that investor would only be subject to tax on the income in accordance with its own local requirements.

In principle, this is a significant step for the government to take and shows the commitment to insurance-linked securities transactions. However, it is questionable whether it will make a large difference in practice, however, as in most cases as equity investment in ISPVs is expected to be minimal.

Stamp duty
The consultation paper does not mention stamp duty. This will be an important consideration, as transfers of bonds issued by ISPVs would be subject to stamp duty at 0.5% unless certain conditions are met, or the government introduces a new exemption. The absence of a clear exemption would be a disadvantage for the United Kingdom when compared to the existing leading insurance-linked securities jurisdictions. It may be that the government has not yet considered this issue.


In some respects, the proposals are radical and show a genuine commitment to encourage more insurance-linked securities transactions in the United Kingdom.

The willingness to introduce a protected cell company regime is a significant step. This regime would have considerable value to many different types of structured transaction, well beyond insurance-linked securities. Currently, the government proposes to limit it for use only in insurance-linked securities transactions. However, there will be a flurry of activity to seek its extension for use in other transactions if it is introduced.

As a package, the reforms should address most of the obstacles that have traditionally been seen as preventing the growth of UK insurance-linked securities transactions. The outstanding issues are withholding tax and stamp duty, which will be disincentives for insurers wanting access to as many potential investors as possible, including those in jurisdictions which do not have a tax treaty with the United Kingdom.

However, where insurers know their potential investors, and assuming the government proposes a suitable exemption in relation to stamp duty, the proposals should be attractive to both UK and international insurers.

For further information on this topic please contact Steven McEwan, Julian Craughan, Tauhid Ijaz or Robert Ripin at Hogan Lovells International LLP by telephone (+44 20 7296 2000) or email (,, or The Hogan Lovells International website can be accessed at

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