Opportunity of a lifetime

Saturday, 01 October 2011
Article on the flexible and protective legal framework of Luxembourg life insurance policies

Luxembourg life insurance companies (LLICs) are regulated by the law of 6 December 1991 on the insurance sector, as amended (the Law). However, unit-linked life insurance policies (ULLIPs) are defined in the circular letter 08/11 (the Circular) of the Commissariat aux Assurances (CAA).2. ULLIPs are hybrid Luxembourg life insurance contracts (LLIPs) combining life cover and investment components. No guaranteed returns are provided by LLICs, the investment risks being borne by the policyholder (PH).

Considering the small size of the Luxembourg domestic market, ULLIPs are mainly distributed on a cross-border basis. Indeed, LLICs have taken advantage of the Third Life Directive (92/96/CEE), dated 10 November 1992, creating a common market for insurance services in the European Union (and then across the EEA) via the establishment of a single passport. Accordingly, LLICs have to abide by the Luxembourg prudential and investment rules as well as, inter alia, local tax and insurance contract laws.
So LLICs provide a flexible, though secured, environment, while offering PHs a product that is compliant in their country of residence. This is particularly important in the current tax and regulatory environment reflected in the Financial Market Supervisory Authority newsletter number 18.

While LLIPs offer a flexible and protective legal framework for all PHs, some PHs may be attracted by the investment potential of ULLIPs. LLIPs are attractive structuring tools also offering PHs a highly protective legal environment worth considering in these times of financial uncertainty.

Financial guarantee

LLIPs are construed on the legal concept of the ‘stipulation pour autrui’. The LLIC commits to pay the proceeds of the policy to a designated beneficiary, upon the death of the life assured or the term of the policy. The beneficiary can be family-linked or a third party to the PH, and their consent is usually not required.

In certain conditions, the premium may no longer be considered as funds belonging to the PH’s estate. From that date onwards, the PH holds a claim against the LLIC. The invested amount can, therefore, not be seized by the PH’s creditors and is, in many civil-law countries, exempt from succession tax.

The framework of LLIPs enhances a wide spectrum of estate and succession planning. For instance, a split of ownership beneficiary clause may ensure transmission over two generations. In addition, LLIPs have proved to be tax-efficient tools depending on applicable local laws and double tax treaties entered into with Luxembourg. It should be noted that non-Luxembourg residents are exempt from tax in Luxembourg and LLICs are not subject to taxation on income gains in their life insurance funds.

LLIPs may yet be used as a financial guarantee, for example, to secure a loan granted by a financial institution, enforceable without formality if structured as a Luxembourg pledge.
The Luxembourg insurance professional secrecy towards all parties different from PHs, including legal heirs, may also be an element of consideration for PHs. Whatever the rationale for subscribing LLIPs, PHs will benefit from the following protection scheme.

Protecting subscribers

The Law offers PHs a unique protection scheme in Europe should LLICs encounter financial difficulties or enter into insolvency proceedings:

  • LLICs’ liabilities are represented by technical provisions covered by matching movable assets, segregated from the assets of the LLICs.
  • In case of bankruptcy of LLICs, PHs are granted a ‘super preferential right’ over the segregated assets of the bankrupt LLICs, overriding those of all other creditors. If segregated assets show there isn’t enough to cover the LLICs’ liabilities, the PH holds a preferential right on the outstanding assets of the LLICs.
  • LLICs keep a permanent inventory of the segregated assets, an update of which is produced to the CAA on a quarterly basis. When LLICs are in breach of their prudential obligations, the CAA is entitled to take appropriate measures, including freezing the segregated assets.
  • Segregated assets are deposited with a custodian bank approved by the CAA, located in the European Economic Area (EEA) or, in specific conditions, outside the EEA. The bank enters, along with the LLICs and the CAA, into a standard deposit agreement whereby it, notably, agrees to comply with all restrictive measures ordered by the CAA, including those referred to above. Each deposit agreement needs to be approved by the CAA.

While using LLIPs as a structuring tool benefits from a high level of protection, some PHs are willing to accept a higher risk exposure in order to access the investment universe of ULLIPs.

Investment possibilities

ULLIPs, otherwise known as variable capital contracts, are LLIPs linked to external, e.g. UCITs, or internal funds of which the policy is allocated units. Internal funds have no legal personality. They are either collective funds, opened to a multitude of policyholders or dedicated funds, which are linked to a single policy (DFs).

The premium paid to the LLIC is invested in those funds, in turn invested in various underlying assets mirroring the investment strategy chosen by the PH. LLICs’ financial commitment is the value of the units, which is equal to the net asset value of the underlying assets of the fund(s) linked to the policy. The LLICs’ obligation in terms of return is thus limited to the performance of the underlying portfolio, the risk of market fluctuations being exclusively borne by the PH.

Unlike investments in pure financial instruments, once the premium is paid, either in cash or in kind3 (for DFs only), the LLIC becomes the legal owner of the underlying assets of the funds linked to the policy.

Luxembourg law offers policyholders a unique protection scheme in europe

Tailor-made ULLIPs

A DF is linked to a single dedicated contract and cannot serve as an asset for the contract of another PH.4 The minimum premium on subscription is EUR250,000. Payment of the premium in kind allows PHs to provide efficient structuring to an existing portfolio. In addition, the PH is left with a choice about the investment strategy of the DF reflecting their risk appetite. The investment strategy may, in most cases, be modified during the lifespan of the policy to adapt to the PH’s evolving needs.

Investments in internal funds must comply with the investment rules set out in the Circular. DFs are classified into four types, A to D, each linked to a different risk level depending on:

  • the amount of the premium (EUR250,000)
  • its invested portion into the DF;
  • the declared personal wealth of the PH.

Each type of fund may invest in a wide range of assets referred to in an annexe to the Circular (bonds, shares, UCITS, alternative funds, structured products, etc) within different investments limits, being more or less conservative, depending on its risk level.

As an illustration, a DF will be considered a type B if financed up to EUR250,000 by a PH declaring a personal wealth of EUR500,000. In that case, the DF may, for instance, invest up to 10 per cent of the portfolio in real estate funds located in the Organisation for Economic Cooperation and Development. A type C will require a wealth declaration of at least EUR2.5 million and may invest in the same spectrum of assets without limit. For a type D fund, all three criteria referred to above shall amount to at least EUR2.5 million, and investments in more risky assets, including in derivatives, e.g. options, forwards or futures, are permitted.

It is fair to say that ULLIPs linked to DFs are tailored for well-advised high- to ultra-high-net-worth individuals.

Policyholders’ rights

PHs may, inter alia:

  • increase the invested amounts with further contributions during the life of the policy
  • request partial or total surrender based on the terms and conditions of the policy
  • renounce the policy within a fixed period of time following the conclusion of the contract;5
  • expect mandatory yearly valuation statements.

Individuals looking for flexibility and profitability through mid- to long-term investments while considering efficient financial and estate planning should consider ULLIPs as a real opportunity. They will, in addition, benefit from Luxembourg’s multicultural and highly specialised workforce operating in a reliable environment. Indeed, Luxembourg insurance companies and well-diversified ULLIPs have proved to be resistant to the financial turmoil.

  • 1. Issued on 2 December 2008.
  • 2. The Luxembourg regulator of the insurance sector.
  • 3. If not prohibited by the laws applicable in the PH’s country of residence.
  • 4. In exceptional cases, the CAA allows several contracts subscribed by a PH, or several PHs who are relatives, to be linked to a single DF.
  • 5. The premium paid in cash is, as a matter of precaution and until the term of the renunciation period, usually invested in time deposit accounts.
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Patricia Ferrante

Patricia Ferrante is former Head of Corporate Legal at Lombard International Assurance SA, Luxembourg.

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