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Private Placement Variable Products: Onshore vs. Offshore

The tax and investment advantages of offshore variable insurance products have resulted in increased sophisticated investor interest.

Judith A. Hasenauer, 10/03/2013

A number of insurers that are domiciled in the U.S. have developed variable insurance products to be sold on a private placement basis. These products are designed for "sophisticated" purchasers who meet requirements specified under the rules developed by the SEC to enable sophisticated investors to purchase products that have not been registered with the SEC and are not subject to the regulatory supervision that applies to registered variable insurance products.

In addition, a number of foreign insurers offer similar products in offshore (i.e. non-U.S. ) jurisdictions that, while not really "private placement" products, are directed toward the same markets as would be the case with a domestic U.S. product that met the standards for the private placement exemption from the U.S. securities laws. It is not unusual for U.S. residents to purchase variable insurance products from such offshore insurers.

In our previous article on the subject of private placement variable products, we discussed a few of the reasons why purchasers of these products are motivated to do so. We will expand on the descriptions of the motivations for such purchasers, the motivations of the insurers that offer them, and the differences between onshore variable insurance products and offshore ones.

Variable insurance products sold in the U.S. are among the most regulated financial instruments in existence. They are subject to the full panoply of federal securities regulation, including the requirement that such products be registered with the SEC as investment company securities, that the separate accounts that hold the assets underlying the product be regulated in the same manner as applies to mutual funds, and that the sales of the products be done through securities broker-dealers and their associated persons that are members of FINRA.

In addition variable insurance products are regulated by state insurance regulators that must approve the insurer's entry into the variable insurance business, approve the products themselves, and license the salespeople who offer the products to consumers. Moreover, the IRS even has a role in the supervision of variable insurance products since these products must comply with strict requirements imposed under federal tax laws. Thus, it is relatively obvious why insurers would desire to avoid any element of these regulatory requirements--particularly when dealing with large cases that often run into millions of dollars in premium contributions.

The regulatory process in the U.S. for variable insurance products that do not qualify for the private placement exemptions can be confining and make the products fairly expensive to administer and therefore often reduce the appeal of these products to affluent sophisticated purchasers. The investments that underlie registered variable insurance products are generally copies of retail mutual funds, and such investments are less appealing to purchasers than are more flexible and exotic investment vehicles. Nevertheless, even with variable insurance products that are exempt from federal securities laws, state insurance regulators often restrict the types of investments that may be used with any variable product--registered or private placement. In addition, state premium taxes often cause sophisticated purchasers who are planning on making large premium payments to have a reduced interest in the products. It is for this reason that some U.S. residents chose to go to offshore jurisdictions to purchase their variable insurance products.

Many non-U.S. insurers have offered variable insurance products for many years. In fact, the first form of variable life insurance was developed in several European nations and has remained the predominant type of life insurance sold in many of these countries. It was only logical that variable life insurance would be transplanted to the U.S. and that many non-U.S. residents would seek variable life insurance products that have underlying U.S. investments. Indeed, there has been a consistent demand for U.S.- dollar-denominated variable life insurance and variable annuity products, even those issued by non-U.S. insurers. Several of the Channel Islands, Bermuda, and a variety of Caribbean countries have developed dollar-denominated variable insurance products that appeal to non-U.S. residents and U.S. residents as well.

As the process of developing variable insurance products by non-U.S. insurers proceeded, the market for such products for U.S. residents also expanded. The federal income tax requirements for variable insurance products purchased by U.S. taxpayers apply regardless of where the product is issued. If the product fails to meet these requirements, it may not qualify as "insurance" for purposes of federal income taxes. Therefore, non-U.S. insurers that permit U.S. residents to purchase their products have developed products that are in compliance with U.S. federal income tax laws. These U.S.-compliant products are usually purchased only by U.S. taxpayers. Non-U.S. taxpayers rarely want products that are subject to the limitations that apply to U.S.-compliant products.

Judith A. Hasenauer, JD, CLU, is an attorney with the law firm of Blazzard & Hasenauer, P.C. She devotes her practice exclusively to the financial services industry, providing consulting on the development and regulatory clearance of products, compliance issues, distribution issues and related matters, such as advisory activities and industry initiatives.

The author is not an employee of Morningstar, Inc. The views expressed in this article are the author's. They do not necessarily reflect the views of Morningstar.

The author is a freelance contributor to MorningstarAdvisor.com. The views expressed in this article may or may not reflect the views of Morningstar.

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