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Features - July 2007

 

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Insurance: invaluable wealth management tool

Insurance: invaluable wealth management tool

A serious consideration in a continually changing world

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The Bahamas Investor Magazine
June 27, 2007
June 27, 2007
Marnin Michaels and Jana Dimitrova

In the history of the wealth management industry focusing on global families, we have seen an evolution of the manner in which we work with clients. Seventy-five years ago, that was very common for many people to use a simple bank account for wealth management solutions. It was perceived as all that was necessary and that “bank secrecy” would ensure that whatever planning needed to be done would take place. Over the years, however, the nature and range of wealth management tools have changed and we have witnessed the evolution of other wealth management strategies.

Historically, the traditional vehicles used were trusts, foundations, establishments, companies and the like. In the course of the past 20 years, we have seen the use of various hybrids of these, in particular, the use of financial products. And starting about 15 years ago, the use of life insurance as a wealth management strategy started to take form.

The reason for this development was that the public policy association with life and pension products has provided a preference, in most countries, for those products. First and foremost, life insurance receives special tax treatment, which is the driving force behind its popularity. If properly structured, life insurance provides tax-deferred growth of cash value, tax-free access to cash value, and tax-free death benefits.

Planning benefits
The preferences afforded to life insurance can be rich grounds for planning. In some cases, such planning takes advantage of various incomes, net wealth or inheritance tax preferences associated with the product. In other cases, the benefit may be of an asset-protection nature. In many jurisdictions, life insurance or various pension plans are outside the scope of a bankruptcy estate.

Because of these preferences, many practitioners in the tax planning area, particularly in view of the greater complications associated with using traditional vehicles, started focusing on insurance. This interest was further fuelled by tax and reporting complications associated with some of the traditional vehicles. In many cases, trusts, foundations and companies were being deemed transparent or, in particular, were being subjected to additional information reporting requirements. In contrast, the area of life insurance was not only an area that was being developed but, specifically, had tax and reporting preferences designed to encourage its use. Of course, when the more traditional products were originally designed, they were designed with the purpose of being developed in the home country, for the home country, and not with a view towards international wealth management.

Also as a result of preferences afforded to insurance products, the uses of life insurance have grown many and varied. Life insurance policies are used to preserve wealth as proceeds from insurance create the liquidity to pay debts and establish a source of capital to generate income for surviving family members. Life insurance policies are used to make charitable gifts instead of giving to the government a portion of one’s assets as an estate tax. Wealth replacement trusts, funded with life insurance, provide benefits to heirs in lieu of the gifted assets. Life insurance policies also equalize inheritances; passing a valuable business to an actively involved child can create the need to compensate other children. Life insurance can give equal amounts to other siblings who do not have interests in the business.

As the sophistication of financial products has grown over the years, the nature of the life insurance product has also evolved. At one end of the spectrum, some countries only require a one per cent risk shifting in order for a product to qualify as life insurance. Such products are known as “101 policies” or, colloquially, as “wrappers.” In other countries, more sophisticated and complicated wealth-shifting mechanisms are required. The United States, for example, has extremely sophisticated wealth-shifting requirements and effectively requires a one-to-four or one-to-five death benefit. One thing is clear, however: while they may be subject to further regulation due to their nature, life insurance products will not simply cease to be used because, unlike traditional wealth planning tools, they are more likely to withstand scrutiny.

New products
So what does this have to do with The Bahamas? Well, The Bahamas continues to grow and evolve as a financial services centre focused on the wealth management industry. Unlike other international financial centres that have focused on non-private wealth management services, The Bahamas has made this a priority and various members of the Bahamian financial services segment of the government have been very active in promoting this approach. We have seen developments in The Bahamas that encourage and develop the new products. In particular, we have seen the development of the Bahamian foundation, something very similar to the Liechtenstein foundation, at least in concept.

However, one of the areas in which The Bahamas has historically lagged behind is that of life insurance. Life insurance is an area in which, to be fully functional in the wealth management industry, the jurisdiction needs to have appropriate life products available and, particularly, available from the home country. Until this occurs, wealth management industries will be required to look outside of The Bahamas for a solution that can be kept in-house. Moreover, when one looks at the international institutions in The Bahamas, many of them are seeking a place to put their life carrier for handling the Americas. At the present time, this is a place where, if handled properly, appropriate growth can take place. So, why should we care? We should care because this is an area that is growing and other people are looking to develop and, without appropriate measures, this will be an area where we will fall short.

Bios
Marnin J Michaels
Marnin J Michaels was recently elected chair of the European Region Private Banking Practice of Baker & McKenzie Zurich.

Michaels’ practice focuses on international estate planning, trusts taxation related to the US jurisdiction and money laundering legislation—particularly the US Patriot Act.

Michaels is also a member of the Board of Advisors of the Journal of International Taxation and a member of the Editorial Board of Trusts & Trustees.

He has published in a number of  academic journals including: Journal of International Taxation, Tax Planning International and World Money Laundering Review.

Michaels is a graduate of Wilkes University and obtained his law degree from the Syracuse University College of Law.

Jana Dimitrova
Jana Dimitrova has been an Associate with Baker & McKenzie Zurich since 2005. She specializes in tax law and has practised as an international and corporate tax lawyer in Washington, DC, where she was an associate with Chadbourne & Parke LLP and with Skadden, Arps, Slate, Meagher & Flom LLP.

Dimitrova’s practice has focused on structuring financial products for US and European banks and insurance companies and tax planning for high-net-worth individuals. Her expertise also includes foundations, trusts, life insurance and annuity products and the establishment of structures for tax-efficient holding of assets and businesses in multiple jurisdictions.

She is a 2001 graduate of Harvard Law School who was admitted to the Bar in the District of Columbia. Dimitrova earned a BA from Colgate University in 1998.

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