Border Crossing

• Ronald J Panko
• November 2001
• 

by Ron Panko

Nationwide Life Insurance Co. is rapidly building an offshore annuity business through banks, wire houses and broker-dealers that sell to foreign citizens working part of each year in the United States. Such accounts offer privacy and a haven from taxes, but they are a market that insurers based in the United States have barely tapped.

"It's pretty unusual, but it will become more usual as they see the benefits," Richard Duke, a Birmingham, Ala.-based attorney with expertise in international law and taxes, said about domestic insurers entering the offshore market. "A lot of banks are getting into offshore investing, using a foreign custodian retained by the trustee or the foreign corporation manager. It allows them to get around complying with the U.S. Securities Act of 1933, which can be expensive." That act, passed during the Depression, sets forth regulation of the securities industry in the United States.

Nationwide entered the offshore markets in 1998. Its offshore distribution company, Nationwide Financial Services Bermuda Ltd., has about 23 employees. This year, through August, it had $171 million in premiums through its bank distribution channel, which generates 95% of the business. "That's a 138% increase over the same period last year, so it's a very vibrant, growing business for us," said Matt Reibel, president of Nationwide Financial Institutions Distributors Agency Inc. "It represents more than 7% of all business we do through financial institutions." Reibel projects that Nationwide's total sales this year through financial institutions will reach $3.8 billion.

Nationwide's offshore market share is difficult to estimate. According to the company, about $7 trillion may be invested in offshore markets, or about one-quarter of all the world's wealth. But as Reibel pointed out, offshore accounts are confidential--generally outside the reach of government tax collectors and regulators--and there is no trade organization that attempts to collect statistics. Reibel said the only U.S.-based providers of annuities to the offshore market are Nationwide and MFS Investment Management, Boston, the first company to offer a mutual fund in the United States.

Of the $7 trillion, about one-half is believed to be in real estate, one-third in mutual funds, about 5% in insurance products and 12% in bank deposits. Large mutual-fund companies have subsidiaries offshore, as do foreign financial-services pro- viders, such as Deutsche Bank, said William Pingleton, vice president of Nationwide Financial Offshore Sales.

Some U.S. investors are willing to forgo the investment transparency and protections offered by the Securities Act of 1933. If they meet minimum net worth and/or income requirements, they may invest in private placements, for example, or they may invest in an offshore account. Nationwide's offshore initiative is for people who are not citizens of the United States, Bermuda or certain other countries, including Cuba, Iraq and Iran.

Nationwide's typical customer is about 50 years old, a professional (doctor, lawyer or business owner, for example) and has a family, Pingleton said. Customers have certain regulatory protections from Bermuda, and they are protected by the name and the good faith of the underwriting company, Pingleton said. Nationwide also offers asset protection against political risks and currency devaluation that they might otherwise face through investments in their home countries. Nationwide provides company-backed fixed annuities and its Best of America variable annuities, which offer large and world-renowned money managers as well as the opportunity to annuitize. More than 70 countries are represented in Nationwide's client base, with the majority from Latin America and Asia, where political and economic instability is more prevalent, Pingleton said.

No Soliciting

Nationwide is not involved in any client prospecting because of U.S. laws that limit companies on how they may solicit. Instead, partners at more than 160 firms inside and outside the United States initiate contact with prospects. Key bank partners are Chase Manhattan, SunTrust and Wells Fargo.

Typical prospects are existing clients of a bank. "The adviser would then talk to the client about the bank and services it offers, the benefits of offshore investing, and the benefits of variable annuities," Pingleton said. "If there is interest, the bank sends information to clients once they leave the U.S."

Clients then would have to sign application papers while they are outside the United States. Pingleton said bank offices in port cities like New York, Miami, the District of Columbia, San Francisco and Los Angeles are most responsible for initiating sales. Banks in Chicago or other midwestern cities typically do not generate offshore business, he said.

Clients buy non-U.S. registered products, primarily because financial institutions are not required to report those accounts to governments and do not withhold tax. The products also provide some protection from estate taxes. Pingleton said that while U.S. citizens are allowed estates of up to $675,000 before any estate tax applies, the exemption for non-U.S. citizens is only $60,000.

Banks are the chief distribution outlets for Nationwide's offshore annuities, mainly because the insurer has "a very solid relationship" with them domestically, Pingleton said. And workers from foreign countries traditionally go first to banks when investing outside their home country. "As time passes and they become more comfortable with financial markets, they may gravitate to a wire house, and then may go on to the broker-dealer channel," he said. "But banks are the first line of opportunity."

Advisers that actually prospect for offshore business make up only a small proportion at the banks. "It's a niche market," Reibel said. "They already have international clientele, and they're at branch offices that serve the ethnic population. The producers themselves are ethnic, so that ties them into their clients."

The banks, meanwhile, have come to understand that the more different kinds of business they can enact with these clients, the more they retain them. "Many of the banks we worked with to this point didn't even realize they had this opportunity," Reibel said.

Offshore Variable Life

Duke, who teaches an international tax program at St. Thomas University in Miami and is co-authoring a book about asset-protection trusts, said offshore variable life insurance represents an even bigger opportunity for domestic insurers than offshore annuities. That's because the death benefits of annuities are subject to the estate tax. Also, insurers would be able to offer a "European type of contract," which is more attractive to a purchaser than a U.S. product because it avoids high producer commissions, Duke said. "They're not even close; a policyholder is immediately positive in cash value in Europe," he said. Variable life expenses can be further reduced by basing the operation in a low-tax or no-tax jurisdiction, he added.

Nationwide said this summer it would introduce an offshore variable life product, but then it decided to shelve those plans.

Those who support offshore products, such as Duke, argue that the products serve as a check against governments raising taxes. But governments around the world in recent years are pressuring offshore havens and institutions to be less secretive about their dealings and to know the source of their depositors' money, said Vernon Jacobs, a certified public accountant, writer and publisher in Prairie Village, Kan., who has made a career advising people on taxes and asset protection. He is editor and publisher of two reports, "Offshore Tax Strategies" and "Global Asset Protection."

"Four or five years ago, a person could open a bank account with a wire deposit," Jacobs said. "That's almost impossible now. Now a bank wants to see the depositor, wants to ensure this is a valid customer with valid sources of income. There's a great deal of sharing of information between banks and government where there are allegations of criminal activity."

Governments are likely to use the recent terrorism in the United States to buttress their long-standing efforts to require even more transparency in offshore banking, Jacobs said.

Governments have long known they were losing tax revenue to offshore accounts, but Jacobs said that only recently have those losses represented large amounts of money. "The thing has exploded over the last five years," he said. "Before, it wasn't even on the radar screen."

IRS Applies Pressure

In 1996, the United States substantially increased penalties for those who failed to report income from offshore investments, Jacobs said. A key event in the battle occurred last year, when the Internal Revenue Service and other federal agencies assigned a joint task force to penetrate offshore money havens. The task force tried to bring charges of money laundering against a Cayman Islands banker, and the banker plea-bargained by agreeing to turn over records of some 1,500 accounts to the government, Jacobs said. "It was a nuclear bomb to the offshore world," he said. "The IRS has been diligently working on those 1,500 accounts, and other agencies are looking for drug money laundering and other illegalities."

Last year, the IRS won an extraterritorial judgment against foreign banks to gain access to credit-card information, Jacobs added.

In addition, the United States, the United Kingdom, Canada and about 30 other countries have formed the Organization for Economic Cooperation and Development, based in Paris, to promote cooperation in many kinds of ventures among democratic nations in an increasingly interconnected world. A current campaign, Jacobs said, is to increase tax transparency in all countries.

"A subset of that agenda is to promote or strong-arm countries into a concept called tax harmonization, which is the solution to what they refer to as tax competition among nations," he said. That, of course, would be bad news for the offshore industry, and it is an initiative Jacobs opposes. "If we didn't have the tax havens, we'd have to invent them," he said. "They provide the level playing fields between countries...Everyone goes to tax havens for tax harmonization, but the OECD wants tax harmonization at a high level of tax."

Clean Money

Accounts that offer privacy and confidentiality, of course, are where government investigators expect to find the money that supports terrorism networks. Pingleton said Nationwide has "very strict" requirements of the institutions with which it deals. "The institution is required to do a check on any funds that come in," he said. "You have to know your client and source of funds, and the responsibility lies with the banks, the institution, Bermuda and the company issuing the product. So that's a minimum of two or three checks.

"Everyone in the process goes out of the way to make sure it's clean money," Reibel said.

Jacobs offered two schools of thought on terrorists using the offshore industry. One is that terrorists' money is not going through traditional offshore channels, and government investigators will find very little or will freeze very little through traditional money-laundering tax-haven channels. Instead, terrorists probably have their own channels.

The other school says that the cost in terms of loss of liberty for trying to trace down every dollar of money terrorists have moved through the banking system will be too high vs. the likely gain. Privacy may not be protected by the U.S. Constitution, but it's highly prized by most people, Jacobs said.

Duke said that whenever government passes laws that chip away at privacy, even for the sake of tracking terrorists, the new law also will "get at the common man." But the recent terrorism has left him with mixed feelings, Duke said.

"I don't like the IRS, but I don't like the illegal offshore promoters even more," he said. "I'm very much against the power of government, but a lot of my free-market beliefs of the past are being eradicated. If the government is not able to fight for us, then who will fight for us?"

Terrorism and governments' reaction to it will scare away "the illegitimate people" in the offshore business but may stimulate legitimate activity, particularly offshore life insurance, Duke predicted.