The Intelligent Quarterly from the publishers of The Insurance Insider

Spring 2012

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So it is official. The sovereign government of one of our industry's domiciles of choice is to be bailed out by the European Union, the International Monetary Fund (IMF) and bilateral loans from non-Euro members of the EU - UK, Sweden and Denmark - to the tune of some EUR67.5bn.

With the finance achieved at an average interest rate of 5.83 percent, and set over a medium-term timeframe of an average of 7.5 years, Ireland has gained a breathing space. And the international (re)insurance community can also exhale a collective sigh of relief.

"Ireland may also have gained a reprieve for its totemically low 12.5 percent corporation tax rate, but the victory was hard won"

Ireland is not the only major insurance domicile in history to have received assistance from international financial institutions. Those with long enough memories will remember the profligate UK's own recourse to the IMF to tide the nation over during a sharp liquidity crisis in the 70s.

But one thing is clear: The expansionist phase for Irish international financial services is unlikely to be repeatable in the current uncertain climate.

Ireland may also have gained a reprieve for its totemically low 12.5 percent corporation tax rate, but the victory was hard won. The average interest rate that Ireland has been forced to bear exceeds that of spendthrift Greece by some 600 basis points.

Many would argue that Greece's overspending government was far more responsible for its own woes than that of the Irish republic, which was in surplus and has its main two banks to blame for fuelling an unsustainable property boom that turned to bust when the global financial crisis hit.

The rescue deal also allows Ireland only a single additional year to get its budget deficit back down below the 3 percent originally envisioned.

Before the bailout was unveiled, Dublin's original plan was to reduce its funding shortfall to 3 percent of GDP by 2014, with EUR6bn of the total budgetary adjustment front-loaded into 2011. Ireland will now have until 2015 to achieve this.

Part of what worried the markets enough to provoke the pan-Eurozone financial crisis in the first place was a calculation from potential buyers of Irish government debt.

They projected that the deflationary effects of Ireland's savage self-imposed government spending cuts would cause a negative loop of low-to-zero growth, high unemployment and feeble tax revenues that would end in eventual sovereign default.

Given the relatively punitive rate of interest on the bailout and the admission that by 2014 one fifth of Irish tax revenues will be spent on interest payments, the deal may not ultimately inspire the market confidence that the EU is seeking.

The medium-term nature of the loans could also be construed as a negative, with experts estimating that the terms only allow Ireland to keep out of the international financial markets for the next two years. This is scarcely a knockout blow, especially given the uncertainty surrounding the future direction of the Irish economy over a 24-month period where savage real cuts to public spending will suck billions out of the economy.

The deal is hardly akin to the 50-year US-backed "Brady bonds" of the 1980s that finally put a floor under decades of region-wide debt crises in Latin America.

Meanwhile, other observers were surprised at Ireland's significant EUR17.5bn participation in its own bailout, which is being financed largely through a dip into the nation's pension reserves.

Sovereign drag?
However much the markets may or may not be tamed by the actions of international financial institutions, even the EU and the IMF cannot control the ratings agencies. They will have their own view of Ireland's eventual ability to pay its way, and this can jaundice their view of firms based there.

As the sovereign debt crisis continued, rating agency Standard & Poor's (S&P) lowered Ireland's sovereign credit rating by two notches from AA- to A in late November. The nation is still on credit watch with negative implications and S&P expects to update its rating in the first quarter of 2011.

However, the agency did say it expected Irish debt to remain investment grade.

Under S&P ratings criteria, subsidiaries can only be rated higher than the sovereign in specific circumstances and the change directly affected RSA Insurance Ireland, Aviva Insurance Europe and Allianz Plc. All were placed on negative credit watch in parallel with their host.

However, the agency clarified that the insurers it can rate above the sovereign "write most of their business with policyholders outside the financial centre, hold most of their investments in a form other than local sovereign debt of that financial centre, and hold most of their deposits in banks domiciled outside that financial centre".

After pressing from the international community, S&P issued further clarification that the insurers concerned are typically captive insurers of corporates based outside Ireland, captive reinsurers of insurance groups based outside Ireland, or subsidiaries of global insurance groups that conduct the majority of their EU business under an Irish licence.

The Dublin International Insurance & Management Association (Dima) was quick to seize upon the announcement. It pointed out that this meant that its members fall within the S&P criteria for companies that are rated independently of the sovereign position, and that therefore generally their ratings will not be directly impacted by any changes to Ireland's sovereign ratings.

Taxing questions
As the EU and the IMF came to the negotiating table at the end of November the international (re)insurance community was looking anxiously at the final terms for any sign of negative movement on the country's favourable corporate tax rates and rules.

The nation is a popular hub for EU headquarters among many in the international P&C (re)insurance sector because of its low corporation tax rate and lack of controlled foreign company legislation.

Irish ministers had strongly denied that the nation's tax status, which historically has rankled with some higher tax EU member states, including France and Austria, was up for negotiation in return for the bailout funds.

Irish corporation tax is not a major political issue in the country - a consensus exists that puts the measure at the heart of Irish economic policy.

Indeed Fine Gael, the main opposition party and the probable dominant partner in any new coalition government likely to be formed after elections early in 2011, told IQ that it "believes that the 12.5 percent corporation tax rate has proven to be of enormous benefit to the Irish economy and will be pivotal in attracting inward investment and job creation into the future".

Only smaller parties such as the nationalist Sinn Féin have shown any sign of dissent in the past.

But despite the strong denials, the subject is never far from the EU agenda and crops up periodically in official gatherings of EU finance ministers. Should Ireland need another bailout in the future, it may not be able to resist the pressure next time.

"The centre's reputation has also made a strong recovery since being dubbed the "Wild West of European finance"

Ireland is the domicile of choice for the EU holding companies of international (re)insurance groups. Those that benefit from the country's tax regime include major Bermudians Axis, Arch, Alterra, Everest Re, PartnerRe, RenaissanceRe and XL, as well as Ace and Lloyd's (re)insurer Beazley.

Global broker Willis also moved its global holding company to Ireland at the beginning of 2010.

Dima members transacted in excess of EUR25bn in international P&C premium through Dublin in 2008 and this figure increased in 2009, according to Dima CEO Sarah Goddard.

Ireland's recent changes to dividend taxation continue to make it an ideal location for holding companies.

In the Irish Finance Act 2010, although transfer-pricing rules were introduced, Ireland extended its 12.5 percent corporate tax rate to certain foreign dividends received from non-tax treaty countries. It also introduced an exemption for portfolio dividends that could attract even more multinationals to the jurisdiction.

There is also no controlled foreign company legislation in Ireland, which means that, provided profits are not repatriated, foreign trading can be carried out through a corporate entity in any low-tax jurisdiction.

Not all gloom
But despite the considerable uncertainty surrounding the Irish sovereign debt position over the next few years, there are some positives that proponents of Dublin can cling to.

Click to enlarge Low corporation tax rates appear politically institutionalised, having come through the ultimate test of fire during the bailout. Major Irish political parties have accepted that too many well paid jobs are dependent on international business remaining in Dublin to risk capital flight for a few Euros more in tax.

Also, on the regulatory front Dublin remains a committed EU member and is likely to continue to be among the first to enact any EU insurance directives that enhance its position in this sphere. Despite the difficulties and obvious failures to prevent the bubbles of the past, its regime is still deemed fair and efficient in international circles.

With major price falls experienced already, the property correction is well advanced and the "final heave" approach to recapitalising Irish banks should help crystallise the last of the main writedowns. This coupled with labour market and pension reforms will make locating to Ireland a lot less painful for adventurous corporations than in the past, as office and labour costs fall.

Despite US quantitative easing, the Eurozone crisis is finally predicted to have a widespread devaluation effect on the Euro, again making Dublin a relatively cheaper place for holders of dollars to do business.

And ultimately, the only way innocent international funds held in Dublin could end up being frozen Argentina-style would be if EU institutions failed utterly to act if Ireland needed to ask for another round of rescue loans. Given that Ireland is in the Euro that is hardly a realistic option.

In the unlikely event that the Eurozone were to crack to the point that Germany was tempted to leave and form a "hard" EU currency with core allied northern European economies, then all bets would be off and capital might fly. But that isn't going to happen any time soon, is it?

The problem today is that so many financial certainties have been swept away - indeed, this is a neat summary of Ireland's predicament.

So much of the domicile issue is about the external perception it gives clients and suppliers, as well as the sovereign in question's "direction of travel".

Do not bet against Ireland coming through its humiliation with its international (re)insurance sector largely intact. However, in today's climate there is simply too much uncertainty to bet against any more unexpected events occurring. As a consequence, redomiciling is again unlikely to be top of any board's current priority list until the rolling sovereign crisis has calmed. And that could be sometime yet.

The centre's reputation has also made a strong recovery since being dubbed the "Wild West of European finance" in a New York Times article at the height of the finite reinsurance scandals of 2005.

The subject exploded onto the scene after a Spitzer-led probe and subsequent prosecution of a sham $500mn reinsurance of AIG written out a Dublin subsidiary of Gen Re.