Incorporated cell companies: the Cayman approach

30-11-2012

Paul Scrivener

Incorporated cell companies: the Cayman approach

Paul Scrivener, partner with Cayman Islands law firm Solomon Harris, outlines proposed new legislation to permit Cayman Islands segregated portfolio company insurers to incorporate their cells.

It is probably fair to say that when incorporated cell companies (ICCs) began to be introduced in some offshore jurisdictions a few years ago, with Jersey in the British Channel Islands being the first, the Cayman Islands did not see the need immediately to jump on the bandwagon. It preferred to wait and see how this very innovative—if not cutting edge— product developed and what appetite there was for using it.

For some time there was no significant demand for ICCs even in the jurisdictions which championed them, but the Cayman Islands continued to keep this development under review and began to identify a number of commercial drivers pointing to the need for Cayman to introduce ICC legislation, at least in its insurance sector.

Two factors in particular, of equal importance, stood out. The first related to the US tax treatment of offshore protected cell companies. While there was continuing uncertainty as to how the Internal Revenue Service would regard an unincorporated cell of an offshore insurer, an incorporated cell appeared to be in a much stronger position to make its own tax election, under its own federal tax identification number. Second, it was increasingly important for cells within the same segregated portfolio company (SPC) to be able to contract with each other to facilitate reinsurance and quota sharing. Sponsors and consultants were starting to demand this with increasing regularity and, unfortunately, this was not possible with unincorporated cells.

Through healthy collaboration between the Cayman Islands government and private sector participants, in particular the Insurance Managers Association of the Cayman Islands and the Financial Services Legislative Committee, a draft bill was circulated for consultation in July this year and at the time of writing this article in October 2012, there appeared to be a real likelihood that the legislation would find its way on to the statute book in the near future. For the purposes of this article I will assume that the legislation was enacted substantially in the form of the consultation draft as amended by the consultation process.

At the time of writing, Cayman ICCs would be specific to the captive insurance sector and would not extend to other areas of Cayman’sfinancial services industry. The new legislation would amend the Insurance Law rather than the Companies Law and would be structured as a modification to the existing regulatory regime for SPC insurers rather than a change in substantive law. The other difference from jurisdictions that currently offer ICCs, is that cell incorporation in Cayman is achieved by a separate company being established by the SPC underlying the relevant cell, rather than the cell itself taking on incorporated status.

"Third parties unfamiliar with cell companies may find a PIC easier to understand than an unincorporated cell because of its separate legal identity."

The Cayman Islands considered carefully the original model developed in Jersey and had conceptual concerns about the legal structure. Rather than allowing a corporate entity to create other corporate entities within itself, it was felt that a more conservative solution, based on clear and well-established principles of corporate law, was preferable. An SPC that wanted to incorporate one of its cells would set up a regular Cayman exempted company that would be known as a ‘portfolio insurance company’ (PIC) and would be owned by the SPC on behalf of the cell in question. Essentially, the cell owns the PIC and the PIC—for all practical purposes—replaces the cell.

If the cell had an existing insurance programme, in the future that programme would generally be operated by the cell’s PIC and no longer by the cell; if the cell had never operated, all future business would be conducted by its PIC, rather than through the cell. A PIC is simply a subsidiary of the SPC, but tied to a particular cell of that SPC.

Because a cell must always own its underlying PIC, only that cell—or, strictly, the SPC on behalf of that cell—could ever hold the voting shares in the PIC. However, there is nothing to stop a PIC issuing non-voting shares (preferred shares, for example) to another person or entity. In many SPCs, an unincorporated cell is owned by the client/s of the SPC for whom the cell was established and frequently that ownership is created by issuing non-voting preferred shares to the client/s. If a PIC is established under that cell, the business and assets of the cell move down to the PIC and we therefore believe that in many cases the client/s might feel much more comfortable having a direct shareholding in the PIC.

Regulation and oversight

The PIC will be regulated by the Cayman Islands Monetary Authority (CIMA) but, as long as it remains a PIC would not need its own insurance licence. The PIC basically falls under the umbrella of the insurance licence of its parent SPC. Even though the PIC would not need to obtain an insurance licence from CIMA, it would have to register with CIMA as a PIC. There would be a straightforward registration process and an initial and annual registration fee—a figure still to be determined at the time of writing.

The level of regulatory oversight that CIMA would have over a PIC would be largely the same as that for an unincorporated cell. So, for example, audited financial statements for each PIC would need to be filed with CIMA. However, the ability to simply register in this way only applies as long as the PIC is wholly owned by the cell of a licensed SPC. So, for example, if a PIC were to be sold off to a third party—perhaps as part of becoming a standalone captive—the PIC would have to obtain its own insurance licence.

Once the legislation is passed, the objective is to make it as userfriendly as possible for an existing SPC insurer to incorporate one or more of its cells with minimum disruption to ongoing insurance programmes. This will be achievable. The incorporation of the PIC would be the same as any incorporation in the Cayman Islands—a 24- hour process. The registration of the PIC with CIMA would be largely the same as the current procedure for creating a new cell for an SPC. Most importantly, the legislation provides a streamlined process for novating the assets and liabilities of the existing cell programme to the underlying PIC. Automatic novation by operation of law is achieved by obtaining consent from relevant creditors and by filing with CIMA a straightforward declaration sworn by two directors of the SPC containing certain prescribed particulars.

In some jurisdictions, incorporated cells are promoted as being a superior product to unincorporated cells because it is said that that the ‘walls’ are higher and thicker than those of an unincorporated cell. This thinking did not actually feature in the development of the PIC in the Cayman Islands. The PIC concept came about because the jurisdiction wanted to offer the same benefits of cell incorporation without actually incorporating the cell itself.

While there are obvious attractions to the PIC being a separate company from the SPC and its cells, in terms of liability protection, the PIC is not seen as a superior model compared to an unincorporated cell. Rather, the ability to incorporate its cells is an important additional string to the bow of an SPC and a natural development. As long as both incorporated and unincorporated cells are set up and operated correctly and in accordance with all applicable requirements of Cayman Islands law, both structures will provide statutory ring-fencing of specific pools of assets and liabilities.

Although the PIC developed from a need for intra-cell contracting within a single SPC and to assist in obtaining a federal tax identification number for individual cells, a number of additional benefits have been identified. One particular advantage is governance flexibility. Unlike an unincorporated cell, a PIC can have its own board of directors which need not comprise the same members as the SPC board. There would simply be a need to obtain CIMA approval for those members of the PIC board who were not already CIMA-approved. Other perceived benefits are that third parties unfamiliar with cell companies may find a PIC easier to understand than an unincorporated cell because of its separate legal identity, and a PIC would be able to transition more easily to a standalone captive than an unincorporated cell.

It is unlikely that as soon as the legislation is passed every SPC will immediately establish a PIC under every cell. For some SPCs their existing structure with unincorporated cells will continue to serve them well. However, it is expected that there will be a significant number of SPCs that will wish to set up one or more PICs to address current limiting factors such as intra-cell contracting and the tax uncertainty surrounding non-US unincorporated cells.

Discussions to date with clients and consultants in the US point to the fact that the ability to set up PICs will bring new insurance business to the Cayman Islands and provide an important additional revenue stream for CIMA and the Cayman Islands government.

Paul Scrivener is partner and head of the insurance group at Cayman Islands law firm, Solomon Harris. He can be contacted at: PScrivener@solomonharris.com

Cayman, Solomon Harris, cell companies, captive, insurance

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