28 November 2013Analysis

Cell innovations

Cayman enacted cell captive legislation back in 1998 following its successful implementation in Guernsey in 1997 and the concept has proved to be an attractive addition to the captive landscape. According to statistics from the Cayman Islands Monetary Authority (CIMA), nine of the 24 captives formed during 2013 were cell companies, or segregated portfolio companies (SPCs) as they are called in Cayman. Of the 750 captives that called Cayman home by the middle of 2013, 134 were segregated SPCs, within which there were 657 individual cells.

As Kevin Poole, client services director at Kane in Cayman made clear: “As the captive concept is embraced by more middle market entities, the expectation is that more cell companies will be formed, given the cost and set-up advantages compared to other types of captive.”

The cell concept is an attractive lower cost option to businesses that are keen to develop a captive, but do not have the size, financial capabilities or premium volume to establish a single parent captive. As Poole explained: “Cell captives provide participants with a lower cost of entry compared to setting up a pure captive. They are also more straightforward to establish and additional cells can easily be added. In addition, the flexible capital requirements which cell structures can offer, coupled with the fact that they require less senior management input, are also beneficial aspects of the cell captive concept.”

"The sponsor of the cell captive can be the agency itself, which is then able to offer a share of the risk to its client and/or assume a share itself."

The cell concept has received a boost in recent months thanks to the implementation of the Affordable Care Act in the US. As Paul Scrivener, partner and head of the insurance group at Solomon Harris detailed, some single parent healthcare captives are exploring the potential to go down the SPC route as they look to add physicians groups into their insurance programmes. Some are considering changing from single parent to a cell structure in order to firewall liabilities brought into their insurance programmes as a result of consolidation or restructuring, he said.

Others are looking at how they can grow their captive by writing third party business through a cell structure, by establishing programmes for joint venture partners or outside organisations, said Scrivener.

“Another area that is a strong fit for the cell captive concept is agency business along with life and annuity contracts, as there are distinct benefits to the segregation of assets which are easily understood in the life industry,” added Poole. “In the case of agency business, the sponsor of the cell captive can be the agency itself, which is then able to offer a share of the risk to its client and/or assume a share itself.”

Cayman has recently taken further steps to strengthen its capabilities in the cell captive space with the development of the protected insurance company (PIC), which aims to complement the existing capabilities of the SPC by effectively allowing the cells of an SPC to incorporate, giving rise to a number of benefits. The new PICs do not need to be licensed as would be the case with a stand-alone captive, explained Scrivener—although they do need to register with the CIMA—and are able to write insurance business under the umbrella of the SPC’s insurance licence.

The new legislation permits the setting up of a PIC underlying the cell of an SPC, with the PIC then able to transact with other cells within its SPC. Scrivener said that when the appropriate filings have been made to CIMA, business written in a cell is then novated into the underlying PIC, and the PIC can “readily contract with the cells of its SPC”.

“While not revolutionary, the new PIC legislation is another useful tool in the captive armoury,” Simon Owen, principal of Hyperion Risk Solutions and Folio Insurance Management, explained. He added that such developments are prudent, particularly as the jurisdiction takes great pride in its ability to provide sophisticated and flexible solutions to an increasingly diverse range of clients.

Alan Craig, partner at Campbells in Cayman, agreed that while PICs are a welcome addition to the existing SPC capabilities, there was in fact little that could not have been done through existing structures. By introducing the legislation, however, Cayman heads off charges that it lacks the kind of structure available to captives elsewhere, he said.

The PIC of the crop

So what exactly do PICs offer beyond the capabilities already available through SPCs? The concept is still in its early stages, but already a number of benefits have been identified by proponents of the new structures. First among these is the potential for the PIC to act as risk pooling mechanism within the wider cell structure. As Scrivener explained: “Some clients wanted the ability for one cell to be able to contract with another within the same SPC—for example by ceding reinsurance business to another cell. That wasn’t previously possible within the same cell structure because a cell is not a separate legal entity, but the PIC now makes that possible.”

Craig also highlighted the potential for risk-pooling arrangements, whereby an additional cell, designated as a PIC, can now be established to “pool risk for risk sharing or tax characterisation purposes”. With a clearly defined separate personality, PICs are able to contract with other cells within the wider structure. This can be done through reinsurance or quota share arrangements within the same cell structure, he said, rather than having to do so with a third party, as is currently the case.

Scrivener explained that a lot of group captives want to add a ‘mixer cell’ in order to achieve risk distribution from a US tax perspective. Through the new PIC structure such capabilities can be achieved within the cell structure.

The second potential benefit of a PIC is to act as an incubator for a cell considering the option of becoming a standalone single parent captive. As Craig explained, such entities “can be easily spun off”, with the owner benefiting from a structure that is close in form to a standalone captive, but that benefits from the risk pooling and relative low cost structure of a SPC before it decides to go it alone.

The owners of the PIC—or an SPC considering such an entity—can also cut their teeth while within the SPC structure, before going it alone. Craig said that this is one of the leading draws of the cell structure. “When a parent is starting out and doesn’t have the understanding of the operation of a captive or is not of the required scale, the idea is that they will benefit from involvement in a SPC structure that has more experienced players involved in it, or is operated by one of the insurance managers.” Thus SPCs have the potential to allow players to learn based on practical experience, while the PIC has the potential to be a nucleus for a new, separate insurer.

PICs are also likely to be more readily understood by outside players from a tax perspective. As Poole outlined: “As a separate legal entity for US tax purposes, the PIC can make its own tax elections under its own federal tax identification number.” Scrivener added that US tax advisers are attracted by incorporated cell structures because they tend to give them a “much stronger hand when looking to establish with the IRS the separate tax status of a cell”.

The same is true regarding dealings with third parties such as banks and asset managers. As Scrivener explained, some struggle to understand the cell concept, but a PIC provides counterparties with greater clarity regarding the company they are contracting with. “Where there is uncertainty regarding the nature of cells, PICs should help to head off any issues by virtue of being a separately defined company.”

A drawback of a cell is that there is no board of directors and therefore a cell owner has no role to play in the governance of the cell’s affairs. Instead, responsibility for the cell rests with the board of the SPC itself. In contrast, because a PIC is a company in its own right it will have its own board of directors and therefore the cell owner can have a voice at the board table and a say in the management of the cell’s business. This is an attractive proposition for a prospective cell owner.

The PIC legislation is yet to be brought into force, but it seems likely that the new designation will help to complement Cayman’s existing cell captive capabilities. As Scrivener concluded, the development will certainly generate some business for Cayman while “further enhancing our captive toolbox”.