21 January 2020Analysis

Why cell captives are surging in popularity

Cell captives have been gaining popularity in recent years, with insureds increasingly attracted to them for their flexibility, diversity and the economics these vehicles offer.

While total active captive numbers were down 1 percent in 2018, this trend was offset, in part, by growth of 3.7 percent in cells. That left the number of P&C captives marginally higher, according to Strategic Risk Solutions.

It is now increasingly common to see large multinationals create their own cell captive as part of their enterprise risk management strategy. Traditionally, cell captives have primarily been utilised by small to midsize companies. This article will provide an example that underpins why you might consider a cell captive over a single purpose, standalone captive structure as you explore your alternative risk financing strategy.

“A cell captive provides the flexibility to address present and future challenges and needs, including the addition of cells as needs develop over time.”

There are several considerations for using cell captives to finance risk. First, most US and offshore domiciles require a minimum statutory capitalisation of $250,000 for a cell captive, well below the $500,000 typically required for a standalone captive.

There is considerable value in structures that provide long-term flexibility for multiple exposures and purposes. The purposes and needs of the captive today may be materially different in the future, meaning flexibility in design should be paramount. While some captive insurance advocates are happy to set up multiple single purpose standalone captive entities, it is important to consider the implications of this approach.

Owing a captive is a bit like owning a truck. You typically buy a truck for one specific purpose but as time goes on, changes happen and needs shift; the truck (or captive) can be used for different purposes. If structured correctly, a cell captive strategy can facilitate alternative uses. A cell captive provides the flexibility to address present and future challenges and needs, including the addition of cells as needs develop over time. Establishing a new cell within the cell captive has the additional benefit of being a turnkey approach, if done correctly.

Clients are also attracted to cell captives because of the ease of setting-up multiple cell structures within them, the lower cost of capitalising them compared with standalone captives, the flexibility in the captive ownership structure, their widespread regulatory acceptance in most captive domiciles and lower startup costs.

They also enjoy increased support from the sponsoring entities and provide tax flexibility, as each cell within a cell captive can chose how it will be taxed. There are also many existing cell captives from which insureds can rent capacity.

Case study

Here’s a recent example from an old friend who could have saved himself considerable frustration if he had considered a cell captive before creating a standalone, single purpose captive.

A group of auto dealers pooled $500,000 in capital and created a domestic standalone, group captive to write workers’ compensation and garage keepers’ liability coverage, beginning January 1. On May 1 my friend (the broker) called, as some of his new members had operations in Colorado and Florida and needed open lot coverage. The market required a $1 million to $2 million retention, due to hail and wind exposure.

Four months later we spoke again. The broker was wondering how he might use the captive to write an employee benefit, medical-stop loss (MSL) programme for the multiple members using this newly created captive. His advisors told him he needed to either start and capitalise two new standalone captives for the MSL and open lot coverages, or convert the standalone captive to a cell captive. Because he had not formed a cell captive, his client was not effectively positioned to expand coverage offerings, using the standalone structure.

Had the captive’s owners taken a long-term approach and set up as a cell captive, they would have saved $250,000 in capital, avoided a structural revamp and been able to use the turnkey flexibility provided by a cell captive to solve the need for both new coverages.

Benefits of a cell captive

The benefits of using a cell captive apply to both single and multiple entities (groups). They provide flexibility in structure, allowing core cell captives and their individual cells to be formed as corporations, limited liability companies, reciprocals, mutual corporations, non-profit corporations, or risk retention groups.

Cells may even have different structures within the same core. For example, it is possible to use a protected cell and/or incorporated cell in the same cell captive.

The capital required to incorporate a cell may be minimal if the cell’s risk is fully funded or reinsured, and it provides tax flexibility, potentially lowering the overall tax burden. The fees, such as audit, captive management, legal and investment fees associated with a cell captive are lower, because the costs are shared among the various cells, creating expense efficiencies.

Incorporated cells may be converted into other incorporated cells or captives if necessary, while solvent protected cells may be sold, transferred, converted or assigned to a new or existing cell captive, enhancing their flexibility. Individual cells may be extracted and converted into a new cell captive, such as a sponsored captive, a pure captive, a risk retention group or an industrial insured captive or an association captive.

However, it is worth noting that assets of protected cells may not be used to pay any expenses or claims other than those attributable to each protected cell. Assets and liabilities of a protected cell are kept separate from, and cannot be commingled with, those of other protected cells.

Of course, every approach has its downsides and that also applies to cell captives. When using a cell within a cell captive of a service provider, such as a captive manager, fronting company or third-party claims administrator, it may not always be easy moving your cell to an alternative cell captive if you change service providers.

As an incorporated cell, you should be able to move to another core structure, but with some restrictions. You should negotiate how this would work up front, which can minimise the risk of disputes when needs or strategies change.

An incorporated cell may also enter into its own contracts and can be individually sued and sue others, apart from other cells and the core.

As in all alternative risk financing options, there are both pros and cons to cell captives. These pros and cons form the essential conclusions of feasibility due diligence studies and will guide your decisions about which option best suits your needs, both short and long term. This, coupled with qualified advisory expertise, is necessary to get to the best alternative for you and your firm.

Each cell captive is different, and if you have seen one cell captive, you definitely have not seen them all. Dig deep and wide to ensure you’ve considered the best alternatives to captive type, design and formation before implementing your solution.

Lawrence Cook is a sales executive at Sedgwick Captive Services. He can be contacted at:

Chris Mandel is senior vice president of strategic solutions at Sedgwick and director at the Sedgwick Institute. He can be contacted at: