2 November 2015Actuarial & underwriting

Protected cell risk exposed by court decision: Fitch

A recent court decision highlights the presence of multiple sources of credit risk in protected cell structures, according to Fitch Ratings.

Fitch has updated its views on protected cell companies (PCCs) following a federal court decision on a dispute that arose in a reinsurance contract involving a protected cell.

The case Fitch is referring to is the recent decision in the federal court case, Pac Re 5-AT v. AmTrust North America. Pacific Re is a protected cell company (PCC) domiciled in Montana. Its cell, Pac Re 5-AT, was the subject of a captive reinsurance agreement with AmTrust North America.

Fitch said the case illustrates the linkage between an individual protected cell and its PCC and the decision suggests that the failure of a protected cell's PCC could potentially cause disruption or financial stress for the protected cells in that PCC; therefore, prospective cell sponsors should consider the creditworthiness of the PCC when forming a protected cell.

“Fitch believes the primary credit focus when the PCC structure was designed was the protection of each protected cell's assets from the creditors of the other protected cells,” said Donald Thorpe, senior director, insurance, Fitch.

“There are many linkages to be considered in a credit analysis of a protected cell besides the segregation between the individual protected cells. The weakest link often determines the final credit rating of an entity, and the weakest link in a PCC structure may not be the risk that individual protected cells pose to each other.

“The ruling concludes protected cells are not separate entities from their PCCs. Additionally, the PCC is the actual holder of the insurance license. To Fitch, the case raises the question as to how the protected cell continues in the event its PCC fails.”

The firm said that previously there has been a dearth of court cases on this or other aspects of the PCC structure, therefore Fitch believes this case makes a significant contribution to the history of PCCs.