segregated portfolios s - atlas insurance management · using segregated portfolio companies...

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CRADD 2006Order your copy now at

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Captive ReviewCRADDANNUAL DOMICILE DIRECTORYCaptive Review

Annual Domicile Directory 2005

2005

A Captive Review and Pageant Media publication

Captive ReviewCRADDANNUAL DOMICILE DIRECTORY

2006

A Captive Review and Pageant Media publication

Workshops[


WorkshopTo be involved, please contact Nick Morgan on +44 (0)20 7269 7589 or email [email protected]

Captive & ART Review May 2006

Segregated portfolios have evolved since the fi rst protected cell company was launched in Guernsey 1997.

The enactment of the PCC legislation marked the opening up of a route for smaller corporations to dip their toes in the captive insurance market. Since then the model has been enshrined in most other domiciles that licence captives.

In this Captive & ART Review workshop three experts outline the advantages, pitfalls and advice on best practice for any risk manager considering a move now or in the future into a protected cell environment.

Martin Eveleigh, chairman of Atlas Insurance Management, studies the opportunities that await risk managers examining so-called rent-a-captives.

The cell structure should enable the cell to reinsure the excess risks of other cells and to buy reinsurance from the commercial market while avoiding the need for multiple administration costs such as insurance licences, audits and capital contributions.

The structural fl exibility of protected cells is great and the possibilities widening as legislation develops, he says.

Paul Scrivener, who heads the insurance group at Cayman Island-based Solomon Harris, warns of the importance of ensuring the integrity of a cell structure is not compromised by a lack of attention to detail or poor administration. It is not enough simply to set up and segregated portfolio company correctly only to proceed to overlook the ongoing requirements.

“The directors must ensure operational sloppiness does not offer an Achilles heel to any creditor,” he writes.

Control and costThe third contributor to the workshop is from Guernsey itself, Tim Spafford of CIIC-Sogecore Insurance Managers.

Spafford advises the control and cost are key to any decision on how and whether to develop a captive insurance programme. He outlines the basic capital requirement and explains a cell is likely to appeal to small- and medium-size businesses owing to a lower capital cost benefi t without the increased operating costs of a pure wholly owned captive.

It is of course important to choose a domicile that is credible, has good relations with the country the business’ country of origin and a good legal system.

Governments have the right to determine their own legal systems and it could be very dangerous for one country to brush aside another’s laws, especially when it relates to a company formed and licensed in that country.

Bill Lumley introduces

segregated portfolios in the

second set of articles in the

Workshop

Segregated portfolios

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The use of segregated portfolio (or protected cell) companies (SPCs) as rent-a-captives is well established, widely known and has been much written about. However, the fundamental feature of SPCs, namely the ability to segregate risks within one corporate entity, opens up a host of other possibilities.

Large corporate groups with different operating divisions can give those divisions considerable autonomy within an SPC. Each division or each

geographical region can operate its own cell and, in co-operation with the group risk managers, set their own retention levels and benefi t from their own loss experience and good risk management. The cell structure makes it simple to cater for different regional needs such as different currencies, different statutory insurance requirements, different languages and so on. The cell structure should also enable the group to establish a cell to reinsure the excess risks of the other cells and have this reinsurance cell buy reinsurance from the commercial market. All this can be achieved while avoiding the need for multiple insurance licences, multiple audits and multiple capital contributions.

Risk differencesRent-a-captives, group captives and conglomerate captives may segregate risk by insured, but this is not the only way to distinguish between risks. The insurance industry more often distinguishes risks by class. Both captive and commercial insurers may see benefi ts in segregating risks in this way. For example, a company that has successfully insured its general liability risks with its captive for several years may hesitate to begin insuring a different class with the captive for fear of the possible adverse consequences to the captive as a whole. Converting the captive to an SPC and segregating the two lines of business avoids any need to form a second captive, which saves time, cost and the ongoing administrative and regulatory burden. It also allows the one captive to benefi t from the success of the new line of business so that retained earnings can

strengthen the overall balance sheet. Segregating risks in cells makes it easier to cease writing business in the captive, perhaps in the event of a change in market conditions. If multiple captives are used to write different classes, withdrawal from one class leads to the liquidation of the captive. There is no such problem with a cell arrangement.

For commercial insurers and reinsurers as well, segregation by class and also segregation along geographical lines may be attractive in certain cases as it allows management to closely control the allocation of capital to risk. Of course, there are potential problems with this, such as how the rating agencies would react, but a reinsurer wanting to enter a new market cautiously or even to assist existing reinsureds by providing cover outside its usual range might take advantage of a cell structure.

Finally, how about distinguishing between risks according to appetite? In simplistic terms let’s imagine investor group A wants to form an insurer writing business whose loss profi le is predominantly high frequency/low severity. Investor group B also wants to form an insurer but write business that tends more towards low frequency/higher severity. Both groups want to introduce some balance into their underwriting portfolios. They unite to form an SPC – Cell A writes 80% high-loss frequency business and 20% high-severity business, while Cell B writes the opposite. Both sets of investors write their chosen book and separately manage the investment strategy of their cell, but combine their resources for all administrative, marketing, corporate and regulatory purposes.

The structural fl exibility offered by SPCs is enormous. As legislation develops, the possibilities will only increase and remember, SPCs need not transact only or even insurance business.

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Martin Eveleigh examines the opportunities of segregated portfolios


SPC the possibilities


❝Converting the captive to an SPC and segregating the two lines avoids the need to form a second captive❞

Martin Eveleigh, a barrister and chartered insurance practitioner, is chairman of Atlas Insurance Management.

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www.CAPTIVEandART.comCaptive & ART Review May 2006

Protected cell legislation exists in several jurisdictions with the major offshore jurisdictions taking the lead in this respect. The concept is relatively straightforward. A particular type of company can be incorporated which is able to create one or more cells in order to ring-fence pools of assets and liabilities within the company. Generally, a creditor dealing with one particular cell can only have recourse to the assets of that cell and is

denied recourse to the assets of other cells or the general assets of the company. The Cayman Islands insurance industry in particular has been keen to utilise the vehicle, but what are the drawbacks and the challenges?

Down to the directorsIt is important the integrity of the structure is not compromised by a lack of attention to detail or poor administration. Under Cayman legislation the directors have a responsibility to ensure the assets of each cell are properly segregated from the assets of all other cells and from the general assets. Physical segregation of assets rather than merely accounting segregation is fundamental and therefore each cell should have its own bank account and custody account. The directors should run each cell’s affairs from an operational point of view as if it were a separate legal entity, even though under

the Cayman legislation it is not. In that way, physical segregation should fall into place naturally and the structure should not be tainted.

It is a Cayman requirement that the words ‘segregated portfolio’ are always used as part of the name of the cell. Assets cannot be transferred between cells otherwise than at full value and where transactions or agreements are entered into on behalf of a particular cell, it must be made clear on the face of the relevant agreement or document that the execution is on behalf of that cell. Any delinquency on these nitty-gritty requirements might compromise the statutory ring fencing.

Loud and clearThe message is clear – it is not simply enough to set up an SPC properly and then forget about the ongoing requirements that must be met. Any administrative or procedural defi ciencies provide ammunition to any creditor seeking to challenge the statutory ring fencing. The directors must ensure operational sloppiness does not offer an Achilles heel to any creditor. Would a court always respect the SPC structure if a challenge came before it? In the absence of any fundamental fl aws in the set up or ongoing operation of the SPC, you would certainly expect a court in the Cayman Islands to respect the integrity of the structure and the same would probably apply before a court in any of the jurisdictions that have adopted cell legislation.

However, if the matter came before a court in a jurisdiction where the SPC concept was alien, there is no guarantee the structure would be respected. It would depend upon the court’s willingness to apply Cayman law and upon issues of local law and public policy. Therefore, as much as possible should be done to try to avoid connecting the SPC with jurisdictions other than the Cayman Islands, for example, by ensuring policies and other legal agreements are governed by Cayman Islands law and made subject to the jurisdiction of the Cayman courts and wherever possible assets are held within the Cayman Islands. It will never be possible to avoid the risk of a creditor seeking to bring a claim in a jurisdiction which they believe may support their challenge to the SPC but the greater the nexus to the Cayman Islands, the better.

Paul Scrivener from Solomon

Harris looks at some of the challenges of

using segregated portfolio companies

Lifting the fog

Solomon Harris is a specialist commercial law fi rm based in the Cayman Islands with particular expertise in captive insurance and other alternative risk products.

❝It is a Cayman requirement that the words ‘segregated portfolio’ are always used as part of the name of the cell❞

Paul Scrivener is a partner in commercial law fi rm, Solomon Harris, based in the Cayman Islands and was formerly a partner in

UK law fi rm Eversheds.


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Workshop[

The two key words clients often use when considering a captive insurance programme are ‘control’ and ‘cost’. In the current environment it is worth considering why anyone is in fact considering a captive at all. There is little taxation benefi t, if any, (one of the former drivers for setting up such a vehicle) and there are all the additional elements of having another company and the associated costs. The pure captive is required to hold more meetings

than before, abide by greater requirements in respect of corporate governance issues and there is also the travel time and director’s responsibilities. That is not to say the pure captives do not work. They do and very well indeed – but not for everybody.

The basic capital requirement for a new captive insurer is £100,000, which despite its relative diminution of value since minimum capital was introduced, is still more than captive users want to pay if they are unable to make full use of that capital. However, this is still a signifi cant cash sum. Therefore Guernsey in 1997 came up with the cell concept. The cell was designed to provide another alternative to the traditional captive so clients did not have to provide the £100,000 referred to. Typically the capital requirement for cells is much lower depending on the premium being written and the type of risk.

SME appealTherefore a cell is likely to appeal to the small- to medium-size enterprise due to the lower capital cost benefi t that a cell provides and without the increasing operating costs of a pure wholly owned captive. Whether the prospective owner is considering a cell from either the ‘control’ or the ‘cost’ point of view; the cell can achieve both. A cell permits the owner to take control over their insurance programme to the extent business is

ceded to it. It allows them to demonstrate to reinsurers a real interest in any risk being reinsured thus controlling reinsurance cost. Once the cell has been established for a year or so (assuming the fi rst year is profi table) it can start to provide insulation against the vagaries of the insurance market. Once again we see market rates falling in many areas and the familiar statement that the insurers are going to get it right this time but the roller coaster will, in all probability, continue as before – something the cell owner can, to a degree, protect himself against.

Other methods of regaining control in the face of rising prices are to take larger deductibles or demonstrably improve risk management so underwriters accept the improvement in risk. The cell can help achieve this as effectively as a pure captive by better control and management.

In the risk management arena the cell provides the opportunity to collect and assess loss data in a format that may not be available if reliance is placed solely statistics which are produced at renewal time. This is due to time pressures which inevitably arise. Regular meetings or reviews of information from the manager enable loss data to be analysed and steps taken to improve risk management. This should in turn result in lower insurance costs.

Clients use their cells for deductible fi nancing for PI insurance or as a method of providing an added service to their clients by offering an insured product to compliment their main product. Apart from the traditional property risks there are many different uses including debt management and guarantees or to support a business acquisition to name a few.

www.CAPTIVEandART.com 45

Control and cost

Tim Spafford from CIIC Guernseylooks at the associated costs within a captive cell


❝Other methods of regaining control in the face of rising prices are to take larger deductibles or demonstrably improve risk management❞

Tim Spafford is managing director of CIIC-Sogecore Insurance Managers. He is also a chartered insurance practitioner and a chartered accountant.


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