As the first domicile to establish PCCs, Guernsey's segregated cell company management services have been driven by the island's experience and knowledge of the sector. Mike Johns of ARM explains the advantages of this insurance solution.
Though the original concept can be traced back to the Cayman Islands in the early 1980s, it was Guernsey that became the first domicile to introduce protected cell company (PCC) legislation in 1997. Even at the early introduction stage the legislation was hailed as one of the most innovative insurance solutions to be introduced to the captive and alternative risk transfer markets.
These early accolades have proven to be correct as the success of the PCC can now clearly be demonstrated by the number of cell entities in existence worldwide. In Guernsey, as of 31 May 2012, 68 PCCs and five incorporated cell companies (ICCs) are registered with a combined total of 395 individual cells. The legislation has subsequently been replicated in many domiciles worldwide with new additions joining the arena on a regular basis.
The growth in cell formation is primarily due to one fact. The introduction of the PCC opened the concept of self-insurance/risk retention to a much wider market. Previously, captive insurance was viewed as the sole domain of the large Fortune 1000 companies. Captives were structured to retain large amounts of risk and consequently, companies' operating costs were viewed as prohibitive to smaller companies both from an initial capital requirement and in terms of management costs.
The introduction of the PCC lowered the operating costs considerably and led to the formation of many third-party owned PCCs, which are effectively derivatives of the rent-a-captive concept. The owners of these new PCC vehicles were prepared to supply the required minimum capital and allow third parties to form their own cells in order to write business completely protected or segregated from the other cells within the PCC. The owners of the cells can benefit from the profit generated from within their cell while the owner of the PCC receives a fee for the use of the capital supplied to form the vehicle.
The cell owners must still fund the risk gap, the difference between the limits written and premium received into the cell; but this can be mitigated in many ways, including with the use of reinsurance. The benefits of using this structure are not limited to capital requirement. The ongoing operational costs of the PCC are met by the PCC owner, who has control over the central core. As such, the board of directors; auditors; and, if required, actuaries; are all remunerated by the core. An element of these operational fees is usually built in to the fee charged for access to the PCC.
The major disadvantage of utilising a third-party PCC is that the individual cell owner loses an element of control. The PCC, including all of its cells, is considered a separate legal entity. The board of directors is appointed to oversee the operation of all the cells and exercise full control over the business written and overall strategy of each cell. In practice, they listen and consider the requests and requirements of the cell owners.
More recent developments see PCCs being used by insurance brokers, intermediaries or managing agents to write the more profitable lines of their business by retaining more of the underwriting risk and, hopefully, the corresponding profit that is generated. This provides brokers with additional revenue streams rather than the commission usually ceded by the insurance market. These entities are termed, somewhat unflatteringly, either a producer owned insurance company (POIC) or producer owned reinsurance company (PORC) depending on the underwriting structures involved.
As is the case with traditional captives, the management of third-party PCCs is usually entrusted to a regulated insurance manager, such as Alternative Risk Management Limited (ARM). ARM is an independent insurance manager based in Guernsey with offices in Bermuda and Malta. It manages 14 third-party owned PCCs, as well as probably the world's largest (in terms of premium volume) ICC, which is owned by a large international bank. The insurance policies offered by these entities vary from 'loss of flying licence' insurance for commercial pilots to property portfolios. The cells are also used for innovative solutions such a transformers and capital arbitrage.
In addition to managing third-party owned PCCs, ARM also operates its own Guernsey-based PCC, Windward Insurance PCC Limited, as well as a Bermuda-based segregated accounts company, ARM Insurance Company Limited, providing comprehensive cell facilities across multiple jurisdictions. ARM has 165 insurance entities under its management and has established strategic relationships with many middle market brokers, making it one of the world's largest independent managers.
As a privately owned company, ARM's independent status means it can provide captive management facilities to these brokers, enabling them to provide captive consulting services to their clients, something only the 'big four' brokers (Aon, Marsh, Willis and JLT) provided in the past. It is the middle market enterprises that have provided the growth in cell formations we see today. Indeed by far the majority of new formations are cells rather than the traditional pure captive.
As mentioned previously, the brokers themselves are now seeing the benefits that cells have created for their clients and are seeking to utilise these structures for their own purposes.
However, while the cell market has seen growth and the captive industry is fairly buoyant, there are dark clouds on the horizon. The spectre of Solvency II draws near for the insurance industry and while Guernsey has clearly stated its position, many domiciles have not. The Solvency II regulations have still not fully set out how PCCs will be treated. This is combined with FRS accounting reporting requirements, Fatca, and new corporate governance rules arising out of International Association of Insurance Supervisors (IAIS's) core principles. In most domiciles, there is a regulatory or reporting burden being placed on both the board of directors and the insurance manager.
This will inevitably lead to a rise in operational costs for the client, which, in turn, could lead to the question: is this form of self-insurance cost effective? Everyone agrees that a certain level of regulation is necessary and unavoidable. The captive industry has grown and it is working pragmatically and progressively with regulators. As a result, the PCCs and ICCs have developed as cost-effective ways to self-insure. The worldwide growth in the use of cell structures demonstrates that there is still an appetite to self-insure and create innovative structures as an alternative to working in conjunction with the conventional insurance market.
Let's hope that the ever increasing burden of regulation and compliance does not erode the cost savings and kill the goose that has laid a truly golden egg.
Originally published in the Captive Review, Cell Company Guide 2012
For more information about Guernsey's finance industry please visit www.guernseyfinance.com.
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