In a recent market briefing delivered to the Cayman Islands' (re)insurance industry, global credit ratings agency AM Best announced its proposal to change its criteria for rating cell companies including Segregated Portfolio Companies (SPCs) established in the Cayman Islands. The proposal signals a move away from a one size fits all approach towards applying direct ratings to incorporated cells within a cell company structure. We take a closer look at what this proposal means for SPC (re)insurers looking to obtain a rating.
AM Best has been rating insurance companies for over 125 years, reporting on 16,000 insurance companies in over 100 countries and remaining the only global credit rating agency focused exclusively on insurance. In a first for Cayman, five of AM Best's senior leadership team recently delivered an on-Island insurance market briefing to the Cayman Islands (re)insurance industry that covered a wide range of topics impacting the global reinsurance, life/annuity and property and casualty sectors.
At the briefing, AM Best announced a public consultation on changes to its criteria for rating alternative risk transfer (ART) vehicles, particularly addressing how this criteria applies to cell companies. Broadly, the changes aim to enhance clarity of the rating methodology, broaden the classifications applied to cells, and establish a direct rating approach for certain cells within cell company structures.
How does AM Best's criteria for rating ART vehicles work?
The ART criteria governs how AM Best applies its credit rating methodology to a broad range of ART entities, including single-parent captives, group captives, risk retention groups, self-insurance funds, and protected cell companies.
Currently AM Best only recognises one umbrella classification for cell companies, referring to every cell company across all jurisdictions as a protected cell company (PCC). AM Best define a PCC as "the legal entity comprised of a core and one or more incorporated and unincorporated cells which have assets and liabilities separate and apart from the assets and liabilities of other cells". Whilst AM Best evaluates each cell individually, those evaluations are carried out in order to apply one overall rating to the PCC, being the rating of the cell evaluated as the "weakest link" in the PCC structure, taking a lowest common denominator approach.
This stems from AM Best's view that all of the PCC's policyholder rights should be ranked as being on an equal footing with each other, so that no set of policyholder rights are preferred over another in the structure, in the event of any solvency or financial issues impacting the ability to meet any policyholder liabilities.
As those involved in establishing and operating SPCs will be acutely aware, the "weakest link" approach does not fit well with the nuances of the SPC structure. In each segregated portfolio or cell, parties can segregate the assets and liabilities of lines of business that may differ significantly in terms of the nature and extent of the risks involved, affording greater financial certainty for counterparties and protection to policyholders of business written in each segregated portfolio or cell, whilst benefiting from the cost saving of an efficient single corporate structure.
Recognising the need for revisions to the ART ratings criteria since the (re)insurance industry and its use of cell company structures has significantly evolved over the last 20 years, AM Best initiated a call for comments to gather industry feedback on its proposed changes.
What are the key proposed changes to cell companies?
The key proposed changes to the ART rating criteria for cell companies are as follows:
- Broadening Classifications: AM Best proposes replacing the term "protected cell company" with more specific terms such as: (1) "unincorporated cell company" where only the unincorporated cell company is an incorporated legal entity, and the individual unincorporated cells may not be considered separate legal entities, as is the case with a typical SPC structure; (2) "incorporated cell company" composed of individual cells, each of which is a separate incorporated legal entity (as would appear to apply to an SPC which writes all its business in portfolio insurance companies, which are separate legal entities and the Cayman Islands equivalent of an incorporated cell) and (3) "mixed cell company" comprised of both cells that are unincorporated and incorporated legal entities (which would appear to apply to SPCs which write business in a mixture of segregated portfolios and portfolio insurance companies). This change aims to reflect the diverse structures used in the market more accurately.
- Direct Rating Approach: The new criteria proposes a direct rating approach for assigning Issuer Credit Ratings (ICRs) and Financial Strength Ratings (FSRs) as follows: (1) for incorporated cell companies, incorporated cells would be rated individually applying AM Best's methodology to each incorporated cell; and (2) for mixed cell companies, only the incorporated cells would be rated individually applying AM Best's methodology to each incorporated cell, meaning that the unincorporated cells will not receive a direct rating.
- Building Block Considerations: AM Best's methodology includes specific building block considerations for balance sheet strength, operating performance, business profile, and enterprise risk management. The updated application of this methodology to cell companies will include: (1) combining financial statements to generate Best Capital Adequacy Ratio (BCAR) or pseudo-BCARs for each individual cell, quarterly monitoring, and review of capital quality and management plans; (2) assessing a cell's premium growth, historical profitability, and feasibility studies; (3) assessing the cell's product and geographic concentration, management and TPA quality, reporting and depth of domicile experience; and (4) applying a holistic view of risk appetite and tolerance, risk management controls, retentions, limits and reinsurance arrangements and domicile legal cases testing separation of assets and liabilities.
- Weakest Link Approach: as above, AM Best proposes retaining the "weakest link" approach for unincorporated cell companies, where one rating will be assigned to the unincorporated cell company as a whole based on the assessed rating of the weakest cell. This approach appears to be influenced by the fact that an unincorporated cell is not a separate legal entity and is unlikely to hold its own insurer licence or be the issuer of insurance policies, where the cell company tends to issue the policy on the cell's behalf.
What impact will this have on SPC insurers in the Cayman Islands?
As those familiar with Cayman Islands SPCs will know, an SPC may allocate assets and liabilities to different unincorporated segregated portfolios within the company and establish portfolio insurance companies, being incorporated legal entities permitted to write insurance business on a segregated portfolio's behalf without obtaining a separate insurer licence. For an update on SPC developments, see here for our previous Conyers Coverage article on a case addressing segregation principles for an SPC.
Under the proposed changes to the criteria for rating cell companies and SPCs, it appears that an SPC structure that operates all of its business through portfolio insurance companies may fall within the classification of an incorporated cell company, enabling insurers to seek individual direct ratings applicable to each portfolio insurance company established on behalf of a segregated portfolio. However, it appears that an SPC with no portfolio insurance companies would likely be treated as an unincorporated cell company, with an overall rating applied on a "weakest link" basis, being the same as the criteria currently applied to SPCs.
Despite the focus of the proposed changes on incorporated entities, the SPC's core principle of statutory segregation of assets and liabilities operates robustly to provide a degree of segregation that, in our view, would enable each segregated portfolio to be capable of being assessed for a direct credit rating, particularly given the SPC's regulatory status and obligations and that the segregation principle has been legally tested and reinforced through a number of cases within the rigorous process of the Cayman Islands' judicial system.
Whilst individual credit rating recognition for segregated portfolios is not yet proposed, the current proposals signal a more open and realistic acknowledgement of the nuances of cell company and SPC structures, which if embedded, may pave the way for more sophisticated and granular credit rating criteria to be applied to SPCs in future.
Enhanced criteria for rating SPCs is a sign of progress
AM Best's proposed updates represent a significant step towards refining credit rating criteria for SPCs and cell companies. Not only do the proposed changes provide greater clarity and transparency in the rating process, but they also represent broader international recognition of SPC and cell company structures, demonstrating the increased maturity and standing of the SPC regime.
The consultation closed for public comment on 20 February 2025 and we understand that AM Best are in the process of considering the feedback and proposals, with an update on the progress of the proposed changes expected in the second half of 2025. Conyers will be monitoring for updates and sharing our views on how the new ratings criteria can be more usefully and accurately applied to SPC structures being utilised by (re)insurers in the Cayman Islands.
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