Since their introduction in 1998, segregated portfolio companies (SPCs) have proved to be extremely popular vehicles in Cayman’s captive insurance industry. SPCs were originally developed to provide an improved model of the traditional contractual rent-a-captive.
However, in the fifteen years that they have been on the statute book, they have been used in many different circumstances. Indeed, they have been used wherever there was a need to create legally “ring-fenced” accounts or portfolios within a single licensed insurer thereby ensuring that policyholders or other creditors only had recourse to the assets of a specific account or portfolio and not the entire balance sheet of the SPC. Statistics of the Cayman Islands Monetary Authority (CIMA) bear witness to their popularity with captive owners and their consultants. As at 30 June 2013 there were 134 SPC insurers, out of a total of 750 Cayman captives, writing almost US$500 million in premiums.
Fine turning the SPC
Although not relevant to all SPC insurers, for some a drawback of the SPC was that none of the segregated portfolios, or cells for short, of an SPC was a separate legal entity. Only the SPC itself was a legal entity and the cells were simply ring-fenced divisions of that legal entity. Why was this a drawback? There are two principal reasons. First, any contract between one cell and another cell of the same SPC can never be legally binding because of the absence of two legal parties. This therefore prevents reinsurance and risk pooling arrangements between cells of the same SPC which for some SPCs is commercially undesirable. Second, there is considerable uncertainty over the U.S. federal tax status of an unincorporated cell of an offshore insurer casting doubt over whether a cell can be treated as a separate taxpayer and make its own tax elections such as a 953(d) election and an 831(b) election. These issues were capable of being addressed if it were possible for an SPC insurer to incorporate one or more of its cells and thereby create the separate legal identity that was needed.
On 25 March 2013, the Insurance (Amendment) Law (the Amendment Law) was enacted in the Cayman Islands to allow SPC insurers to incorporate their cells for the first time.
It is, arguably, the most significant legal development for Cayman’s insurance sector since the introduction of SPCs in 1998. The Amendment Law, whilst now on the statute book, is not yet in force at the time of writing this article but will be brought into force once necessary amendments have been made to the underlying Insurance Regulations. These amendments will deal with administrative matters, such as additional forms and returns that are required and also more substantive issues such as the capital and solvency requirements for incorporated cells.
This legislation was widely anticipated and was the product of a tremendous collaborative effort over a two year period between the Cayman Islands Government, the Insurance Managers Association of Cayman (IMAC) and the Financial Services Legislative Committee, a private sector/public sector committee tasked with maintaining Cayman’s financial services legislation at the cutting edge.
A different approach to cell incorporation
Incorporated cell legislation is not new and was first developed in Jersey several years ago. However, the Amendment Law provides a model for incorporated cells which differs from that in Jersey and other domiciles. It is specific to the insurance sector, where there was a pressing need for incorporated cells, and, at this stage, does not extend to other sectors of Cayman’s financial services industry. The legislation amends the Insurance Law rather than the Companies Law and was deliberately crafted as a modification to the existing regulatory regime for SPC insurers rather than a change to substantive law which would have taken much longer to implement.
However, the most important difference with the Cayman model is that cell incorporation is achieved by a separate company being established by the SPC underlying the relevant cell rather than the cell itself taking on incorporated status. Cayman has adopted a more conservative solution than competitor jurisdictions, one that is based on clear and well-established principles of corporate law. An SPC insurer that wishes to incorporate one of its cells will set up a regular Cayman exempted company – called a portfolio insurance company or PIC for short – which will be owned by the SPC insurer on behalf of the cell in question. Effectively, the cell will own the PIC and the PIC, for all practical purposes, will replace the cell. So if the cell has an existing insurance program, going forward, that program will be operated by the cell’s PIC and no longer by the cell. A PIC is simply a subsidiary of the SPC but tied to a particular cell of that SPC, a concept which can readily be understood by parties dealing with an SPC and its PICs. Only one PIC can be established under each cell.
Whilst PICs were developed to address the intra-cell contracting problem and provide greater certainty as to the U.S. tax status of an offshore insurance company cell, PICs have a number of other benefits over a traditional cell. Although they would have to be approved by CIMA, the members of the board of directors of the PIC need not be the same people as the members of the board of directors of the SPC insurer itself. This provides governance flexibility and gives a voice at the board table for cell owners which they typically do not have with a regular SPC because of the fact that there is a single board at the core level responsible for the affairs of all cells of the SPC. For third parties unfamiliar with SPCs and the cell concept, a PIC is probably easier to understand than a cell simply because it is a separate company.
A PIC can also transition more easily to a stand-alone captive than a cell because it is a separate legal entity with its own constitutional documents and board of directors. Therefore, the transition is likely to be much less disruptive than would be the case with the hiving-off of a cell. There is very limited judicial authority in any jurisdiction surrounding the legal efficacy of the ring-fencing concept in a traditional cell company and whilst legal experts generally agree that the concept will withstand close judicial scrutiny in the case of a properly established and operated cell structure, there is no doubt that a PIC will benefit from well-developed case law supporting corporate limitation of liability.
A PIC will be regulated by CIMA but as long as it remains a PIC it will not need its own insurance licence. Instead it will operate under the umbrella of the licence held by the SPC insurer which controls it. The legislation provides for a straightforward registration process with CIMA for each PIC.
The level of regulatory oversight that CIMA will have over a PIC will be largely the same as for a cell. So, for example, audited financial statements reflecting the financial condition of each PIC will need to be filed with CIMA.
However, the ability for a PIC to simply be registered with CIMA only applies as long as the PIC is whollyowned by the cell of a licensed SPC insurer. So, for example, if a PIC were to be transferred to a third party, perhaps as part of becoming a standalone captive, the PIC would have to obtain its own insurance licence and could not continue writing insurance business until it did so.
Only a cell – or strictly the SPC acting on behalf of a cell – will be able to hold the voting shares in the PIC. In this way, the PIC will at all time be controlled by the SPC through a cell and hence why it is appropriate for the SPC insurer’s licence to extend to each PIC established by the SPC insurer.
Establishing the PIC and Automatic Novation
The incorporation of the PIC will be the same as any incorporation in the Cayman Islands – a 24 hour process once the necessary due diligence/know your customer information has been provided on the directors and principals. The registration of the PIC with CIMA will be largely the same as the current procedure for creating a new cell for an SPC. Creating a cell generally takes just a matter of a few days, with the principal step being the filing of a business plan for the new cell with CIMA.
In developing the Amendment Law one of the issues that had to be considered was the need for a streamlined process for novating the assets and liabilities of an existing cell program to the underlying PIC. This is addressed in the Amendment Law by providing for an automatic novation by operation of law by simply filing with CIMA a straightforward declaration sworn by two directors of the SPC containing certain prescribed particulars and obtaining creditor consents.
New business opportunities
Discussions with clients and consultants in Cayman and the U.S. point to the fact that the ability to set up PICs will bring new insurance business to Cayman which might otherwise have been lost to other domiciles. Therefore, PICs should provide an important new revenue stream for CIMA and the Cayman Islands government and help in maintaining Cayman’s position at the cutting edge of developments in alternative risk management.