Q&A – PORTFOLIO INSURANCE COMPANIES

Portfolio insurance companies, or PICS for short, were introduced into Cayman Law in early 2015. As we move towards the end of 2016, Captive Insight caught up with Paul Scrivener and Kay Carter of the Insurance Group of Cayman Islands Law Firm, Solomon Harris, to chat about where we are with PICS these days.

CI: For readers who may not be that familiar with a PIC can you briefly outline what they are and the role they play in the captive insurance industry?

PS: PICs were introduced into Cayman’s Insurance Law as a means by which a cell of a segregated portfolio company (SPC) could effectively become incorporated and have its own legal personality. An unincorporated cell of an SPC is not a legal entity in its own right and therefore cannot contract with other cells of the same SPC (e.g. for risk pooling or quota sharing purposes). Nor can it have its own board of directors. There is also a material level of uncertainty as to the US tax status of an unincorporated cell. A PIC overcomes all of these drawbacks because it is a company in its own right, albeit that for regulatory reasons it must at all times operate under the control of a “parent” SPC insurer. A PIC is able to write insurance business by registering with the Cayman Islands Monetary Authority but it does not require its own insurance licence. I was very closely involved in the development of the PIC legislation and so it was with some personal satisfaction that I saw the legislation reach the statute book.

CI: How popular have PICs been in the relatively short time that they have been on the statute book?

KC: We certainly didn’t anticipate a stampede of PIC formations from the outset and that has turned to be the case. There are currently six PICs registered with the Cayman Islands Monetary Authority (CIMA) with some others in the pipeline but what we are seeing is that virtually every SPC that we have worked on over the past few months is talking about the likelihood of establishing one or more PICs in the near to medium term. What we are identifying is a number of additional attractive features of PICs that may not have been obvious at first sight and which go beyond the core advantages of intra-cell contracting, providing a corporate governance mechanism and tax certainty.

CI: Can you talk a bit more about those attractive features?

PS: Sure. Just to take a step back for a moment, I should mention that when PICs were being developed the main focus was to facilitate contracting between cells of the same SPC (which was simply not possible, legally, with unincorporated cells) and to give greater tax certainty. However, for the PICs that have been established so far, whilst tax certainty has been important in some instances, the main driver has been the ability to have a separate board of directors for the PIC i.e. separate from the board of directors of the parent SPC. This has proved to be a significant advantage for sponsors compared to using an unincorporated cell. However, as PICs have been thought about more, a number of other advantages have been identified. For example, it is easier for a PIC to transition to a stand-alone captive because it is already a legal entity. In contrast, the owner of an unincorporated cell would have to establish a new vehicle and go through what could be a cumbersome novation process. This is in fact the case with an actual situation on which we are currently advising. Again, unlike an unincorporated cell, a PIC can merge with another Cayman captive or a foreign captive or even be used to allow a cell of a foreign captive to redomesticate to the Cayman Islands. In the context of a merger, we are currently assisting one client where the use of a PIC will enable a Bermuda captive in run-off to be amalgamated with a Cayman SPC in circumstances that would otherwise not have been legally possible. The PIC can offer quite a lot of possibilities and the concept is easier to explain than an unincorporated cell. Our hunch is that we will see an acceleration in PIC formations over the next year as knowledge and experience of them continues to grow.

CI: What is the usual ownership structure of a PIC?

KC: It really depends on what the PIC is being used for. The fundamental aspect, as required by the PIC legislation, is that all the voting shares must always be held by the parent SPC insurer through one of its cells. In this way, CIMA knows that every PIC is always under the control of a licensed insurer. In the case of a PIC, where both economic ownership and voting control will be in the hands of the SPC insurer or perhaps the parent of the SPC insurer, the PIC simply issues regular common shares to the SPC insurer. However, where there is a split between voting control and economic ownership, as there would be for example in a rent-a-captive cell company, it will be necessary for the PIC to issue not only common shares but also a separate class of non-voting participating shares to the economic owner. This will ensure that the economic owner participates in profits, whereas the controlling shareholder does not. There is complete flexibility to develop whatever share rights are appropriate for any given circumstances as long as the SPC maintains voting control.

CI: I understand that Solomon Harris has been involved in the formation of every PIC so far which will obviously give you a good perspective on who is forming them and what they are being used for.

PS: Yes, that’s right. Two of the PICs, including the very first one, were set up by a California-headquartered insurance and employee benefits agency whose client base is middle market companies nationwide. They formed an SPC insurer to provide a facility for their clients to participate in risk transfer and/or reinsurance (primarily, workers compensation and employee benefits). They selected Cayman not only because of its established cell company legislation but also because they found the PIC concept attractive because a group of clients owning a PIC could appoint their own board of directors to manage the affairs of the PIC. The
SPC was set up so that no business was to be written in the core or any of the cells; only in the PICs. The first PIC was formed in 2015 to allow a portfolio of agribusiness clients to participate in a risk transfer reinsurance mechanism for workers compensation coverage. The SPC has the right to appoint one board member to a PIC board of potentially seven members. A second PIC was established by the same client
earlier this year for a different group of businesses reinsuring similar risk.

KC: Another client was very proactive with the Cayman Government as to the urgent need for PIC legislation when it was still at the drawing board stage. They are a North Carolina-based consulting firm to the engineering and construction industry. They wanted to develop a cell platform to allow their clients to self-insure with the idea being that each client who was interested could have their own PIC and their own
board of directors to manage the PIC. The first PIC was set up last year and is owned by an affiliate of a Pennsylvania-based construction management and general contracting firm to initially write subcontractor default insurance. In this case there is a two person PIC board with one appointed by the consulting firm and one by the economic owner of the PIC. A second PIC for a different contracting firm was recently formed.
Our third example is different. A stop loss underwriter initially established a cell in an existing SPC platform formed by a captive insurance manager. The cell was subsequently replaced by a PIC. The PIC writes stop loss insurance for entities affiliated with the stop loss underwriter. The PIC board is comprised of two appointees of the stop loss underwriter and there is no representation from the SPC owner.

CI: You mentioned earlier that even though a PIC has to go through a registration process it isn’t actually licensed by CIMA. Does that mean that the regulation of a PIC is not as robust as that of a licensed insurer?

KC: The regulation of a PIC is equivalent to that of a licensed insurer as the regulatory framework under the Insurance Law applies in pretty much the same way as for a licensee so as to avoid PICs being used for regulatory arbitrage. So, for example, a PIC is required to file a business plan with CIMA and maintain the same level of regulatory capital as a stand-alone captive writing the same type of business, although
in the case of a PIC, CIMA does have discretion to modify the regulatory capital requirements where it considers it appropriate to do so.

CI: Where do you see PICs going from here?

PS: I am confident that we will now see some decent growth in PIC formations. It has been a modest start but there is a great deal of chatter about PICs in the industry. Like anything that is new, there is inevitably a time lag whilst consultants and sponsors do their due diligence and get comfortable. We have one client at the moment that is looking at a structure that would involve multiple PICs right from set up. If this moves ahead, there will be a major boost in the PIC numbers but even without that, I predict that over the next 12 months we will still see a good number of new formations and a growing awareness of what the PIC has
to offer.