North Carolina’s Debbie Walker discusses the protected cell captive insurance company structure in the state and its benefits
North Carolina’s captive insurance laws provide for the formation and operation of many types of captive insurance companies that can be used by business owners to manage their businesses’ risks. One common type licensed by our state is the protected cell captive insurance company (PCC).
Since the inception of the state’s captive insurance industry in 2013, the North Carolina Department of Insurance (NCDOI) has licensed 34 PCCs and approved more than 470 cells of those insurers. As a side note, the NCDOI has also licensed special purpose cell or series structures with more than 90 approved cells or series leading to more than 560 cells and series approved since 2013. The special purpose cell or series structures are similar to PCCs; however, for purposes of this information, we will only discuss the PCC structures.
As statistics indicate, the PCC is a popular captive insurance structure. To understand why, let’s first consider exactly what a PCC is. Under North Carolina law, a PCC is a captive insurance company that may establish and maintain one or more protected cells. The assets and liabilities of each of those cells are segregated and insulated from the assets and liabilities of the PCC and its other cells.
The flexibility provided by law for establishing a PCC and its cells is one reason this structure is popular. The PCC may organise as a stock, mutual or non-profit corporation or as a manager-managed limited liability company. Through statutory provisions, the assets and liabilities of a protected cell of the PCC are walled off from the assets and liabilities of the rest of the PCC.
Even with these provisions in the law, some desire to establish ‘incorporated cells’, which are cells that are legally organised as business structures separate from the PCC. Although the name might imply differently, incorporated cells may organise under any form of business organisation authorised by the commissioner. Whether the PCC has incorporated or unincorporated protected cells, or both, the entire PCC structure is considered a licensed captive insurance company under the state’s laws.
A unique aspect in North Carolina’s statutes is the discretion granted to the commissioner to allow a lower capital requirement for the PCC core if the core does not bear any insurance risks and its cells are fully funded to meet their individual obligations.
Upon approval by the NCDOI of an entity’s application to form and operate as a PCC, the NCDOI issues a license for the PCC to operate according to its NCDOI-approved business plan. Before a protected cell of a PCC may operate, prior NCDOI approval of the protected cell’s business plan must be obtained. The PCC is licensed by the NCDOI, and protected cell business plans of the PCC are approved by the NCDOI so that the protected cells may operate under the license of the PCC. If the business plan of a proposed cell is similar to that of existing cells in the same PCC, the NCDOI is typically able to streamline its approval process. The statutes do not limit the number of cells a PCC can form.
Once a PCC is licensed, it is subject to NCDOI regulation so the department can monitor the PCC and its protected cells to make sure it is abiding by captive insurance laws and maintaining adequate liquid funding to meet obligations. Indications of compliance, operational or financial issues require closer scrutiny by the NCDOI and possible action if such issues cannot be resolved to the NCDOI’s satisfaction.
The NCDOI’s regulation of each cell is similar to the regulation of a standalone captive insurance company. Each cell must maintain adequate capital and surplus; assets of good quality, diversification and liquidity; adequate reserves; reinsurance where appropriate; and it must operate within its NCDOI-approved business plan. Certain transactions of the PCC require the prior approval of the NCDOI, such as material business plan changes, dividends and affiliated loans.
The captive insurance laws allow a protected cell of a PCC to transfer to another PCC or become a standalone captive insurance company, subject to the NCDOI’s approval of a transfer agreement or conversion plan. All assets and obligations of the protected cell before the transfer or conversion remain the assets and liabilities of the protected cell after the transfer or conversion. The PCC is released from all obligations of the cell that transfers to the new PCC.
The ability to convert from a protected cell to a standalone captive insurance company is appealing to some business owners. The PCC is also appealing to some business owners that may want to get their feet wet in the captive insurance industry by first participating in a cell of a sponsor’s PCC. Once they are comfortable, they may decide they want their own standalone captive insurer. They can convert their protected cell or transfer the business of the protected cell to a standalone captive insurer.
A PCC can be used many to meet the needs of the owner and insureds. A few examples are as follows:
- A captive manager may sponsor a PCC and allow its clients to obtain insurance through participation in protected cells of the PCC. In this type of arrangement, the sponsor is typically the captive manager of the PCC and its cells. Many small-to-medium-sized business owners have decided this is the best option for their entry into the captive insurance industry.
- A business owner may form a PCC to obtain insurance for its businesses’ risks. The PCC may form protected cells whereby each cell provides a different type of coverage to the companies or each cell provides coverage to a different business unit, division, department or company.
- A commercial insurer may form a PCC to provide its insureds with an opportunity to participate in protected cells of the PCC where each cell assumes related and unrelated risks of the insured from the commercial insurer. By assuming this risk, this may be a way for the insured to reduce its insurance costs.
- An agency that produces business for a commercial carrier may form a PCC that allows each of its agents to participate through a protected cell of the PCC, which assumes a portion of the produced business from the commercial carrier. Through participation in the protected cells, the agents can share in the risks and rewards of the business they produce for the commercial carrier.
- Multiple business owners may opt to participate in a protected cell that is based on the group captive insurance model where they pool and share their risks. There may be multiple protected cells in a PCC for different groups of participants.
These are just a few examples of ways the PCC structure may be used. It is not an exhaustive list. New uses of PCCs continue to be developed as needs and risks arise.
Cost efficiencies may be gained by using a PCC and its protected cells vs. forming and operating multiple standalone captive insurance companies. In a PCC that has only unincorporated protected cells, the same officers and directors are responsible for the management and oversight of the entire structure. This may be the case also with incorporated protected cells; North Carolina laws state that unless otherwise permitted by the organisational documents of a PCC, each of its incorporated protected cells must have the same directors, secretary and registered office as the PCC.
The PCC and its protected cells will usually have the same captive manager, auditor and actuary, and the protected cells’ documents may generally be the same from cell to cell. These factors generally lead to efficiencies in the formation, management, and operation of the PCC and its protected cells, resulting in lower costs. For example, cost savings may save money on financial reports.
Only one annual report and one audit report are required for the entire PCC structure, with each report including a supplemental schedule that provides a balance sheet and income statement for each protected cell and the core.
Instead of filing a separate Statement of Actuarial Opinion for each protected cell and the core, a PCC may file a combined Statement of Actuarial Opinion, which includes an opinion for each protected cell and the core.
With the ability to submit each of these reports on a combined basis resulting in only three total reports vs. three individual reports for each protected cell and the core, a cost and time savings are generated. Finally, a single premium tax return is filed for the PCC structure. Tax is paid on the premium generated by the core and its cells. If all cells were each required to file individual returns, this filing process would take much more time and the cost to produce those returns would be higher.
The PCC structure will likely continue to appeal to small, medium and large-sized businesses due to the flexibility and options that it offers. Business owners taking their first step into the captive insurance industry or those experienced in the use of captive insurance will find this to be a favourable option for managing risks.
