Malcolm Cachia of Strategic Risk Solutions discusses cell solutions for doing business in the EU and UK
The utilisation of protected cells (cells) to provide valued solutions has continued to gain increased appeal and traction in recent years with the alternative risk landscape has evolved considerably since cell legislation was first introduced in 1997 as a way to open up the mid-market to alternative risk.
The introduction of statutory ring-fencing of assets and liabilities within a cell company provided the ideal opportunity for many small and mid-market companies in the US and European markets to access alternative risk financing for the first time. This allowed them to take advantage of the risk management solutions offered by a traditional single parent insurance captive without having to establish a captive of their own. The cell company structure provided a low-cost entry vehicle which offered the benefit of being able to use the capital of the core company within which the cell is created to fund their capitalisation requirements besides also cost efficiencies across governance, risk and capital management due to the sharing of costs with other cell owners.
At year-end 2018 there were approximately 6,300 standalone captives and whilst the number of cells is largely unreported due to differing classifications in the various international jurisdictions it is believed that cell formations outnumber the standalone captives.
Today it is widely acknowledged by market professionals that the utilisation of cell structures will continue to grow and generate a high level of interest in the years ahead as companies without captives or cells are being forced to look at them particularly in times of a hardening market and concerns regarding capacity.
Large companies are also using cell structures as a tool to free up capital with some looking to transfer legacies to cells before closing the standalone. This allows them to return capital to the parent while continuing to control their own risk retention and claims.
Protected cell companies are playing an important part in the scope, design, implementation, funding, and financing of strategic risk financing programmes.
They are enhancing currently established programmes and serving as the catalyst for the development and implementation of new structures blending finance, insurance, and risk management.
They offer shareholders the potential advantages of a cost-effective risk- financing vehicle, reduced overall insurance costs, profit retention, reinsurance market access, cover for uninsurable risks and flexibility in programme design.
US versus Europe
While an increasing number of US states have introduced cell legislation in recent times, the landscape of the cell is, however, somewhat different in Europe. There are significant differences between the European and US captive insurance markets relating to, among other, regulations, capitalisation requirements and licensing time-frames. On the European front Malta, Gibraltar, the Isle of Man and Guernsey all boast cell legislation, however, well-established captive homes, such as Luxembourg and Dublin, are yet to introduce such measures.
EU/UK access
Malta is the only full EU member state with protected cell company (PCC) and incorporated cell company (ICC) legislation and being a member state enjoys the freedom to provide services and directly cover risks throughout the EU and the EEA. Companies which need to provide insurance cover for European risks or customers can utilise a cell structure within a Maltese PCC to benefit from an effective and efficient risk financing solution that takes advantage of EU pass porting rights and thereby maintain direct access to all member states of the EEA.
On the UK front uncertainty still exists regarding what market access will be granted to the UK and Gibraltar as a result of Brexit.
Again with Malta likely to be in the medium term the only member of the EU single market with insurance protected cell legislation, a Maltese cell in a PCC with a UK branch set up offers the real possibility to maintain direct access to writing UK risks should a hard Brexit become a reality.
Multipurpose and flexible utilisation
Cells can be enabled not only for use in traditional captives, reinsurance or insurance-linked security models but also for direct third party writing of risks and consumer business or as an efficient and low-cost fronting facility.
It is common for captives and cells to also be profit centres by including customer and ancillary business which not only provides added revenue but also delivers capital efficiencies by creating added diversification.
Common key functions including actuarial, risk management, compliance and internal audit apply across the PCC.
For the purposes of meeting Solvency II requirements, it is possible for the PCC to produce a single Own Risk Solvency Assessment for the entire PCC which will include also its cells. The same applies to report and disclosure
requirements, with one Regulatory Supervisory Report and Solvency Financial Condition Report and with the PCC having in place all necessary resources to meet other quarterly and annual reporting as one single legal entity.
Under Solvency II, a cell owner will typically only need to invest own funds equivalent to the cell’s notional solvency capital requirement, which, with small undertakings, often falls far below the typical standalone insurer minimums. Surplus funds of the core which are in excess of Solvency II capital requirements can, subject to the core’s risk appetite, be lent to cells.
Brokers and intermediaries operating a successful and profitable business are also recognising the opportunity to move away from a commission and fee-based reward to a focus on underwriting profits through a protected cell which will also provide them with more stable market capacity.
The in-house availability of data, risk and technology knowledge and the confidence in the potential profitability of their business is driving the decision for them to seriously consider converting to a principal with the possibility of also accessing the reinsurance market for support.
Cells can also enable new ideas to be incubated or new business models to be attempted at a far lower cost than a standalone insurer.
This removes the dependency on a third party principal or the need to divulge intellectual property to third party principals or fronters.
Protected cells offer much promise thanks to their capital, cost and governance efficiencies, especially in a Solvency II environment.
Well-resourced PCCs can provide cells with the regulatory expertise, infrastructure and economies of scale only usually found in well-developed incumbent insurers.
The PCC model allows cells to focus on their specific risks and business plan while the core provides broader support to ensure regulatory and good governance requirements are met. A degree of autonomy is provided to cells through committees that have representatives of the cell owner together with core representatives under the board’s delegated authority in order to enable a faster decision-making process.
