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The Benefits of Segregated Portfolio Insurance
by Conor Jennings
Caledonian Insurance Services
Limited
A segregated portfolio
company (SPC) or protected cell company (PCC), as it is known in some
jurisdictions, is a single legal entity, but the company is made up of
individual "protected cells". It has a "core" capital
(the ordinary share capital provided by the owners) but in addition each
cell has its own capital (usually redeemable preference shares), provided
by the client using that cell. Each cell is completely separate from each
other but linked to the common core.
The assets of one cell are statutorily protected from
the creditors of another. Therefore a variety of organisations can safely
use different cells within one company.
The great advantage of this SPC concept is that it is
an easy and cost-effective way for a small organisation to take advantage
of the captive insurance market. Not only is the cost lower, but the amount
of senior management time that needs to be spent in dealing with insurance
matters can also be considerably reduced.
A captive insurance company is a wholly-owned insurance
subsidiary of a non-insurance parent, which is used to self-insure the
risks of the parent and associated companies. A segregated portfolio insurance
company can be independently owned and capitalised, providing the insurance
facility through legally separate financial cells for each insured client
or activity.
Each cell owner will acquire a number of redeemable preference
shares in order to capitalise the cell, and as a mechanism to receive
future profits in the form of dividends. This is formalised in a shareholders'
agreement.
British Virgin Islands insurance regulations require the
cells to maintain a minimum solvency of 20% of net premiums, but this
may need to be greater to meet the risks to be covered within the cells.
SPCs are similar to traditional rent-a-captives except
for the very important fact that if a rent-a-captive program goes bankrupt,
the assets of the entire program, including those of the insureds, are
at risk, whereas with an SPC, the assets are secure. The assets of the
insured are separate from those of the captive and vice versa. In addition,
the assets of the insureds within the captive are protected from the effects
of bad or adverse selection, underwriting or losses. This is, in effect,
creating a regulatory and accounting wall around the captive cell (ring-fencing).
SPC Usage
SPCs offer an extremely cost-effect alternative to full blown captives
and can be used for a number of different purposes.
Rent-a-Captive
The SPC owner offers traditional rent-a-captive services to clients with
the added security of statute to support the segregation of assets and
liabilities between cells. This has been popular with insurance companies
who have wanted to ‘lock in’ their good policyholders, especially
those with better than average loss experience who have been considering
establishing their own captives. This concept has also been used by some
insurers to attract good business away from competitors who have no such
facility.
Insurance Companies
Another development has seen the use of SPCs by insurers as an alternative
to a standalone captive for their own reinsurance retentions, using a
separate cell for their own activities alongside the cells of client companies.
Associations
Association Captives have operated successfully for very many years, providing
insurance cover to members of trade associations or companies trading
in a particular industry. Too often, however, the idea of an association
captive is too difficult to sell to the potential participants, because
of a disinclination to share risk, or even to share information between
individuals or companies who operate in direct competition with each other.
The SPC concept is ideal, as it permits segregation of assets and liabilities
as well as enabling confidentiality to be observed.
Offshore Life Insurers
Offshore Life Insurers have embraced the concept of SPCs to provide added
protection to policyholders. Using separate cells for individual policies
or products does not greatly increase running costs but ensures segregation
of risk (and supporting asset classes). Should the life insurer decide
to write also general business and become a composite, the SPC structure
is one of the few accepted corporate structures to accommodate this without
having to establish a separate general insurer (with associated cost of
capital and marginal costs).
Global Program Solutions
Segregated Portfolio Companies are also used to restructure global insurance
programs through a captive-type operation. By using an SPC, the global
company can separate its risks geographically or by subsidiary. Each cell
can then be capitalised to meet its particular requirements, and most
importantly it can be rated in accordance with the success of its own
risk management programs.
In the event of Merger and Acquisition (M&A) activity, an SPC-structured
captive is far better suited to the identification, inclusion or removal
of individual trading companies or subsidiaries. Insurance cover for joint
ventures and strategic alliances can be provided through the captive on
a fully segregated basis.
Special Purpose Vehicles / Transformers and Securitization
The SPC structure can also be used as a platform for any type of special
purpose vehicle (SPV), including those established as transformer vehicles
to support securitizations. Structuring an SPV as an SPC also has the
advantage of enabling the segregation of different classes or categories
of investor. Using SPCs for umbrella investment funds also offers many
advantages, and is becoming increasingly popular as a result.
The proof of true legal segregation of cellular assets
is even more important in the area of SPVs and funds than for the more
traditional Rent-a-Captive vehicles.
SPCs in a Hard Insurance Market
The captive insurance market has been thriving over the past few years
as a result of the increase in global insurance premium rates, the reduction
in capacity and the reduction in cover available. In most countries, traditional
captives have only been available to organisations with a large premium
who could justify the high set-up and operational costs of a captive.
However, the ready availability of SPCs means that the cost of entry to
the captive arena has fallen dramatically, thus encouraging more companies
to reduce their ‘exposure’ to the traditional insurance market,
and to enjoy the substantial benefits of increased self-retention.
Furthermore, the SPC concept will be of particular interest
in the US where Congress has given the most advantageous tax treatment
to US and offshore small property and casualty insurance companies under
Section 501(c)(15) of the Internal Revenue Code. Essentially, an insurance
company primarily engaged in the business of insurance that receives less
than $350,000 in annual insurance premiums is tax exempt, subject to certain
restrictions. In the past, individuals would set up their own small privately
held captives and have to cover all the associated costs themselves. However,
they now have the opportunity to share these costs with similar individuals
in the form of affinity group SPCs.
The Role of the British Virgin Islands
BVI is the fourth largest offshore captive domicile in the world. This
is primarily because it is the chosen home of many small to medium sized
captives. BVI has built up an excellent relationship with the ‘middle-American’
market and has earned the enviable reputation of being a professional,
well-regulated and cost-effective jurisdiction. Therefore, with recently
introduced SPC legislation, BVI is now in the perfect position to provide
even more sophisticated products to an enormous market.
For further information about forming an SPC
in BVI, please contact:
Conor Jennings
Managing Director
Caledonian Insurance Services Limited
Caledonian House
69 Dr. Roy’s Drive, P.O. Box 1043
Grand Cayman, Cayman Islands
Tel: 345 949 0050
(Dir 345 914 4875)
Fax: 345 814 4875
E-mail Conor Jennings
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