Incorporated Cell Captives

THE CONCEPT

One of the hallmarks of the international financial services industry is its constant drive to create new products in response to the risk management and financial planning needs of successful businesses.  The captive insurance industry, responding to the need of smaller businesses for faster set-up and more affordable administration of captive insurance companies, created the protected cell company structure.  A protected cell company exists where there is a core company with cells or sub-accounts attached to the core.  The purpose of a protected cell company is to centralize certain administrative functions, while segregating the assets and liabilities of the different cells or sub-accounts of the protected cell company.  This enables each cell to engage in the business of insurance, separate and apart from the other cells.  While the protected cell company structure has many advantages, it may present significant liability issues, as the cells or sub-accounts are not separate from the core.  As a result, it is not clear whether the cells or sub-accounts are completely protected from the liabilities of the core.

In response to this issue, some jurisdictions have enacted legislation that provides for the separate existence of the individual cells.  These jurisdictions have created a captive insurance company structure known as the incorporated cell company.  The incorporated cell company structure is similar to the protected cell company structure in that it involves individual cells that are attached to a core company.  The difference is that, under the incorporated cell company structure, each cell is a separate legal entity that files its own articles of incorporation and  obtains a separate taxpayer identification number.  The hope is that this separate legal identity will protect the cells from the liabilities of the core and the other cells.

The incorporated cell company structure has two primary components.  The first is the Incorporated Cell Company (“ICC”), which acts as the core.  The second is the individual cells attached to the ICC and known as Incorporated Cells (“IC”).  Under the incorporated cell company structure, the ICC obtains an insurance license from the jurisdiction’s insurance regulators.  The ICC’s license permits ICs attached to the ICC to engage in the business of insurance.  The ICs do not obtain an insurance license, but simply register under the ICC.  It is the ability of the IC to essentially borrow the insurance license of the ICC that results in lower set-up and ongoing administration costs for the IC.  In order to register under an ICC, an IC is required to execute an operating agreement with the ICC.  In addition, the ICC must control a majority of the board of directors of the IC registered under it.  RMC has established an ICC in St. Lucia, one of the jurisdictions with a favorable incorporated cell company statute.
 

THE BENEFITS

The incorporated cell company structure achieves many of the same benefits of a stand-alone captive insurance company (e.g., risk management, ownership, and tax benefits), but at a fraction of the cost.   

Pooling of Professional Support

The incorporated cell company structure permits the pooling of professional support necessary to establish and manage a captive insurance company.   Typically, the ICC will retain professionals, such as insurance managers, actuaries, auditors and lawyers, who possess the experience and knowledge necessary to develop and manage a captive insurance program.  Spreading the costs of these professionals among the ICC and the ICs attached to the ICC reduces the costs to the individual ICs.

Established Policy Options

Generally, an incorporated cell company statute provides that an IC can only issue policies approved by the ICC.  Before an IC is even established, the ICC will have obtained an actuarial study of different types of insurance.  The ICC’s actuarial study will provide pricing parameters for the policy lines approved by the ICC.  This means that, as long as the IC desires to issue a type of policy pre-approved and priced by the ICC, the IC will not be required to obtain its own actuarial study.  This is another example of how the incorporated cell company structure reduces the set-up costs for the IC.  If an IC desires to issue a type of policy not already approved and priced by the ICC, it will be required to obtain its own actuarial study at its own cost.  In addition, it will be required to obtain the consent of the ICC.

Separate Legal Entities

Each IC will file articles of incorporation and have a separate legal identity.  In addition, the IC’s relationship with the ICC is a contractual, rather than a structural, connection.  As a result, as long as the IC maintains its separate corporate existence, the expectation is that the shareholders of the IC will not be liable for the debts and obligations of the IC, including insurance claims made against the IC, or the debts and obligations of the other ICs or the ICC.  In addition, the dissolution or insolvency of one IC should not affect the other ICs.

Fast Set Up

Because the ICC has already obtained an actuarial study and has approved and priced the types of insurance available to the ICs, an IC can be established much more quickly than a stand-alone captive.  As long as the client provides complete and accurate documentation, the process can be completed in 45 – 60 days. 

Portability

Incorporated cell company statutes generally permit an IC to separate from its ICC and become a stand-alone captive.  Under the incorporated cell company structure, an IC already has a separate legal identity.  It will have filed its own articles of incorporation and will have a separate board of directors.  In addition, it will maintain a separate bank account and will be required to maintain the minimum capital and surplus required by the jurisdiction.  As a result, an IC should be able to convert to a stand-alone captive with less disruption than would occur in other captive insurance company structures.
 

THE LIMITATIONS

Investments

Because an IC is an insurance company, it may be required to pay insurance claims.  In addition, an IC, like any other insurance company, will be subject to regulation by the insurance department of the jurisdiction where the IC is domiciled.  In order to ensure its ability to pay claims, the insurance department will require the IC to maintain a minimum level of “reserves”.  An insurance company’s reserves are that portion of its assets set aside to pay claims.  Assets in excess of its reserve are considered surplus.  The reserves that an IC will be required to maintain are determined by the IC’s actuary in a feasibility study and are based on anticipated claims.   Because reserves support an insurance company’s ability to pay claims, they are subject to strict investment and solvency guidelines.  If, at any time, the IC’s reserves do not meet the minimum requirements of the insurance department, the IC will be declared insolvent.  This may result in the suspension or revocation of its registration under the ICC or the complete liquidation of the IC. 

In addition to regulation by the insurance department, the IC’s investment strategy will be subject to the supervision of the ICC.  Typically, an ICC will limit the investment options of the IC.  This accomplishes two goals.  First, it enables the ICC to safeguard the solvency of the ICs registered under it.  Second, by limiting the ICs to pre-determined investment options, the ICC can reduce the investment costs incurred in connection with the operation of the ICs linked to it.  The pre-determined investment options generally focus on growth and protection of principle.  Preapproved investments include brokerage accounts (with pre-approved managers), fixed or equity-indexed annuities, high cash-value equity-indexed life insurance and cash.    Investments in real estate, mortgages, loans and factoring are generally prohibited.

An IC’s investment strategy should include an emphasis on equity-indexed products.    An equity-indexed product guarantees a minimum rate of return with the possibility of a greater return based upon an applicable index, such as the S&P 500, up to a maximum amount (cap) set forth in the contract.  One reason an IC should use an equity-indexed product is the elimination of down-side risk, with the potential for market rate returns.  In addition, an IC is required to obtain an annual audit of its assets and liabilities.  Generally, equity-indexed investments, with a guarantee of principal, are fully credited towards the IC’s solvency requirements by its auditors.

Governance

An IC is a corporation, duly organized under the laws of the jurisdiction where it is domiciled.  It is separate and distinct from the ICC and the other ICs linked to the ICC.  It is formed by filing articles of organization with its domicile and has shareholders, a board of directors and officers.  Even though an IC is linked to an ICC, its insurance business is separate from the insurance business of the ICC and the other ICs.  An IC will be required to execute an operating agreement with the ICC.  The ICC will establish certain parameters for the operation of the IC’s insurance business, such as the types of risks that can be underwritten and the investment policy of the IC.

 

IMPLEMENTATION

Feasibility Study

The first step in the process of forming an IC is to obtain a feasibility study.  RMC will arrange for the feasibility study to be performed by an independent actuary who is an expert in the property and casualty insurance business.  The actuary examines the nature of the client’s business, assesses the types of risks faced by the business and determines whether these risks can best be mitigated through a captive insurance company.  As part of the study, RMC will provide a pro-forma analysis, comparing the costs and benefits of insuring the client’s risks through a captive insurance company, buying insurance in the commercial market or doing nothing.  In most cases, we will be able to demonstrate that a captive insurance company can provide significant benefits to the client.

Establishment and Administration

If a client desires to form an IC, the client will execute an administration agreement with RMC, and RMC will begin the process of forming the IC under the ICC that RMC has already established.  RMC will prepare all applications required by the regulatory authority.  The client will be required to provide certain information and documentation in order for RMC to complete the registration process.  RMC will rely upon the accuracy of the information and documentation provided by the client, and the client’s failure to provide such information and documentation in a timely manner may cause a delay in the establishment of the IC.  Once the IC’s registration has been approved, RMC will work with the IC to underwrite the risks to be insured by the IC, establish and collect premiums and issue insurance policies.  RMC will invest the assets of the IC at the direction of the owner (within the parameters established by the ICC).  RMC will obtain reinsurance where necessary. Once the IC has been formed, RMC will continue to provide certain actuarial and administrative services to the IC.  RMC will bill and collect premiums and adjust claims.  RMC will work with the IC’s accountant to prepare and file tax returns and work with an independent auditor to prepare the audit report that is required by the insurance department.  In addition, RMC will manage the operation of the IC to ensure compliance with incorporated cell company statute of the jurisdiction where the IC is domiciled.