Gibraltar PCCs and their future

Since the enactment of the first legislation at the end of the last century, a lot has happened on the protected cell companies (PCCs) front...

Since the enactment of the first legislation at the end of the last century, a lot has happened on the protected cell companies (PCCs) front.

Firstly, there are an ever increasing number of jurisdictions that have implemented similar regulations. Although the name of such companies might differ (eg, segregated portfolio companies or segregated account companies) depending on the jurisdiction, the basic legal principle remains the same: a cell company is a corporate vehicle that is permitted to segregate its assets and liabilities between different cells of itself, for different purposes, with the result that a creditor’s recourse against the cell company is limited to whichever cell was transacted with. Where a cell becomes insolvent, the remaining cells of the structure are not affected and continue to operate as normal.

The cell company regulations therefore addressed the perceived weakness of rent-a-captives where assets being pooled, users are insecure about their exposure to unlimited liability in the event of a claim by one or more of the other users. Whereas traditional insurance, through the common fund mechanism, ie, pooling, demands that the premiums of the many fund the losses of the few, PCCs ensure that their premiums are protected against the losses of the many.

There are now more than 50 jurisdictions around the globe that have adopted cell company regulations, and this number is expected to grow further, while established domiciles such as Gibraltar continue to adapt their regulations to an ever changing environment. This clearly demonstrates that the PCC concept has gained international recognition and that it is becoming an increasing alternative in insurance placements for the years to come.

Gibraltar

Gibraltar has always been at the forefront of PCC promotion and use, being the first EU jurisdiction to promulgate a PCC Act, in 2001. Before this, only offshore domiciles had similar legislative frameworks and Gibraltar saw the opportunity offered by its EU jurisdiction status to enhance the concept further and combine cell solutions with the ability to write direct insurance across the EU/European economic area (EEA) on a freedom of services basis.

This proved to be a very wise move from the Gibraltar insurance industry stakeholders and legislator, as is for example demonstrated by the success of White Rock Insurance (Gibraltar) PCC Ltd the first ever EU-based PCC. Since its establishment in 2002, White Rock has established more than 50 cells and currently has 22 open cells, which makes it by far the largest PCC in the EU.

Other PCCs, whether life or non-life companies, have set up in Gibraltar to avail of its favourable legal framework and ability to ‘passport’ across Europe.

Various factors explain this success, but one key element remains the unparalleled speed (at least in the EU) at which the Gibraltar Financial Services Commission is able to license PCCs and authorise individual cells. This, combined with the pragmatic and proportionate approach taken by the Gibraltar regulators, gives the visibility and clear framework indispensable for the conduct and development of business.

The various uses of cell companies

Cell captives

Cell captives can be used to assist clients who wish to retain their own risk, as they would do with a standalone captive. This is no doubt the main use of cell companies for insurance purposes.

Typically, this solution may suit companies that do not wish to meet the minimum capitalisation requirements imposed in the EU because the programme they want to write is too small to efficiently leverage the minimum capital required. There can also be cost efficiencies for companies using a cell captive as opposed to a standalone captive. A PCC may also suit clients with specific needs or that require a shorter-term solution than the commitment of owning a captive, as they incur lower formation and operating costs and have much faster entry and exit strategies, than the captive alternative.

Fronting cells

The participants of the 2013 study conducted by the Captive Insurance Companies Association identified the traditional fronters’ requirement for collateral as one of the three biggest challenges in owning a captive.

Thanks to the legal segregation of assets and to some contractual arrangements, the need for collateral is not as critical for PCCs. For example, the Aon-owned White Rock generally does not require collateral for pure fronting arrangements to captives or to the reinsurance market.

This partly explains the Gibraltar-based PCC’s success in offering fronting cells to write its clients’ risks across Europe (the company is licensed for all non-life classes of business), allowing them to access the reinsurance markets or their captive. In the latter case, fronting is required either because the captive only has a reinsurance license (eg, Luxembourg reinsurance captives) or because they are established outside of the EU/EEA (eg, in Bermuda or Guernsey) and are therefore not licensed to write insurance across Europe on a freedom of services basis.

The objective for White Rock in this arrangement is to provide access to licensed paper. However it is important to note that where the cells operate as a ‘pure front’, the insured has generally no formal ownership or control over the activities of the cell. The transaction from the insured’s viewpoint is no different from the traditional market.

Other uses

Thanks to the flexibility offered by these vehicles, PCCs lend themselves not just traditional captive purposes, but much more. For example, cells have been used successfully to facilitate and accelerate the run-off of all or part of some (captive) insurance companies. Cells are also increasingly being used in insurance-linked securities (ILS) to facilitate securitisations and to transform capital market products such as derivatives and catastrophe bonds into insurance products. In the same way and overwhelmingly, it is insurance risk that is transformed into financial risk or risk that the capital markets can accept.

For their part, life insurance PCCs tend to be used by high-net worth individuals who desire control, transparency and security over the management of their assets.

The main advantages for users of cell companies

Although most are inherent to the particulars of the cell company structure in itself, many of the advantages that the cell users can benefit from also depend on the approach and policies of the cell company promoter. The advantages generally enjoyed by users are as follows:

Cell captives

• Lower formation costs: reduced capital (no minimum for cells), zero legal costs since the cell structure has already been incorporated, and generally lower application/registration costs.


• Lower running costs: generally reduced management fees, no non-executive directors, lower audit fees, no individual cell regulatory return, lower cost of maintenance of fiscal reps network, lower annual regulatory fees, zero tax exempt fees, and zero filing fees, etc.


• Easier and quicker set up and exit: cell formation can take place in a matter of days/weeks and it is not necessary to appoint a liquidator to close a cell.

• ProfitableCompetitive fronting fees: fees are generally charged on a variety of bases dependant on premium volumes, number of territories, and services provided, etc.


• Continuity of cover: fronting is sometimes the core product of the cell company promoter. In this case, unlike traditional insurers, the fronting offer is not dependent on the market cycles or on participation in other layers or lines of the clients’ programmes. Clients can therefore expect continuity in the availability of fronting services.


• Flexibility on wordings and limits: as the promoter generally requires that the reinsurance agreement contains a ‘follow-the-fortune’ clause, wordings can therefore be more flexible than the traditional carriers that tend to impose their own wordings, exclusions and limits.


• Often, no collateral required: as explained above, the cell structure can allow its promoter to get out of the requirement for a letter of credit, parental guarantee, premium deposit or any other form of guarantee, generally imposed by traditional carriers, especially when fronting for captives is involved.


• Speed of payment of the reinsurance premiums: speed of payment of the reinsurance premiums is a key issue, especially when the reinsurer is the client’s captive. Since fronting arrangements are made through dedicated cells, the promoter can contractually commit to pass the premiums over to captives or reinsurers within strict deadlines.


• Specific advantages: each promoter might develop specific niche products.


Other types of cells

Given the many other uses that can be made of cells, it would be impossible to give an exhaustive list of the advantages enjoyed by the cell users. However, in the main, cells provide an opportunity for a flexible structure, easy and quick set-up, and a cost effective solution to put in place and to maintain.

Solvency II: the next growth opportunity for Gibraltar PCCs?

The increasing number of new cell company jurisdictions will undoubtedly intensify competition and potentially dilute the revenue streams of the established domiciles. Practitioners and legislators in the competing domiciles will persist in attempting to differentiate their cell company products in the hope of creating a competitive advantage or just publicity.

There is no doubt that the Gibraltar insurance industry and the legislators will continue to work hand-in-hand to bring innovation and improvements to cell companies, instead of resting on their laurels.

Gibraltar, along with other EU jurisdictions, will have to implement Solvency II by 2016. However, although the directive might often appear a challenge, it will also bring opportunities, particularly for the existing and new Gibraltar PCCs that will benefit from the expertise, know-how and resources available locally, both within the industry and at the regulator.

Indeed, the directive may lead to increased costs that will particularly affect EU-based smaller captives and open market insurers. We have seen above the existing benefit of pooling the running costs of a PCC between its promoter and cell clients. The fact that a PCC is a single legal body that will have to comply as a whole is likely to make pooling even more pertinent when it comes to addressing the new requirements under all three pillars in terms of regulatory capital (Pillar I), governance (Pillar II—risk management, internal audit, investment and other committees, production of an Own Risk and Solvency Assessment, etc), and reporting/disclosure (Pillar III) requirements.

Inevitably, there will be situations where the resulting increases in costs associated with regulatory changes will result in a captive parent’s decision to exit and shut down its standalone captive. In many cases, this is difficult to achieve and so a PCC provides the facility of ‘rump warehousing’ through which a particular block of risk is transferred to a cell in the PCC and the captive owner is effectively able to shut the captive subsidiary down, while being able to continue to self-insure through an EU-based cell.