IN113 - Choosing Between a Captive Insurance Company and a Protected Cell Company - Issues to Consider

Captive insurance vehicles are becoming increasingly popular to assist organisations to:

• Reduce the cost of their insurance
• Help manage the risk
• Provide some certainty in a mercurial insurance market

Introduction

Dixcart is often asked by clients whether they should use a captive insurance company or a cell in a protected cell insurance company for their insurance needs and this note has been produced to try to assist clients in this decision-making process.

What is a Captive Insurance Company?

A captive insurance company is a wholly owned insurance subsidiary of a non-insurance parent, which is used to self-insure all, or part of, the risk of the parent and associated companies. These may be industrial, commercial or government organisations.

The captive insurance company concept has been of major benefit and a significant contributor to the profitability and balance sheet strength of thousands of organisations throughout the world.

The growth in the captive insurance industry reflects changes in the way that organisations finance risk. Increasingly conventional insurance provides protection against catastrophic risk with alternative, more flexible approaches to cover lower levels of potential losses.

What is a Protected Cell Insurance Company?

A protected cell company (PCC) 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.

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 protected cell insurance company.

Each cell owner will require 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.

What are the Similarities between a Captive and a PCC?

The major similarity between a captive insurance company and a cell in a protected cell insurance company is that both are used to provide insurance cover to the organisation that owns either the captive insurance company or the cell.

To the outside world the way in which these are used and work is identical. They can take on insurance risk from the organisation that owns them and, if they wish, can use re-insurers to reduce this risk or eliminate it altogether. The security to cover the risk can be provided by share capital, retained profits, letters of credit from banks or re-insurance into the market.

What are the Differences Between a Captive and a PCC?

A number of differences exist between captive insurance and protected cell companies.

Costs and Management Time:

• A captive insurance company is a wholly owned insurance subsidiary of a non-insurance parent, which is used to self-insure the risk of the parent and associated companies. A protected cell insurance company is independently owned and capitalised, providing the insurance facility through legally separate financial cells for each insured client or activity. It is the cell which is capitalised by the “parent” company.


• Since there is a need to meet capital and solvency requirements, stand-alone captive insurance companies have generally been restricted to organisations with insurance premiums of €1m and above. To overcome this size restriction on the use of captive insurance and allow smaller organisations to benefit from the captive insurance market, Guernsey introduced legislation in 1997 to permit the use of protected cell companies. The great advantage of the protected cell company concept is that it is an easy and cost-effective way for a smaller organisation to take advantage of the captive insurance market and can be appropriate for organisations with insurance premiums of €250,000 and above.


• For a protected cell company the amount of senior management time that needs to be spent in dealing with insurance matters can also be considerably reduced. In a protected cell insurance company the directors and insurance managers are provided by the owner of the company and these experts can greatly reduce the amount of time that the management of the parent company needs to spend on insurance matters, compared with a typical captive insurance company.

In addition to costs and management time, other differences that need to be considered relate to the ownership of the company or cell:

Ownership

• A captive insurance company is nearly always owned by the group whose insurance it is handling. This transparent status can be an advantage or disadvantage to the group, depending upon the jurisdictions in which they do business and the type of business that they are involved in.


• A protected cell insurance company is not owned by the group for which it is undertaking insurance work, although the cell may well be. The protected cell company can either be independently owned or owned by a financial institution. With a protected cell insurance company the relationship between the group being insured and a captive insurance vehicle is not so transparent and certainly the protected cell insurance company itself will be independent of the group being insured.

Conclusion

The choice of captive insurance company or a cell in a protected cell insurance company is not just about costs and/or the size of the business seeking to organise insurance in this manner. Some smaller businesses for example are happy to pay the higher cost of a captive insurance company, as for them the status and transparency of having their own captive, together with the direct management input into the captive insurance company, outweigh the additional cost. Alternatively, for some large organisations where the status of having a visible captive is not a priority, they have been able to reduce their costs and management time by using a cell in a protected cell insurance company.

Further Information

If you would like any further information on the choices available or would like to discuss these with one of our experts, please speak to Alex Magell or Alan Corlett in the Dixcart Guernsey office, or your usual Dixcart contact.