Captive cell structures increase in variety and offer more liability protectionReprints
Potential economic, legal and business benefits are helping spur the use of captive cell structures.
Mark Smith, Hamilton, Bermuda-based principal at Deloitte Bermuda, said he is seeing increased use of captive cells, which are legally separated units with a captive insurer, over stand-alone captives.
Where a traditional captive has one corporate owner, a segregated cell structure can have several owners share a common superstructure, but still be legally bulwarked from liabilities of the other owners.
From the perspective of a potential captive owner, a captive cell has an existing management and administrative structure that lessens the time necessary for a new participant to become operational and saves money as administrative costs are spread across the various cells comprising a cell captive, Mr. Smith said.
Steve Kinion, Wilmington, Del.-based director of the Bureau of Captive and Financial Insurance Products for the Delaware Department of Insurance, likens cells to “captives on training wheels.”
In addition to the relative ease with which they can be made operational, primary benefits of captive cells include provisions to segregate and firewall risks of the various member cells, said Kieran O'Mahony, Grand Cayman-based deputy managing director at Aon Insurance Managers (Cayman) Ltd.
“If you are not looking for risk-sharing, a cell company gives you a lot of advantages of a captive without exposure to credit loss from other programs and other members,” he said. “It's akin to owning a condominium as opposed to your own home: You share a common superstructure, but have additional limitations.”
One innovation that may make cells more attractive is the advent of incorporated cell captives.
Tim Faries, a Hamilton, Bermuda-based partner in the insurance group at Appleby Global Group Services Ltd., a financial services firm that advises companies on forming captives, said by incorporating, these protected cell structures are treated as a separate legal entity, thus separating any potential liabilities, and have their own boards or directors.
“From a legal perspective, the introduction of incorporated cells as alternative to typical cell captive structure over the last couple of years has been an interesting development,” Mr. Faries said. “From a captive perspective, incorporated cells give owners even more autonomy and more complete firewalling from other cells.”
Mr. Kinion said Delaware law differs from other jurisdictions in that it gives captive cell participants the option to be “series business units,” which affords them more flexibility in how they define their governance mechanisms and liability arrangements. Currently, there are 612 series captives licensed in Delaware, he said.
“What we have found is that a series (business unit) under a Delaware limited liability company is a great gateway to the captive insurance world,” Mr. Kinion said. “Series under Delaware law are easy to form and dissolve, because there is no filing with the Secretary of State's office as you do in other jurisdictions. You can just amend the limited liability corporation agreement.”
As for which companies and organizations are establishing cell captives, Mr. O'Mahony said he has seen some large U.S. corporations that suffered a significant loss and subsequently were unable to find sufficient insurance market capacity establish a captive cell as a way to tap reinsurance capacity.
“These companies have created a cell or (series business captive) to issue paper for gaps in their program and then reinsure it to 100% capacity,” he said. “So cells can help flesh out missing capacity.”
Small or medium-size companies in areas such as agriculture, forestry and energy are more interested in cells, he said.
“People are willing to join a group cell and knowingly share risk amongst them if they see they are in a peer group that is well-managed from an insurance perspective and with like-minded risks,” Mr. O'Mahony said. “This way, they pay a premium more appropriate to their risk exposure and history; and if there are any underwriting profits, they retain them instead of transferring them to the traditional market.”
Elsewhere, Mr. Kinion said he sees an upswing in cell establishment by smaller companies for financial and tax reasons. U.S. Internal Revenue Code section 831(b) exempts from federal income tax all operating income from captive insurance companies that qualify under the tax law.
“We are seeing a lot of growth in mid-market or micro captives that make an 831(b) election under federal tax law,” he said.