Since the first protected cell company (PCC) legislation was introduced in Guernsey in 1997, this captive structure has quickly grown in popularity, with an estimated 41 domiciles playing host to cells today. And PCCs are expected to show even further growth, as new legislation widens their scope and flexibility, and as Europe’s new Solvency II regulation prompts some captive owners to reconsider their options.
Yet, in their relatively short 13-year lifespan, PCC legislation has never truly been tested in a court of law, which some experts see as a hindrance to the market going forward.
While all captives are relatively conservative when it comes to investing their assets, PCCs take this to the extreme, holding most of their funds in cash or cash equivalents. “The PCCs we rate end up being the pinnacle of conservatism,” AM Best vice-president Steven Chirico says.
“There have not been any good court cases that have tested the protected cell legislation that all these domiciles have. So there’s a bit of hesitation there – the permeability of those cell walls is on everyone’s mind. Until we get one really good court case to go through and see substantiation of those cell walls as impermeable, I don’t think you’ll see that changing.”
A PCC is a single legal entity made up of a core surrounded by any number of self-contained cells. While a parent company can own an entire PCC, using it to segregate different accounts, more commonly a sponsor sets up and manages the structure, leasing the individual cells to different companies.
The sponsor will provide funds for the core of the PCC, but each cell will also have its own capital and will operate as a separate ring-fenced account. In theory, its assets should be protected from the creditors of both the core and from the other cells.
To date, however, there has not been any major test to demonstrate whether each cell owner is indeed legally isolated, with its assets, liabilities and financial performance completely separate from all the other cells. Some fear that should one cell fall into difficulty and be unable to meet its obligations, it could pollute other cells in the structure, with the creditors of the struggling cell seizing funds from the others.
This is highly unlikely to occur in practice, provided the right policy documentation is in place, Kane consultant Clive James explains. “There are various types of PCCs and if you structure them correctly, including all of the necessary shareholder and management agreements, the possibility of one cell polluting another is highly unlikely. The only recourse is back to the core cell and new changes in legislation have restricted this considerably.”
If a situation was to arise where an attempt was made to take funds from other cells within a structure, both the sponsor and regulator should be able to step in to prevent this from occurring. “For certain domiciles, such as Guernsey, the regulator has powers to restrict the movement of money out of captives or individual cells,” James says.
Despite the lack of a major legal test of the PCC structure, there is a high degree of confidence in protected cells and time itself will provide a good track record, James believes. “To date, there’s no court of law that says this structure does work effectively. However, there has been 13 years of historical precedence. Also, with the concept having been introduced now in so many domiciles – including the USA, which is renowned for its litigious nature – I would say they are a well-recognised and robust structure.”
PCCs offer a number of advantages compared to traditional captives, including a speedier and more straightforward set-up, lower entry costs and greater flexibility. There are fewer demands on management, with no requirement for company finance directors or risk managers to regularly attend cell meetings.
In addition, they come with the usual tax advantages for captives, with the added incentive that, at present, they fall beneath the radar of new UK treasury rules that tax 100% of a captive’s profits.
The industry is clearly preparing for a proliferation of PCCs and incorporated cell companies (ICCs) in the future. PCCs differ from ICCs, though they follow a similar structure, in that each cell within an ICC is a legal entity.
Captive management groups such as Marsh and Aon have set up dedicated PCC managers – Mangrove Insurance Solutions and White Rock, respectively. White Rock is an established host to more than 60 cells and recently launched a facility in the Isle of Man. Among the key features it lists is a “worldwide acceptance” of PCCs and “strict controls to protect clients”.
Until a legal precedent has been set to test a PCC, sponsors of protected cells will need to invest more in reassuring their clients that their structures and agreements are watertight. “What we have tended to do as cell sponsor is periodically commission legal opinions from firms of lawyers, which explain to potential clients how the structure works, what the legislation is and why the lawyers believe it’s a robust structure,” Aon Global Risk Consulting’s head of risk finance, Charles Winter, explains.
The conservative funding of a PCC is also a necessary defence, although the means of achieving full funding can be flexible. “We would look for the cells to be fully funded for all foreseeable exposures,” Winter says. “Therefore, the chance of insolvency in any particular cell is low and that is not only for Aon’s protection as the core owner, but is also for the protection of every other cell in the structure.”
‘Me too’ jurisdictions
Forty-one domiciles have cell legislation in place, including Guernsey, the Isle of Man, Bermuda, the Cayman Islands and various US states, and others are joining the ranks. Newer forms of the legislation are also broadening the scope for PCCs; in Guernsey, legislation was updated in 2006 to create greater separation between the PCC core and its cells.
This is making them attractive to a wider number of organisations and industry sectors. But because of the requirement to be fully funded, PCCs remain better suited to short-tail business lines.
“One thing we’ve seen for quite a while is more ‘me too’ jurisdictions: the number of jurisdictions having PCC legislation,” Winter says. “The concept has certainly spread. But one of the issues, particularly looking at sponsored PCCs, is that the owners or sponsors are only going to want so many companies in existence. So despite the fact there is an abundance of jurisdictions enabling it, we might still see the growth in numbers of cells concentrated in the more mature domiciles.”
The introduction of the new Solvency II regime in Europe could play to the strengths of PCCs, as captives within the EU consider their options. While smaller captives will fall beneath the minimum size equirements of Solvency II, medium-sized captives could find themselves subject to a greater burden of compliance and higher capital requirements. The parent companies of these entities might feel they would be better served by licensing a cell or series of cells instead.
As a single legal entity, a PCC will only have to comply once with the new regulation. Therefore, this is not a requirement for each individual cell but for the structure as a whole.
As Winter explains: “If you’re gaining the benefit of a Solvency II-compliant structure, you could increase the interest of that not just to smaller companies but to companies that have a standalone captive in the EU yet are maybe not on such a scale that they’d want to go through their own Solvency II compliance process.”
As long as the legal structure of a PCC continues to stand up, these risk transfer vehicles are likely to continue to grow in popularity. GR