Tom Clark looks at issues surrounding healthcare captives, segregated portfolio companies and catastrophe bonds.
Alternative risk financing is widely used today and continues to develop. The Cayman captive insurance industry has seen many innovations over the past few years, as well as developments which simply reinforce traditional trade and business principles. This growth has introduced new issues to be addressed by the industry.
Cayman has dominated the healthcare captive scene. The risk financing and risk management innovations by healthcare organisations that own captives have proven invaluable. The unsung benefit of the captive concept is the focus on risk management.
Controllers of healthcare captives often include hospital administrators and finance executives, physicians and risk managers. In their day-to-day roles, these healthcare professionals address risk financing and risk management issues and, like workers everywhere, constantly juggle their attention between these and several other matters.
In their role as captive controllers, they meet in an offshore location with only risk and related matters on the agenda. These meetings are immensely valuable, albeit there is a steep learning curve in the early days of a captive, as healthcare providers address the financial aspects of risk management issues. As a captive matures, the feedback from the captive to the insured entity encourages further innovation in risk management.
Enormous savings can result for the healthcare organisations from harnessing funds that would otherwise depart the health system by way of commercial premiums. The patient also benefits, as healthcare providers have more funds and time to devote to their true area of expertise, the provision of healthcare.As the healthcare industry changes, opportunities for a captive expand. One area that has received significant attention is managed care. When parent corporations set up or acquire managed care organisations, they recognise new liability exposures and may add errors and omissions or other perceived liability coverages to the captive's medical, professional and general liability programme, at the primary and/or excess level, with or without reinsurance. The accountability for managing the patient's care leads to increased liability exposures, not only for physicians but for the corporate entity, the policy makers, the system designers, other employees and contracted parties.
Another side effect of managed care is that certain healthcare organisations contract with employers to provide medical benefits to the employer's workforce at a fixed cost. In addition to the types of liability mentioned above, these organisations open themselves to the financial risk of incorrect pricing and they may wish to purchase insurance protection. Some organisations conclude that their expertise is in healthcare and that these contracts bring them into a different realm, so they obtain stop loss protection. Getting it from their own captive ultimately retains these new risks within the corporate group. However, there is scope for captive participation. For example, a healthcare organisation can purchase stop loss protection commercially, with the captive taking a quota share reinsurance of the stop loss aggregate from the commercial carrier.
Traditionally, the healthcare organisations owning Cayman captives have been hospitals and healthcare systems, and groups of physicians, radiologists, anaesthesiologists and dentists have established captives in Cayman. Demographic trends in North America now mean that long-term care is receiving a lot of attention. Long-term care entities have both similar and different risks from hospitals and other healthcare systems. The captive concept is now of interest in the long-term care area, too, and Cayman, with its experience in the healthcare captive industry, is the natural home for long term care captives.Apart from these developments, many of the healthcare captives that originally covered professional and general liability have extended their programmes and expertise to other coverages, such as workers' compensation, with great success.
Segregated portfolio companies
Any form of self-insurance is a big step. Success is not guaranteed. Having the resources to self-insure and to pour into the development of risk management procedures is a pre-requisite. Yet offshore captive insurance is a known quantity and generates interest also for the smaller or more risk-adverse entity.It can be difficult for some entities to take this first step. Cayman Islands segregated portfolio companies (SPCs) allow low-risk participation in a vehicle that provides captive insurance benefits. The particular structure may call for non-voting equity participation, which will allow for return on investment by way of shareholder dividend, or may allow participation in underwriting profits and investment income by way of policyholder dividend, reduced premiums or profit commission.
The return may, instead, be left in the segregated portfolio until the participant disengages from the SPC, perhaps using the profits and experience earned to capitalise and run its own captive.
The SPC concept is not new. The innovation is legal separation of the assets and liabilities of one portfolio from another within a company. Innovation yet to come is the variations on a theme that this new company legislation will spawn.
Segregated portfolio companies already established, or being established, in Cayman are addressing a number of issues. For an existing captive, there is the question of whether to convert to an SPC or to set up a new SPC. To move existing business from the core company into a segregated portfolio requires agreement from all parties to that business - in other words, the shareholders, those (re)insured and those reinsuring.To leave the existing business in the core company may expose that business to liabilities flowing over from segregated portfolios into the general assets of the company, and this may not be acceptable to all parties.
Consideration must be given to how best to structure participation in a segregated portfolio, whether by shareholding or otherwise. It may be attractive to allow different avenues of participation. If shares are being issued, care must be taken to comply with securities legislation. The articles of association may require amendment to allow for different classes of shares with different rights attaching.
A participation agreement may be drawn up to address both returns to participants and exit arrangements. The company and the participant may have tax issues or legal issues to be addressed. Other than shareholders' rights, consideration may be given to participants' control requirements, for example, whether participation on the board of directors or investment committees is appropriate.
The legal separation afforded by Cayman SPCs might not conceivably find recognition in other jurisdictions. It may be advisable for contractual documents to reflect some form of limited recourse, by explicitly stating that the liability of a cell is limited to the assets of that cell.
The directors of an SPC have a duty to establish and maintain procedures designed to segregate, and keep segregated and identifiable, the assets of each portfolio. This also extends to the general assets of the company and, where relevant, to the appropriate apportioning or transfer of assets and liabilities. Transactions entered into by an SPC on behalf of a particular portfolio must be identified as such. There are situations whereby directors of an SPC can be held personally liable for the liabilities of the company and portfolios without indemnification by the company.
Segregation of assets and liabilities must be established from the outset and maintained. Physical, as opposed to book, segregation is recommended. How best to achieve this requires consideration. There is a growing belief that there can be no pooling of assets of segregated portfolios, which would result in the investment profile of an SPC being different from that of other insurance companies.
Cayman has already witnessed much interest in the SPC. Initially, this came from North American insurance companies or insurance agents. More recently, captives writing third party business see the SPC as a practical way to expand.
A great deal of discussion has taken place regarding the overlap between the insurance market and the capital market and vice versa, in particular the catastrophe bonds issued by special purpose Cayman Islands reinsurance companies. The myriad of contractual parties in these deals can make a simple series of transactions look terribly complex.
Cayman insurance regulators, managers and law firms have been responsive in understanding these securitised products. As well as being a successful captive domicile, Cayman is home to a large number of banks, trust companies and mutual funds and boasts its own stock exchange. The sophistication of the environment makes Cayman a natural home for these transactions. The expertise that has developed among Cayman service providers has given the Cayman Islands a significant advantage in addressing new issues arising out of this insurance market and capital market crossover. This has been demonstrated by the continuing choice of Cayman as the preferred domicile for this type of vehicle.
Cayman's regulatory environment is tried and tested. The management companies are experienced. Professional services, the infrastructure and communications are excellent. There are no exchange controls or corporate taxation. The island enjoys political stability, with a responsive and responsible government, and Caymanians enjoy social harmony. Cayman has a sound judicial system and legislative framework. Cayman is an attractive place, not just to visit, but in which to do business.
Cayman captives also benefit from the flexibility and accessibility that derive from the local style of regulatory and management environment. Numerous developments attest to that. Regulation is tailored to full disclosure of principals and ownership, integrity of business plan and financial projections, adequacy of capitalisation versus premiums and exposures, annual audits and certification of compliance with approved plans and the role of the insurance manager.This style of regulation and management allow the regulatory environment to be flexible. That is not to say there is less supervision than in other jurisdictions, but to say that the regulators do have the ability to be flexible. The regulators are also truly accessible and responsive.
Cayman has enjoyed a steady growth in captives and coped admirably with every development and innovation. The flexibility and accessibility come as a pleasant surprise to those who have experienced other captive environments. There is plenty of room for growth and a willingness to grow in Cayman's captive insurance industry.
Tom Clark is vice-chairman of the Cayman Insurance Managers' Association. He has spent the last 18 years in the Cayman Islands with insurance managers and the last 14 with HSBC Financial Services (Cayman) Limited. He has been heavily involved in the development and management of Cayman Islands special purpose insurance companies and related catastrophe bond issues.