Protected, or segregated, cell captives began life in the 1990s. Phil Zinkewicz describes the evolution of this popular solution for undesirable risks.
The captive insurance company concept has undergone several metamorphoses since the offshore movement really got going in the late 1970s. It went from single parent captives that insured only wholly-owned subsidiaries of the parent organisation to single parent captives writing third-party business.
From there, multiple parent captives, jointly owned by a group of companies or persons in the same industry came into being. These are also known as group or homogeneous captives. Then there are heterogeneous captives for companies of similar size but from varying industries, pooling their resources to form a joint-venture captive, also known as an association captive. For companies within the same industry that were not large enough to take advantage of forming their own captives, a "rent-a-captive" approach provided them an opportunity of obtaining the same benefits as owning a captive.
But in the late 1990s, a new concept was born in Guernsey called the segregated, or protected, cell captive, which provides that individual "cells" within the parent captive can enjoy legal insulation of assets and liabilities when another cell experiences losses or even bankruptcy. To date, legislation permitting segregated cell captives has been approved in all major captive domiciles. Moreover, the international business community has accepted the concept of segregated cells for insurance and risk management purposes.
Segregated cell captives started up as a way to isolate certain undesirable risks, that had to be included in the captive for political reasons, from other participants in the captive. For example if an association could not be left out of the captive, but was not a financially sound risk. In this case the risk would be placed into a segregated cell and then moved into the full group once it had improved its financial status.
In some ways this concept is fairly simple, much the same that a young, inexperienced driver in the US has to start out buying insurance in a state's assigned risk pool and is later able to move into the regular insurance market when the driver's experience warrants it. In the meantime, the member in the less than desirable cell had to be fully responsible for its own losses.
But the problem was that this didn't adhere to the insurance industry's concept of "spreading the risk". Dennis Silvia, president of Cedar Consulting, decided to take the segregated cell captive a step further. Says Silvia: "When you looked inside the segregated cell structure, you realised it was void of strategic functionality, despite its imposing facade. However, I became convinced that segregated cell captives could become imposing structures both inside and out."
The key was to approach the captive from a strategic standpoint and make it fit with the structure of the group that was going to use it. In other words, Silvia observed that every group has its own unique structure. He believes that the captive should be complementary to this uniqueness rather than trying to be all things to all members. For example, groups with different sized businesses might segregate the businesses according to comfortable retention levels, so that small businesses might choose to be in a cell with a self-insurance retention of $50,000, while larger companies might opt for $250,000. Jumbo accounts might want even higher retention levels.
The benefits, according to Silvia, are that the structure of the captive allows each cell to find a fronting carrier and reinsurer that have an appetite for the particular type of risk in the cell. "You can use different fronts for each cell," says Silvia, "so that you can better match the appetites of the front and reinsurer."
The next layer
Two years ago, Silvia's approach caught the attention of Sean and Chris Murray, founders of Caitlin-Morgan, a managing general agency based in Carmel, Indiana. Caitlin-Morgan had formed a healthcare risk retention group (RRG) - the Midwest Insurance Coalition Risk Retention Group - in Arizona, primarily for its nursing home clients in Indiana.
The RRG enjoyed a number of advantages that included isolating Indiana healthcare facilities from insurance rates that reflected less favourable loss conditions in other parts of the country; a strong risk management programme that helped to prevent losses as much as possible and mitigate losses that might occur; and utilisation of the Indiana Patients Compensation Fund to cap professional liability exposures. At the same time, it had also established a risk-purchasing group for all its members so that, in addition to accessing the RRG for those who qualified, the members also could gain the advantages of scale when accessing the traditional market.
The success of the RRG attracted other healthcare professionals from other states as Caitlin-Morgan began to expand its marketing reach, and the necessary homogeneity that was partially attributable to the favourable climate in Indiana resulted in some risks not fitting the criteria to be part of the RRG. At this point, the founders contacted Silvia. "In the case of Midwest Insurance Coalition, we had doctors and nursing homes as members," says Chris Murray. "Now, we found that there were fronting companies that would consider nursing home risks, but not physicians. And the opposite was also true. When we heard about Dennis' concept, we realised his was the perfect solution for our needs to provide additional coverages to members ... and also to provide coverage to members from other states."
The new captive will be based in Bermuda, to take advantage of the more flexible regulatory environment there. The company will be able to discount reserves and have better access to the reinsurance market in Bermuda. Initially, the captive will consist of two cells - one for nursing homes and one for Indiana physicians, although later on down the line there may be other cells for physicians from other states. One very large nursing home is considering going into its own cell so it can have a higher self-insured retention level. "As the captive develops and grows," Silvia said, "we anticipate adding a reinsurance 'supercell' where there is risk sharing at the top layers. We also plan on offering various excess layers from which cells can pick and choose."
Peeling off the segments
Both Silvia and Murray insist the "beauty" of the segregated cell programme is that it can create homogeneous cells even in a heterogeneous environment. In the construction industry, for example, the exposures found in the industry may be homogeneous to one sector, but within that sector there are framers, electricians, plumbers, contractors, etc. Different cells can be created within a captive, each cell accommodating a particular exposure, such as roofers or dry wall contractors. Each cell would pay its own level of premiums and sustain its own losses, without affecting the other cells. The same approach can also apply to other industries, such as transportation, with school buses, charter buses, air transportation, and so forth. The idea is to carve out the various risks associated within one industry, so that each segment operates independently. Segregated cells can be designed by industry, by line or even by geography.
Silvia adds that many reinsurers tend to shy away from association-type business, but that the segregated cell programme allows them to look at particular cells that they may deem potentially profitable. Concludes Murray: "Medical malpractice laws vary greatly by state, making the risk profile for doctors in different states quite unique. The segregated cell structure allows us to provide for these differences by providing higher excess layers to those doctors in states where that is needed and a variety of other options, including reinsurance, written either on a quota share or facultative basis."
Phil Zinkewicz is a freelance journalist.