Ian-Edward Stafrace of Atlas Insurance PCC outlines what to consider beyond typical captive and protected cell domicile comparisons.

When comparing captive and cell domiciles, the academia, guides and articles often only scratch the surface of relevant features and characteristics. These can help shortlist options when there is a wide choice. However, some crucial aspects are often missed in the initial shortlisting and considerations.

In this article, we cover aspects and needs that can emerge in the setup journey or years later. These aspects include the:

• need for substance in the domicile;
• potential to write risks directly;
• flexibility to change and adapt;
• accounting standards and ease of group consolidation; and the
• changing expectations of stakeholders such as regulators, investors, customers and employees.

New pain points emerge over time, driven by changes in stakeholder expectations, mergers and acquisitions, or the organisation’s strategy, direction or risk financing needs.

Protected cells should be considered, even by large organisations with established captives. Cells are not just capital and cost-efficient solutions for organisations not large enough to have a standalone captive company. Organisations should delve deeper into the solutions some cell hosts can offer to address the above needs and pain points.

One should move beyond legislation and regulation to determine whether the domicile has host protected cell companies that:

• have significant substance with premises and people in the domicile;
• can cover risks directly in the territories in which the organisation is or may be active in future;
• cover risks inside rather than just outside the captive domicile;
• are long-established contributors to the domicile’s local economy;
• are not restricted to hosting fully funded cells and take an underwriting approach to assess the cells they host;
• have experience with cells writing direct third-party consumer insurance products;
• have non-cellular cores well capitalised beyond regulatory requirements; 
• can rapidly incubate or front risks through their non-cellular core; 
• are independent of international brokers.

Organisations are often unaware that there are protected cell companies with these features. Hence protected cell companies like Atlas provide solutions ordinarily not thought possible.

There are then the more traditional considerations typical in domicile comparisons, including capital requirements, regulatory fees, application timelines, legislation, reserving, supervision, reporting requirements and taxation.

The traditional considerations are relevant. However, focussing on these can cause organisations to miss out on the more financially and strategically impactful domicile features and service providers.

Changing stakeholder expectations

The choice of domicile, particularly onshore versus offshore, often also depends on stakeholders’ expectations, whether regulators, tax authorities, investors, customers or employees. 

With an increased focus on broader sustainability and ESG (environment, social and governance) considerations, captives and cells should be helping their parents enhance their reputation rather than cast doubts on their values and motivations.

Ireland, Luxembourg and Malta are EU member states that have tailored themselves to understand better and proportionally facilitate captives while adhering to EU minimum standards and requirements, including Solvency II and the Insurance Distribution Directive.

Malta is also the only EU member with protected cell legislation. Cells can be capital efficient, with Solvency II recognising cells as ring-fenced funds. 

Reinsurance cells do not need to be domiciled in the EU to cover EU risks. Offshore jurisdictions can offer lower capital and cost-base. However, growing stakeholder pressure has increased the interest in establishing reinsurance cells within the EU, including for organisations headquartered outside the EU like Switzerland.

Malta adopts the latest International Financial Reporting Standards (IFRS), including the new IFRS17. Whilst implementation may be challenging for standalone insurers and captives, PCCs help facilitate compliance as they implement it for their other cells, and in Atlas’ case, for its active core. Compliance with IFRS can help owners consolidate their cells in their groups with increased transparency to stakeholders.

Need for substance in the domicile

Stakeholders are raising the bar for captive substance. With their shared economies of scale, Maltese PCCs give confidence in being onshore in the EU, yet without a standalone company’s complexities, costs and time, potentially saving capital too.

Insurers are increasingly expected to have adequate on-the-ground staff and employed key function holders. PCCs can help address substance requirements as cells form part of a broader single entity that provides shared board, governance and key functions in Malta.

Some PCCs also actively write business through their core. Atlas’s core, for example, is a long-established contributor to its local economy as a traditional non-life domestic insurer with multiple branches and offices in Malta, naturally providing ample substance to the PCC.

PCCs that actively cover risks in their domicile also address arbitrage objections from stakeholders on insurance companies that only cover risks outside their domicile.

Potential to write risks directly

As the only EU member state with cell legislation, Maltese PCCs provide cells with direct access to the European Economic Area single market.

Following Brexit, some PCCs continue to provide access to the UK market. Atlas was one of the first PCCs to submit a branch application to the UK Prudential Regulation Authority. While the application is being processed, new UK business continues to be written under the UK Temporary Permissions Regime.

Fronting partners can provide added value and simplify compliance requirements. However, they can be increasingly selective. Fronters also add costs to the programme, affecting feasibility, especially when premiums are below their rising minimums.

EU direct writing cells are slightly more costly than pure reinsurance cells. However, the saving of fronting fees can make them more cost-effective, notably where local compliance and outsourcing needs in the country of risk are limited or are handled by intermediary subsidiaries of the cell owner.

Maltese PCCs with an active core can also rapidly front and incubate risks, giving more time to assess and set up a cell.

For example, a global captive manager had a client with a US captive who wished to set up a protected cell to cover its EU-based risks. As discussions progressed, it was clear in December that there would not be sufficient time to licence a cell for its 1 January renewal.

As Atlas was already passported to all the countries where the risks were situated for the required classes of insurance, it underwrote the renewal through its core, reinsuring back to the US captive. Atlas provided a quick solution within a couple of weeks during the holiday season whilst allowing much more time for the setup of a cell to be considered within the same PCC.

Flexibility to change and adapt

Many offshore domiciles are well suited for reinsurance captives and cells. They can have lighter regulatory environments, lower taxation and more rapid application and setup timelines. Some have introduced fast-track schemes promoting that they can pre-authorise captive insurance cells to be licenced within 48 hours. For many organisations, this fits their present needs very well.

Other jurisdictions provide a more rounded and robust environment catering for the possibility of consumer distribution or potential third-party protection. Solvency II and equivalent jurisdictions also help reduce the capital cost for insurers fronting unrated captives, which can help fee, collateral and capacity negotiations.

Most PCCs are owned by intermediaries or investors who restrict the cells they host to fully funded programmes with no theoretical risk gap or no potential secondary recourse to the non-cellular core. The cores of these PCCs tend to cover the absolute minimum capital needed for a core without any insurance activity.

There are then the exceptional PCCs with a broader appetite, experienced with writing consumer and third-party business across several countries. Their cores are inherently exposed to risk, so the extent of their resources and surplus capital beyond regulatory requirements becomes an essential factor to consider.

Such PCCs with active cores could be used to initially set up a reinsurance cell with the option to extend the cell’s licence to write third-party business eventually. 

With the pace of change continuously increasing, organisations appreciate the ability to adopt an agile, iterative approach to setting up their insurance vehicles with real options to scale and evolve.

Atlas hosts multiple insurtechs. Occasionally, startups with promising models do not have sufficient data or capital to set up a cell. They may have reinsurance lined up or wish to run a contained pilot to help them attract investors and better estimate projections.

Through its core, Atlas has assisted insurtech ventures in micro-testing parametric and other business models, for example, using blockchain smart contracts to automate underwriting and claims processes.

The non-cellular core can provide a sandbox facility that improves time-to-market and the gaining of actual market data. Business plans and projections can then be revised based on experience.

With these considerations, it should be clear that the organisation’s strategy and domicile choice can significantly be shaped not by the domiciles but by providers in those domiciles, particularly the well-resourced and experienced PCCs that foster sustainable innovation, delivering new solutions to emerging challenges. 

Article first appearing in Captive Insurance Times July 2022 Issue 245