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Segregated Portfolio Companies

Advantages Of Segregated Portfolio Companies

To a very large extent the benefits that may arise through owning a captive insurance company may be duplicated through a Cell Company structure. Some of these benefits can be summarized as follows:

• secure the profit on a program that would otherwise remain with the original carrier
• reduce frictional costs on a program leaving more of the original premium available for claims
• provide cover that might not otherwise be available
• ability to earn investment income on premium/reserves
• formalize deductibles and arrange buy back programs
• access to the reinsurance market where pricing may be less expensive.

Other benefits that may arise through using a Segregated Portfolio Company rather than having a captive could include:

• reduce time required to be devoted to corporate matters e.g. no directors meeting, etc.
• no set up costs
• immediacy of the facility (do not have to wait for incorporation and licensing of company)
• may require less direct cash commitment.

No mention has been made on the potential tax impact of such an arrangement since the circumstances will vary from one shareholder to another. It is always in the best interests of anyone considering purchasing Portfolio shares in a Cell Company to first seek legal advice which should include a review of the potential tax issues.

Ownership & Structure Applications

Upon receipt of a written request, the Company will forward to any potential participant a copy of the Private Placement Memorandum which will include as Exhibits.

• A copy of the Company's Memorandum and Articles of Association (its incorporation documents)
• A Subscription Agreement details the agreed purchase price of the redeemable portfolio shares of the specific portfolio as well as containing representations and warranties to be made by the proposed shareholder.
• A Shareholder Participation Agreement



Each portfolio shareholder is required to enter into a Portfolio Shareholder's Agreement. The agreement contains a number of provisions relating to the rights and obligations of each Portfolio Shareholder, including:

• Conditions under which shares can be redeemed
• The designation of Portfolio Program risks,
• The determination of when dividends may be paid to the Portfolio Shareholder,
• Whether and to what extent the Portfolio Shareholder will be required to indemnify the Company for greater than expected losses.
• A requirement to submit all disputes to arbitration in the jurisdiction of the Cell Company,

A Personal Questionnaire to be completed by the proposed shareholder and which, amongst other items, contains declarations by the proposed Shareholder as to his professional and personal standing.

Participant Information And Collateral

A potential shareholder participant will need to provide information on the nature of the business and the proposed structure of the insurance and/or reinsurance program in which the Company may become involved. This "Business Plan" will be reviewed by the Company's Underwriters who will comment on the structure. If acceptable a quotation will be prepared stating

• the cost of the Portfolio shares
• the cost of managing the Segregated Portfolio
• the nature and level of any additional security collateral required

Collateral will be required where there is a shortfall of assets relating to the attachment point of any aggregate Stop Loss reinsurance or aggregate limit. This collateral will be calculated for each year the risks are renewed and reinsured into the Portfolio. Consequently, depending on how soon any particular year can be closed out, collateral may have to be posted to cover many years at one time. This "cascading" effect should be taken into consideration before any commitments are made to ensure that the anticipated strain can be met. Collateral may be in the form of:

• Specific and/or Aggregate Excess protection
• A Surety Bond to back a Promissory Note
• A Letter of Credit
• An additional cash deposit
• or a combination of any of the above or other security acceptable to the Company

The cost of the shares, being a unit consisting of 1,000 shares, could be a nominal amount, usually between US$1,000 and US$10,000, but may be higher dependent upon the nature or structure of the program.



Start Up Fees

An up front fee is usually charged by the Company for:

• A feasibility study
• Drafting the participant's Business Plan
• Agreeing to the final terms of the reinsurance program
• Processing any regulatory filing associated with the participant.

This fee will be agreed between the parties prior to work commencing on the Business Plan.

Management And Other Fees

Management fees can be charged on a variety of basis according to what method appears most suitable in the circumstances. The cost may be based on;

• A percentage of the premium assumed by the Company; this percentage may range between 1%-5% depending on circumstances
• A percentage of assets; this method is more likely to apply in a run-off situation where little or no premium is being assumed and while there are sufficient assets available.
• A flat fee with an hourly charge component. This is more likely in cases of "run-off".
• In all cases a minimum fee will be applied.
• Remember, the fee also employs a component for the 'renting' of the facility.

The management fee will cover, all legal and regulatory fees imposed upon the Company with the exception of;

• The fee due under the Companies Law which relates to each Segregated Portfolio.
• Any incidental expenses directly attributable to the Segregated Portfolio (e.g. telephone, fax and photocopying)
• Travel and meeting expenses, if required by the Segregated Portfolio owners

The Company will be subject to an annual audit. At present the cost of the audit is absorbed by the Company but the nature and depth of the audit is changing. In the future it may be necessary to pass on part or all of the cost incurred in auditing a Portfolio to the specific Portfolio.



Reporting

Each participant will receive a quarterly report on the performance of their Portfolio and at the end of each year (which may be the calendar year, policy year or some other agreed period) a full accounting of the performance of their programme. A copy of the consolidated financial statements and auditors report will also be made available to each Portfolio shareholder.

The profits which may accumulate in a portfolio may only be paid out at the discretion of the directors. They may be paid by way of a shareholder dividend, or if the program has terminated and there are no outstanding liabilities, through the redemption of the Portfolio shares. The degree to which dividends will be paid will be dependent upon the nature of risks written (long-tail versus short-tail), the predictability of the claims and the general performance of the program over a period of time.

Upon the termination of all the programs/agreements that a portfolio shareholder (via the SPC) may have entered into and the payment of all liabilities, the shares may be redeemed and the residual net profit paid to the shareholder. Termination of liabilities may also be achieved through commutation of risk back to the reinsured or novation to another party.

How Does A Cell Company Work?

The practical manner in which a Segregated Portfolio operates is very similar to a standard captive insurance company. The major differences are:

• any policy issued by or reinsurance entered into by the Segregated Portfolio will identify that specific Portfolio as the part of the insurance or reinsurance;
• all the assets will be held in accounts identified as being part of that specific Portfolio;
• all liabilities will also be identified as being the responsibility of that specific Portfolio.

In other words, any activity that relates to a specific Portfolio should be identified as such.

In terms of the structure of an insurance or reinsurance program, the only difference from a normal captive program is the requirement for the Segregated Portfolio program to have a defined maximum exposure in order that the "gap" can be calculated and collateralized. While captives may be able to purchase Aggregate Stop Loss reinsurance they may decide not to and will base their premium on the ultimate loss pick for the business being written and rely on their capital and surplus to meet any adverse deviation.

There will also be different philosophies between captive owners and the directors of the Segregated Portfolio Company. Typically, the nature of the business to be written through a Segregated Portfolio will be short tail. The owners of the Segregated Portfolio Company will be reluctant to write business where the tail is extensive, and the owners of the Portfolio might find it difficult to meet the collateral requirements year after year if the underlying risks are long tail. The Segregated Portfolio concept is not, therefore, for everyone. What it does provide is an opportunity for those parties that do not wish to commit the time and money to establish their own captive to experience the benefits of a captive situation, and if the experience is good, to then set up their own captive and transfer their business out of the Segregated Portfolio Company. This "stepping stone" approach may be attractive in those situations where a feasibility study demonstrates the benefits of a captive but there is reluctance on the part of the potential principal to make the complete commitment.

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