Celling Solvency II to captives

The use of cellular structures is widespread across the Maltese insurance and funds industry. Malta has legislation in place that allows for the establishment of protected cell companies (PCCs) and incorporated cell companies in the insurance sector, and SICAVs (with sub-funds), incorporated cell companies and recognised incorporated cell companies in the funds industry. Consequently, Malta is an attractive domicile to those market players looking for alternative structures that best satisfy their business needs.

The introduction of PCC legislation has led to the establishment of 13 PCCs in Malta, with more than 20 protected cells being created over the last couple of years. Even though other jurisdictions have introduced similar PCC legislation, Malta has taken the concept a step further. Unlike other jurisdictions, a PCC structure in Malta may be used not only by insurers, reinsurers and captives, but also by insurance managers and brokers established on the island.

Malta is the only full EU member state that has legislation in place regulating the PCC structure, giving insurers the opportunity to create separate and segregated cells within a PCC while allowing them to write business directly throughout the EU by means of the single passport, and to reap the benefits of their business as if they were a separate legal entity.

Throughout the years the PCC structure has been used for many different types of insurance or reinsurance business models. These range from non-European insurers setting-up cells as fronting facilities in order to reduce their European economic area fronting costs, as well as organisations establishing a cell as a captive risk financing vehicle. Other types of businesses that have been adapted to the PCC structure include reinsurers and insurers setting up cells as reinsurance/retrocession facilities, as well as insurers creating cells for run-off business.

The advantages of the PCC structure become clearer once its commercial and legal nature is understood. In commercial terms, the PCC offers reinsurers and insurers the opportunity to write business while benefitting from the efficiencies of its structure. The unique and innovative nature of the company offers a flexible, feasible and cost-efficient structure that provides economies of scope and scale through the sharing of capital and costs (both set-up costs and ongoing), both to the owner of the PCC and all cell owners.

From a legal perspective, a PCC is seen as a single legal entity comprising within itself separate cells that constitute distinct and segregated patrimonies, which are ring-fenced from each other. The PCC enables the writing of business (or the provision of insurance brokerage or management services) through an individually allocated cell, which constitutes a distinct pool of assets and liabilities separate from the assets and liabilities of any other cell and from the non-cellular assets and liabilities (core) of the company.

Consequently, even though the PCC is considered to be one legal entity, creditors of one cell (or of the core) do not have a right of recourse to the assets of another cell. This concept ensures that assets belonging to a particular cell are protected from the claims or liabilities of any other cell or of the core of the PCC. Besides having a right of primary recourse to the assets of the cell with which the creditors transacted, such creditors also have a right of secondary recourse to the assets of the ‘core’, but only once all the assets of that particular cell have been exhausted.

Even though a cell does not have separate legal personality, each cell is treated as a separate entity for fiscal purposes as though each cell were an individual company. Furthermore, dividends can be declared and distributed by a particular cell, notwithstanding that the core or any other cells were not profitable in that same financial year.

In terms of Maltese solvency regulations, while every individual reinsurance and insurance undertaking is required to hold a minimum amount of capital (commonly referred to as the minimum guarantee fund or MGF), each cell within a PCC is not required to individually satisfy the MGF, as it is the PCC as a whole that is obliged to hold the required MGF.

The PCC offers both economies of scale and scope through the common management of the company, since all costs incurred for the management of the PCC (including those related to the core and to the cells) are shared by its owners and by the cell owners. This is a result of the common management and administration of the PCC, which is the sole responsibility of the board of directors sitting at the core.

The benefits of shared capital and common management of the PCC should become more relevant and evident once the Solvency II Directive is implemented. The implementation of the Solvency II regime will mark a radical overhaul to the regulatory landscape for the reinsurance and insurance industry, especially since the establishment of the three pillar system may lead to more onerous costs for captives and smaller mono-line insurers carrying on insurance business throughout the EU. Some of these smaller captives and mono-line insurers may be forced to sell, merge or close down their entities if they do not have the financial and operational resources to meet Solvency II requirements. The PCC will offer a viable alternative to these insurers that may otherwise struggle to comply with Solvency II requirements.

It is anticipated that once the Solvency II Directive is implemented, PCCs established in Malta will be categorised as ‘ring fenced funds’ (RFFs) as described in terms of the European Insurance and Occupational Pensions Authority’s Level 2 implementing measures. Such a categorisation should lead to substantially lower capital requirements for individual cells in terms of Pillar I of the same directive. In fact, while standalone insurers will be required to satisfy both the solvency capital requirement (SCR) and minimum capital requirement (MCR), cells will only be required to satisfy the SCR with no obligation for each individual cell to hold own funds to satisfy the MCR. Since the PCC is one single legal entity, it is the company as a whole (including the ‘core’ and all individual cells forming part of the PCC) that is required to satisfy the MCR.

Furthermore, where the PCC can demonstrate to the satisfaction of the Malta Financial Services Authority that there is diversification between cells and the ‘core’, then diversification effects may be considered in the calculation of the SCR.

In terms of the Level 2 implementing measures, where an individual cell does not have sufficient own funds to meet its own notional SCR, the deficit may be covered by the own funds outside of the cell, which could be transferred to meet the deficit. This would be an added benefit for the cell where the cell has secondary recourse to the ‘core’ (more so where a PCC has a capitalised core). The PCC could lend excess capital held in the core to the cell owner in order for the cell to satisfy its notional SCR.

Another key advantage offered by the PCC is that the share capital, share premium and retained earnings of the individual cell that are classified as own funds that are used to meet its own notional SCR could be included in Tier 1 eligible own funds for the calculation of the PCC’s SCR.

The PCC structure also offers economies of scale and scope in terms of Pillar II through the cost sharing that is present for all PCC and cell shareholders. Since the PCC is one single legal entity, the applicability of the system of governance provisions, the implementation of the key functions and the carrying out of the forward looking assessment of an undertaking’s own risks (ORSA) may be carried out by the PCC as a whole and not by each individual cell. Therefore, the PCC could generate one set of policies and procedures that would apply to all cells.

Furthermore, the PCC could implement one risk management, internal control, internal audit and actuarial function, which would be responsible for all cells forming part of the PCC. Additionally, the PCC would only be required to carry out one ORSA, as opposed to carrying out individual ORSAs in relation to each cell.

The increased costs that may arise as a result of the implementation of Pillar II will be mitigated through the PCC, since the structure leads to significant cost burden sharing while granting cells access to a common pool of knowledge and expertise within the common management system at the core of the PCC. Even though corporate procedures relating to each cell may not necessarily be identical, a common approach may be adopted by the board of the PCC that permeates the structure as a whole.

A similar approach can be taken in relation to the Pillar III reporting requirements, where most of the reporting is to be carried out by the PCC as a whole and not by each individual cell. The majority of the information, data, templates and documents that have to be submitted to the regulator (and public) may be done by the board of directors, who are responsible for compiling, verifying and submitting the same information to the regulator (and public). This results in a cost-effective structure that diminishes the burden on individual captives or small mono-line insurers writing business through a cell.

Malta already has several established PCCs that have the expertise, know-how and resources to offer and ‘rent’ individual cells to any small captives or mono-line insurers that are interested in taking advantage of the PCC structure.

However, the utilisation of PCCs does not only represent an attractive option for those small captives and mono-line insurers that are searching for alternatives come the implementation of Solvency II, but it also presents an opportunity for those industry players that have the insurance expertise and are willing to set-up their own PCC as a platform that offers the smaller captives and mono-line insurers with the possibility of establishing a cell. Industry players could set-up their own PCC structure and market the sale of individual cells to smaller captives and mono-line insurers, while generating revenue both from a cell facility fee charged for the establishment and ‘renting’ of the cell, and from any management fees that the PCC would charge individual cell owners for the management, running and administration of the cell (where management of the cell is not outsourced).

Malta’s legislative and regulatory set-up caters for the establishment of PCCs, whether through incorporation, conversion or redomiciliation, as well as through the creation of cells and the transfer of cellular assets from and to other PCCs. The PCC is being put forward as an advantageous alternative, offering a cost effective solution to the increased costs incurred as a result of the implementation of Solvency II, without sacrificing all of the benefits of enhanced corporate governance and a more risk-based approach under Solvency II.

The PCC may also represent an attractive opportunity for those market players that have the necessary insurance expertise to establish a PCC and are willing to offer it as a platform to those smaller captives and mono-line insurers that are interested in establishing a cell, in order for them to better meet their business needs and the present regulatory realities.


This article was published in Issue 28 of the Captive Insurance Times.