Cayman Islands: Segregated Portfolio Companies and Insurance

The Cayman Islands has continued to improve its position as a jurisdiction of choice for captive insurance companies. As at 31 October 2004, 671 insurance captives were licensed by the Cayman Islands Monetary Authority of which 50 were new licence grants in 2004. The numbers of new license grants are on the rise year on year.

It is one of several jurisdictions that provides for a "cellular" captive company (known as a segregated portfolio company or "SPC"). This brings the benefit of statutory segregation of assets and liabilities to insurance companies looking to introduce new lines of business within an existing insurer so as to ring-fence the performance of the separate business lines. Cayman’s captive insurance market continues to flourish and with the recent changes in the Law, the popularity of the SPC seems set to grow as the benefits afforded to the insurance sector have now become generally available.

An SPC is a single corporate legal entity with the benefit of statutory segregation of assets and liabilities between segregated portfolios established within the company. The assets and liabilities of each cell within one legal entity are legally separate and between which there is no joint liability. This allows one entity to cater for a number of insureds without the risk of cross liability.

When the SPC was first introduced in the Cayman Islands in 1998, the use of SPCs was restricted to licensed insurers. SPCs were utilised by insurers to segregate liabilities arising from different insureds or lines of business within a single company. The SPC structure allowed distinct businesses to be conducted within one company without the risk of losses in one area compromising the overall solvency of the company, its ability to continue in business and to meet its other obligations. The segregation also allowed insureds to better assess the risk profile of the insurer as they required only to review the business of the segregated portfolio through which they were to be insured and to ascertain the sufficiency of the reserves of such segregated portfolio with reference thereto as opposed to conducting an assessment based on the overall business and reserves of the company.

Advantages over traditional methods of creating legal divisions between asset pools (such as setting up underlying special purpose vehicles and negotiating limited recourse provisions with third parties) include greater legal certainty, reduced complexity and administrative cost savings

The SPC concept, under a variety of different names, is now familiar in offshore and some onshore jurisdictions.

Cayman Islands law provides that assets and liabilities of each segregated portfolio within an SPC are legally separate from those of the other segregated portfolios. Creditors of a segregated portfolio have recourse to the assets of the segregated portfolio and to any general assets of the company (being assets not comprised with any segregated portfolio) to the extent that the segregated portfolio assets attributable to such portfolio are insufficient and the segregated portfolio general assets exceed any minimum capital amounts required by any regulatory body in the Cayman Islands (so as to allow the continued operation of the company).

The law also allows the company to completely remove the recourse of creditors of segregated portfolios to the general assets of the company. With insurance structures it is sometimes preferred that creditors have the ability to make a claim against the general assets so as to establish a degree of risk sharing, hence the ability to completely "protect" the general assets is optional.

In common with other Cayman Islands companies, an SPC will be constituted by its memorandum of association which will be supplemented by articles of association which set forth specific regulations concerning the operation of the company and the rights of shareholders to govern the operation of the company (these are akin to the charter and bylaws of a US corporation).

Shares can be issued with rights related to specific segregated portfolios but it is not necessary that shares be issued in respect of segregated portfolios and third party participants who prefer, for tax reasons or otherwise, not to have a direct shareholding in the company can participate in the business of a segregated portfolio on a purely contractual basis.

The segregated portfolios all reside within a single legal entity and to preserve clarity, it is a statutory duty of directors of an SPC to ensure that where a contract is to be binding on a particular portfolio, such contract must be executed in the name of or on account of such portfolio.

Application to place an SPC into receivership can be made by:

• the SPC itself,

• its directors,

• any creditor of a specific segregated portfolio,

• the holder of any segregated portfolio shares, or

• CIMA (if it is regulated by CIMA - for example a licensed insurer).

If the Grand Court of the Cayman Islands (the "Grand Court") is satisfied that:

• the assets attributable to any particular segregated portfolio are or are likely to be insufficient to discharge the claims of the creditors of that segregated portfolio; or

• there is a desire for there to be an orderly winding down of the business attributable to the specific segregated portfolio and it is proposed to distribute those assets to those entitled to have recourse to the segregated portfolio,

the Grand Court may make a receivership order and appoint a receiver over that segregated portfolio’s assets.

The receiver is deemed to be the agent of the SPC and does not incur personal liability unless he is fraudulent, reckless, negligent or he acts in bad faith. The making of a receivership order by the Grand Court creates a stay of proceedings against the SPC in relation to the segregated portfolio in respect of which the receivership order is made. This will not however prevent a secured creditor from enforcing its security against the relevant segregated portfolio. Once a receivership order has been made, the powers of the SPC’s directors cease in respect of the business of or attributable to the specific segregated portfolio’s assets.

The court cannot make a receivership order if the SPC is in liquidation and any receivership order made ceases to be of effect upon the commencement of any liquidation of the SPC. An SPC may not commence a voluntary winding up without the prior leave of the Grand Court if any of its segregated portfolios are the subject of a receivership order. The remuneration and expenses of a receiver are met from the assets of the specific segregated portfolio in respect of which the receiver was appointed in priority to all other claims.

An SPC may be wound up or liquidated in the same manner as any other company incorporated under the Companies Law save that a voluntary winding up requires the leave of the Grand Court if a segregated portfolio is in receivership. However, any liquidator appointed must continue to maintain procedures to segregate and keep segregated particular portfolio assets from other portfolio assets and the general assets of the SPC. Further, he must only discharge specific segregated portfolio creditors’ claims from the assets of the specific segregated portfolio. If the creditor has only a claim against the general assets of the company (i.e. assets that are not part of a segregated portfolio) the Company must pay that general creditor only out of the general assets.

The concept of statutory segregation of accounts is now well developed and recognised in many other jurisdictions including Delaware, Guernsey and Bermuda.

It may be prudent to seek legal advice where assets of a segregated portfolio are located in a jurisdiction that does not recognise the SPC concept, especially in relation to insolvency issues. To reinforce the legal position in such circumstances, it is advisable that Cayman Islands Law be selected to govern contracts to which an SPC is a party and to ensure that such contracts provide that the Cayman Islands courts shall have jurisdiction to determine any disputes.

The SPC is a useful vehicle not just for the insurance sector but also in other areas including mutual funds, multiple tranche debt issue vehicles, property development companies, ship or other fleet owning companies, securitisation and derivative transactions.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.