12 May 2021 by and Insurance Alert

Cell captive insurers: The insurance of first party vs third party risks in cell structures

In our pilot article “When being ‘captured’ is not a dirty wordpublished in March 2020, we briefly touched on the regulatory landscape relating to the conduct of insurance business by cell captives, particularly the extent of compliance by cell captive insurers with the Insurance Act, 2017 (Insurance Act), which ushered in the codified regulation of cell structures.

The two-year transitional period contemplated in the Insurance Act has since come and gone and in the absence of any extension to such two-year period, all cell captives ought to be compliant with the provisions of the Insurance Act. Well, at least that is the theory. Cell captives had a fair amount of corrective actions to perform to get their houses in order. This ranged from updating contractual arrangements to ensure proper ringfencing of the different cells, to limiting the insurance business placed through the cell to either first party or third-party cell insurance business. This latter aspect is of particular significance given that in certain instances cell captives would have been required to split their relevant insurance business between two different cells.

Striking a balance between regulation to attain financial stability and leaving enough room for business to thrive, is a fine art. We have come across a few matters where that balance may not have been achieved, at least not practically speaking. One of these relates to the aforesaid change in how cell captive insurers are to deal with cell owner self-insurance. The Insurance Act introduces restrictions on the risks which cell captives are permitted to insure through a cell: The Insurance Act provides inter alia that cell captives may not insure first party risks and third-party risks in the same cell structure.  

First party risks in relation to a cell captive insurer are the operational risks of a cell owner and the operational risks of:

  1. the group of companies of which the cell owner is a part;
  2. any associate of a company that is part of the group of companies referred to in paragraph (a) above; or
  3. any joint arrangement that a company which is part of the group of companies referred to in paragraph (a) participates in.

In simpler terms, a first party cell structure in relation to a cell captive insurer is used where a cell owner wishes to insure its own operational risks, whereas a third party cell structure in relation to a cell captive insurer is used in instances where an owner of a cell captive insurer cell structure wishes to insure the risks of “third parties,” such as a portfolio of its customers. Historically, cell captive insurers treated all insurance business placed through a cell, other than cell-insurer-self-insurance business, as third-party insurance business. It can no longer do so without regulatory intervention, notwithstanding the adverse commercial implications this may hold. 

With the legal codification of the “rules” applicable to the insurance of first party risks vs third party risks in relation to cell structures being a recent phenomenon, an assessment of the level of compliance with this rule may yet reveal that this blanket rule has unintended adverse consequences. It should not come as a surprise if such assessment concludes that the costs of compliance are not always commensurate to the benefits realisable through this blanket rule. Such an assessment may conclude that the need exists for certain legitimate exceptions to operate in relation to the blanket rule. One such exception may entail an allowance for a third-party cell captive insurer to be able to place a limited percentage of cell-owner-self-insurance business through the same cell. It seems nonsensical to force a cell owner whose primary business entails the placement of third-party insurance business to operate an additional cell simply to self-insure its own risks where such risks are also the subject matter of a reinsurance arrangement. 

However, until those exceptions are promulgated, we suggest that cell captive insurers ensure that they, as well as their cell owners, align their interpretation concerning what would constitute first party insurance business vs third party insurance business to a legal interpretation that is defensible in terms of the Insurance Act to ensure compliance with the applicable provisions of the Insurance Act.

download PDF

The information and material published on this website is provided for general purposes only and does not constitute legal advice.

We make every effort to ensure that the content is updated regularly and to offer the most current and accurate information. Please consult one of our lawyers on any specific legal problem or matter.

We accept no responsibility for any loss or damage, whether direct or consequential, which may arise from reliance on the information contained in these pages.

Please refer to the full terms and conditions on the website.

Copyright © 2021 Cliffe Dekker Hofmeyr. All rights reserved. For permission to reproduce an article or publication, please contact us cliffedekkerhofmeyr@cdhlegal.com

You may also be interested in