Most of this ground-breaking occurred in Bermuda, which through marketing efforts helped to create a market in the United States.

The result was a “rent-a-captive”a Bermuda-based company actually owns the registered trademarkthat allowed owners to capture the benefits of a traditional captive but without the capital or the duty of administration.

But while rent-a-captives did indeed provide accessibility and benefits to their owners, especially in the form of producing the possibility of an underwriting and investment income, some programs exposed them to third-party creditors of others in the same rent-a-captive, despite the contractual segregation of accounts or cells.

In response to this exposure, Guernsey, Europes top captive domicile, introduced legislation in 1997 to legally separate the liabilities of one cell owner from that of another. These are called “Protected Cell Companies” in Guernsey. Similar legislation was passed in Cayman in 1998, called a “segregated portfolio company” and in Bermuda in 2000, called a “separate accounts company” or “private act company.”

Several U.S. domiciles have also enacted similar legislation, including Vermont, South Carolina, Hawaii and New York.

Protected cell companies, commonly called PCCs, are the actual sponsors of the captive in which one or more segregated cells can be used by various owners. The PCC is a corporate entity started with a minimum of capital, called the “core,” which may or may not be exposed if one of its cells is liable to third-party claims and does not have sufficient means to pay off its debt.

While the intention of the segregated cell is to “wall off” the assets of other cells from creditors, in some domiciles the PCCs core capital may be at risk if one of its cells cannot pay off its creditors. This is assuming that the sponsors core capital has not been used to enter into a risk-sharing agreement with an individual cell.

In Guernsey, the first to pass such specialized legislation, the PCCs core capital is completely at risk following the liquidation of an individual cell. Thus, for very good reason, the sponsors of the PCC will be very cautious with whom they do business.

Part of that caution will require the individual cell to have access to a sufficient amount of cash to pay off liabilities, a larger than perhaps needed surplus, a smart business plan and the individual cell will be subject to auditing.

In reality, this puts the measure of safety on the PCC sponsors. For if the PCC ceases to exist, then the individual cell owners will have to find another PCC, perhaps in another domicile.

Under Bermuda legislation, the sponsors core capital is generally not at risk following the liquidation of an individual cell. This may or may not lead the owners of the captive to be as conservative in their cell owners surplus conditions.

Caymans legislation calls for the core capital to be exposed to third-party creditors but only to the extent that the cell being settled has surplus assets.

There is an intensifying competition between offshore and U.S. domiciles in the trend to use PCCs and in the fees that are needed to manage them.

In the United States, some legislation passed in individual states may or may not use any of the above examples as a basis for protecting the core capital, and thus preserving the sponsor of the PCC from folding.

As part of a feasibility study, in fact, its best to thoroughly review the prevailing regulatory and statutory issues in your domicile of choice.

Each domicile must be evaluated accordingly in its statutory treatment of PCCs and while the use of PCCs is increasing, there are still some traditional captives that do not use specialized legislation to segregate individual cells. Some of these captives use “contractual cells,” which basically insure not only their own accounts, but by means of a shareholders agreement, third-party business as well.

Contractual cells can realize a better position in terms of tax deductibility of their premiums because they can be actual risk transfer programs, which satisfy certain Internal Revenue Service guidelines as to deductibility issues.

Though at this point the IRS has not ruled on its position, some PCCs, on the other hand, may only be functioning as supporting the risks of a single entity, and portions of the their premiums may not qualify under IRS guidelines for deductibility under the definition of “risk shifting.”

A possible solution to the single entity PCC is to enter into a risk-sharing agreement with the PCCs sponsor and its core capital.

The use of protected cells is growing dramatically. In 2002 in Guernsey alone there were seven new PCCs and 43 new cell owners, giving the domicile more than 200 cells.

As of March 31, the Cayman Islands Monetary Authority reported on its Web site 65 segregated portfolio companies. This represents 11 percent of the entire captive market in Cayman, with assets of more than $380 million.

It would not be unrealistic to guess that more than 1,000 of these cells would be operating worldwide by 2005.

Originally PCCs were used to foster an increase in the use of rent-a-captives though other uses are constantly explored.

Another use that is rapidly being developed is combining the technology of another type of specialized type of captive, the Special Purpose Vehicle, through the use of a PCC. These are called “transformers” and could be used to manifest risk transfer programs out of a combination of banking and insurance products.

Despite the sophistication of PCC technology, it appears that middle market clients, agency owners and insurance companies wishing to provide opportunities to their clients are mostly using segregated cells.

As the hard market begins its inevitable wane, so, too, may the interest in relying on the insurance industrys cyclical nature.

Judging by the increasing use and acceptance of alternative risk, especially with protected cells and their accessibility, policyholders increasingly have more choices for managing their risk.

Christopher L. Kramer is vice president, alternative risk management for Neace Lukens in Beachwood, Ohio.

Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, May 26, 2003. Copyright 2003 by The National Underwriter Company in the serial publication. All rights reserved. Copyright in this article as an independent work may be held by the author.