Monday, July 10, 2006

Cell captives take off in South Africa
By: Hamish Jooste and Claire Tucker
Recently many companies have chosen to “self-insure” by owning a class of shares (or a “cell”) in special purpose vehicle insurance company (cell captives). This a fairly recent trend in South Africa, and while the legal framework in South Africa does not specifically cater for these structures, it is capable of supporting most of them.
The cell captive insurance concept is designed to bring free choice to the insured party allowing it to choose the most suitable cover to match its risk profile, and giving it the freedom to finance that risk utilising non-conventional, flexible and more profitable self-insurance style structures.
The legal, financial and operational relationships between cell owners and cell captives are usually set out in a “shareholders agreement” (although, legally speaking, this agreement cannot be classified as, nor treated as, a shareholders agreement at all). These relationships are often complex and should vary greatly from cell to cell in accordance with the risk profile of the cell owners.
However, a closer examination of the manner in which the cell captive concept is often implemented shows that choice is often not the outcome of this relationship.
§         Captive companies often create templates of shareholder agreements with a broad scope, attempting to cater, in this way, for the choice the insured party requires, rather than tailoring each agreement to the specific needs of the insured party. Ironically, the end result is that these agreements are not sufficiently adapted to suit the specific needs of the insured party. We have found that, a legal perspective, large portions of these shareholders agreements are often either void for vagueness or for uncertainty. 
§         Cell captives have a multitude of cell owners, and their articles of association apply to all owners. The articles of association often attempt to standardize the cells by stipulating standard terms and conditions which govern each cell. This prevents cell owners whose circumstances are different from the mold contemplated by the drafter from tailoring their cell to maximize returns.
§         The cell owner often assumes a high level involvement in the day-to-day business of the cell.  This role can bring the cell owner within the definition of an “intermediary” (or even in some cases, that of a short-term or long-term insurer) for the purposes of South Africa insurance legislation.  Many cell owners are not aware of this nor of the restrictions (such as limitations on remuneration) which the law imposes on intermediaries.  Furthermore all intermediaries are required to be registered with the Financial Services Board.
§         Despite industry claims that cells are “distinct, watertight and ring fenced legal and accounting entities”, cells are internal administrative and accounting concepts only and, as such, cells do not have separate legal personality.  A creditor of a cell captive company can look to the assets of all of the cells within the company, because there is no legal separation between the company and the cells.  The cell and the funds contained within may be lost if that the cell captive is wound up by a non-cell creditor of the cell captive.

Companies which seek the potentially lucrative returns of self-insurance should temper their enthusiasm for cell captives by being wary of the pitfalls outlined above, and legal advice should be sought in relation to all shareholder agreements presented to them for signing.
Given the growing number and popularity of cell captives in South Africa, statutory recognition and regulation of the cell captive concept is urgently required.  Legislation should provide for a firewall between the cells of each cell captive and should recognise each cell as having a separate legal personality.  It should also cater for the income tax relief which should flow from this separation.