At the end of July 2020, the Financial Sector Conduct Authority ("FSCA") published a draft conduct standard that will regulate cell captive insurers operating cell structures insuring against third party risks. The draft can be found here. The draft follows a long policy-making process. The period for comments to the FSCA closes on 22 September 2020.

What are third party cell captives?

As set out in the Insurance Act, 2017, a "cell captive insurer" is an insurer that only conducts insurance business through cell structures. In short, a cell structure is an arrangement under which a person (the cell owner) holds an equity participation in an insurer that entitles the cell owner to share in the profits and losses linked to specific insurance business placed or insured by the cell owner with the insurer (and that is contractually ring-fenced from the other insurance business of that insurer). Such cell structures can relate to "first party risks" or "third party risks". Somewhat simplified, first party risks relate to the operational risks of the cell owner or that of the group of companies of which it is part (or any associate or joint arrangement of such group). Third party risks relate to the operational risks of other persons.

For example: the owner of a widget store enters into an arrangement with an insurer in terms of which the owner of the widget store subscribes for preference shares in the insurer. At the same time, the widget store owner procures that insurance against the theft of widgets is sold to widget-buyers in the store. The dividends earned by the storeowner on the preference shares will depend on the underwriting profitability of the insurance sold to its customers.

Why the need to regulate?

The FSCA has published a long list of policy concerns to address the regulator's perceived market conduct risks pertaining to cell captive arrangements. Broadly speaking, it is concerned that cell captive insurers have not done enough historically to ensure fair outcomes for customers and that structural conflicts of interest may result in mis-selling, biased decision-making relating to claims and inappropriate business structuring.

What are the key regulatory changes the draft conduct standard will bring about if finalised?

The draft conduct standard puts duties and restrictions on cell captive insurers:

  • The cell captive insurer must, before establishing a cell structure with a particular cell owner, conduct a comprehensive due diligence in respect of the proposed cell owner and the proposed cell structure, essentially considering whether the proposed arrangements will comply with the regulatory requirements and are likely to have the outcomes desired in the "treating customers fairly" programme. Examples of this are that the cell owner must have the systems and processes to support the insurer in complying with the protection of personal information rules, that the cell owner has the financial and operational ability to comply with regulatory reporting requirements (including conduct of business returns) and that the cell structure will result in insurance products that are suitable to the particular policyholders and have fair premiums and claims ratios.
  • The cell captive insurer must also, on an ongoing basis, "ensure" and "be able to demonstrate" that the cell owner and the cell structure continue to meet such requirements and outcomes.
  • The cell captive insurer must keep a central register of all complaints and ensure that the complaints process allows for direct escalation of a complaint to it.
  • The cell captive insurer must inform potential policyholders of its relationship with the cell owner, the equity participation arrangements in place and any other remuneration, fees and charges payable by the cell captive insurer to the cell owner or its associate (and any changes to these during the life of the policy).
  • The cell captive insurer must comply with prior notification requirements, in terms of which the FSCA must be notified of certain prescribed details before the entry into or termination of a cell structure.
  • If the cell owner or any associate of the cell owner is appointed by the cell captive insurer under a binder agreement as a "non-mandated intermediary" ("NMI") of the cell captive insurer, then such appointment may only be made if
    • the cell owner or NMI will render "services as an intermediary" only in respect of the cell structures of that cell owner;
    • the cell owner or NMI will not have multiple cell structures in any one of the life, non-life or micro insurance business categories; and
    • the NMI is an authorised financial services provider. Accordingly, cell owners and associated NMIs will be limited to acting as tied agents of only one cell captive insurer in each insurance category.
  • A cell captive insurer must comply with the requirements of the draft conduct standard from the date of its publication as a conduct standard and will have two years from the commencement date to ensure that previous arrangements become compliant.

The draft conduct standard, once finally published, will be called "Requirements relating to Third Party Cell Captive Insurance Business, 2020".

Any concerns?

We have identified a number of drafting-related concerns in the draft conduct standard, especially in connection with the purported restrictions in respect of NMIs. In addition, it is not clear to us how the prescription of tied arrangements for NMIs will address the various policy concerns highlighted by the FSCA.

With respect to the transitional arrangements, it is not clear what exactly a cell captive insurer must do to ensure that historic cell structures are compliant.

There is no doubt that if finalised in its current form, cell captive insurers will have to bear greater regulatory responsibility for the operation of their cell structures. Whilst there can be no principled objection to such change, it does create a number of practical issues which cell captive insurers will have to address on a day-to-day basis, in addition to re-working their contractual arrangements to ensure that they comply with the new regulatory framework.

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