Assigning Financial Stability Ratings® To Protected Cell Captives

Captive insurance companies allow organizations to internally finance their risks, offering greater control over insurance programs, thus providing customization to meet specific needs or objectives. Captives typically provide cost-effective alternatives, such as centralized functions enhancing operational efficiency and flexibility in risk management decisions, allowing businesses to optimize coverage and increase their financial resilience.

Demotech recognizes certain unique attributes that apply to captive insurance companies, especially protected cell captives (PCCs) and other similarly structured segregated cell captives, such as series captive insurance companies, when reviewing these entities for the assignment of a rating. The review of PCCs involves an evaluation of traditional key rating factors, such as business model, business risk, financial metrics, reinsurance, and operational capabilities. However, due to the unique aspects of PCCs, Demotech’s review of PCCs also includes additional considerations related to the PCC’s domicile, regulatory compliance, legal structure, formation, and key agreements.

Jurisdiction
The regulations governing PCCs, particularly regarding the segregation of assets and liabilities between the core company (the protected cell company itself) and the individual cells, can vary significantly across different U.S. states and territories. Therefore, the PCC’s domicile is an important factor to consider when assigning a rating to a PCC.

Additionally, although most states have comprehensive regulations in place, these regulations can differ mainly in terms of operational requirements, regulatory oversight, and legal protections. Demotech’s review considers the statutes and regulations governing the formation and operation of PCCs in the PCC’s domicile, particularly to assess whether the segregated cells will be treated as separate entities for purposes of the insurance business conducted within each segregated cell.

Regulatory Compliance
Demotech considers whether the PCC and, to the extent necessary, the segregated cells hold the necessary regulatory licenses and approvals to conduct operations in accordance with an approved business plan and otherwise appear compliant with the laws of the PCC’s domicile, and, to the extent practicable, the laws of other jurisdictions in which risks are insured. Demotech may also consider pertinent legal or regulatory proceedings relating to the PCC. As part of the review, Demotech may request documentation related to the business plan of the PCC and its approval by the domestic regulator; documentation related to pertinent litigation or arbitration, or administrative, regulatory, or investigative proceedings of the PCC or any segregated cell; or copies of examination reports.

Legal Structure, Formation, and Key Agreements
Demotech considers the legal structure and formation of the PCC as it relates to the laws and regulations of the domicile. This may include a review of the articles of incorporation and bylaws, or equivalent documentation for a limited liability company, for the PCC and each segregated cell. This may also include a review of key agreements including, but not limited to, cell participation agreements, subscription agreements, shareholder agreements, surplus notes, parental guarantees, letters of credit, indemnification agreements, reinsurance agreements, collateral trust agreements, service provider contracts, collateralization agreements, and other key contracts. As part of its review of the operation of the PCC, Demotech may review governance policies and procedures, board and committee actions and meeting minutes, underwriting guidelines, and risk management policies and procedures. A particular focus of this review is clear delineation of the rights and responsibilities of participating parties, including the appropriate segregation of assets and liabilities, as well as the appropriate operation of the PCC generally to ensure financial stability. The assignment of a rating to a captive or PCC is not a legal opinion and must not be relied upon as an opinion of the compliance of an entity or cell with applicable laws or regulations.
Financial Review
Demotech’s review of a PCC includes an evaluation of key rating factors that impact traditional insurers, as described in this methodology, including capital adequacy, access to funding, reserve adequacy, operational capabilities, as well as the PCC’s management of expenses and the ability of the PCC to meet its business plan or stated financial targets. In addition, a key factor in reviewing PCCs is the appropriate separation of accounts. To the extent that a PCC may have reinsurance agreements, Demotech will consider the amount of reinsurance, retentions, and how the reinsurance is utilized to limit exposure and protect surplus. As part of its review, Demotech may request and review audited financial statements, regulatory examination reports, and other pertinent information.

Tax Compliance
Demotech may consider the tax status of the PCC but does not verify if PCCs or segregated cells are engaged in sufficient risk transfer and risk distribution for federal tax purposes. The assignment of a rating to a PCC or segregated cell is not a tax opinion and must not be relied upon as an opinion as to whether or not an entity or a cell is compliant with applicable tax laws or regulations.

Summary
As the format and function of PCCs vary across domicile and legal structure, our process begins with a review and evaluation of traditional rating factors and then incorporates additional considerations specific to the particular PCC and segregated cells being analyzed. While terminology and design of PCCs may differ by regulatory authority, our process allows us to understand the segregated structure, risk sharing, and regulatory compliance common to entities being reviewed.

As of Feb. 19, 2025, Demotech updated its Financial Stability Rating® (FSR) methodology to include specific information relating to the review and rating of protected cell captives. Our current FSR methodology is available on the Demotech website under the Regulatory section in Exhibit 2 of Form NRSRO.

For questions about the FSR process for PCCs, please contact Barry Koestler, chief ratings officer, bkoestler@demotech.com.

To discuss how to begin an engagement with Demotech or for pricing, please contact Joseph Petrelli, president, jpetrelli@demotech.com.

Barry Koestler directs the team, resources, and overall process of reviewing, rating, and issuing Financial Stability Ratings® (FSRs) for property & casualty (P&C) companies and title underwriters. He is recognized for his expertise in financial statement analysis, as evidenced by earning the Chartered Financial Analyst (CFA) designation in 2003. Under his leadership, his team has continued to refine their financial statement assessment capabilities and processes. In this regard, Koestler spearheaded the development of Demotech’s Company Classification System in 2007, which categorizes all P&C insurers into one of 11 categories based upon their business models.

As a resource to the industry, Koestler has applied his knowledge and experience in directing Demotech’s insurance industry data analysis projects and developing reports such as Serious About Solvency.

Koestler is a summa cum laude graduate of The Ohio State University, holding both a Bachelor of Science in business administration in finance and risk management & insurance and a Bachelor of Science in actuarial science and mathematics.