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In our summer briefing we discussed global credit ratings agency AM Best's proposal to overhaul how it rates cell company structures, including segregated portfolio companies (SPCs) (see here for our previous article on the proposals). The proposals signalled a move away from a single "protected cell company" label for all cell companies and SPCs in favour of more granular classifications and the potential for direct ratings at the cell level for incorporated cells. AM Best has now published its final updated criteria, which we consider here.
What changes has AM Best implemented?
AM Best has adopted the core structural changes previewed in the consultation. First, the blanket "protected cell company" terminology has been replaced with three defined framework terms: (1) "unincorporated cell company" where only the unincorporated cell company is an incorporated legal entity, and the individual unincorporated cells may not be considered separate legal entities, as is the case with a typical SPC structure; (2) "incorporated cell company" composed of individual cells, each of which is a separate incorporated legal entity (as would appear to apply to an SPC which writes all its business in portfolio insurance companies, which are separate legal entities and the Cayman Islands equivalent of an incorporated cell) and (3) "mixed cell company" comprised of both cells that are unincorporated and incorporated legal entities (which would appear to apply to SPCs which write business in a mixture of segregated portfolios and portfolio insurance companies). These terms recognise the legal and operational diversity that has evolved across domiciles.
Second, AM Best has confirmed a direct rating pathway for incorporated cells. For an incorporated cell company (as well as the incorporated cells within a mixed cell company) AM Best may assign Issuer Credit Ratings and Financial Strength Ratings to individual incorporated cells, applying its building-block methodology to each cell on a standalone basis. For an unincorporated cell company, by contrast, only the core entity is rated, with the rating informed by an evaluation of each unincorporated cell and capped by the creditworthiness of the weakest cell / segregated portfolio (described as the "weakest link" approach). This maintains the "weakest link" logic of the previous rating criteria for unincorporated structures where policies are issued by the core and cells / segregated portfolios are not separate legal entities.
Third, AM Best has clarified how the standard building blocks of its overarching credit rating methodology (i.e. balance sheet strength, operating performance, business profile, and enterprise risk management) apply to cell companies and SPCs. The final criteria confirm that when applying ratings, AM Best will focus on the availability of quality data at the cell / segregated portfolio level, consideration of regulatory and legal frameworks underpinning segregation, and a close review of intra-group agreements such as capital maintenance and pooling arrangements.
Key differences from the proposal
While directionally consistent with the proposals, the final criteria introduce some notable refinements:
- Notching below the weakest link for unincorporated cell companies: AM Best now states that as the number of unincorporated cells grows, default and operational risks increase, and it may notch the unincorporated cell company's rating at least one level below the weakest cell. This is new relative to the proposal and creates a clear incentive to manage complexity, concentration and governance across the cell suite. AM Best also outlines conditions under which notching may not apply, including when cell credit profiles are broadly in the "aa-" range, when additional reinsurance, pooling or capital support is available, or when capitalisation and business profiles are generally uniform across the cells.
- Treatment of affiliated structures: The final criteria explicitly contemplate consolidated treatment for cell companies where an insurance group establishes its own cell company that is effectively operated akin to a conventional insurer with equal support across cells. Similarly, the final criteria confirms that a non-insurance organisation establishing a cell company that divides affiliated risks into cells may be treated for ratings purposes as a pure captive insurer on a single entity basis. This potential for a single-entity approach was not expressly developed in the proposals and could be beneficial for corporate groups using SPC platforms for risk segmentation.
- Enhanced legal and data expectations: AM Best details the documents it may require for cell ratings (business plans, formation documents, audited financials, subscription and shareholder agreements, capital maintenance and pooling agreements and details of gross and probable maximum losses per cell / segregated portfolio). The criteria also confirm AM Best's focus on jurisdictional legal reviews, including precedents on the sanctity of cell segregation, bankruptcy and dissolution mechanics, and inter-cell interactions in mixed cell companies.
- Structured finance limitation: AM Best clarifies that where either unincorporated or incorporated cells / segregated portfolios issue structured finance instruments (which are broadly defined to include catastrophe bonds), it will not assign a financial strength rating to those issuers, a constraint that was not highlighted in the original proposals.
Implications for SPCs and Cayman structures
As previously highlighted, for Cayman SPCs with portfolio insurance companies that are separate legal entities the new framework aligns these portfolio insurance companies with incorporated cells, creating a viable pathway to direct ratings at the portfolio insurance company level. This should facilitate more targeted capital, reinsurance and counterparty discussions for sophisticated programs.
For SPCs operating solely through unincorporated segregated portfolios, the weakest-link approach remains the applicable framework for rating criteria, now with the added consideration that proliferation of portfolios may attract notching unless the SPC maintains a rating of at least "aa-" or has additional mitigants are in place.
Across the board, insurers that operate SPCs should expect deeper scrutiny of cell-level capitalisation, risk transfer, and governance, and should ensure robust documentation of capital support mechanisms, clean delineations of assets and liabilities, and credible enterprise risk management processes tailored to each segregated portfolio's risk profile. Given that the segregation principle has been legally tested and reinforced through a number of cases within the rigorous process of the Cayman Islands' judicial system, the increased prominence of legally tested precedent in AM Best's assessment, should present an advantage to insurers operating SPCs in the Cayman Islands that are seeking an AM Best rating.
Overall, AM Best's final criteria largely deliver a more nuanced, architecture-aware approach that rewards legal separation and disciplined governance. The refinements also provide more detail and clarity on specific factors in the rating criteria, supporting the evolution and international recognition of the SPC structure.
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