Insurance Linked Securities regime – the detail

Out-Law Legal Update | 03 May 2017 | 12:40 pm | 6 min. read

LEGAL UPDATE: It was thought that the UK's Insurance Linked Securities (ILS) regime would be delayed because of the general election on 8 June, but reports have emerged that it may be approved before the UK parliament recess on 20 July. 

The UK government first announced its intention to develop a competitive corporate, tax and regulatory framework for ILS vehicles as part of the 2015 Budget. In March 2016, it consulted on its draft proposals for an ISPV regime overseen by the PRA. The November 2016 consultation provides the granular detail of that regime.

The new framework will bring into effect amendments to the Financial Services and Markets Act 2000 (Regulated Activities Order) to introduce a new regulated activity of insurance risk transformation. It will also bring into effect amendments to the Companies Act 2006 to introduce the Protected Cell Company (PCC) structure which will enable multi-arrangement insurance special purpose vehicles (mISPVs) to exist and carry out this new regulated insurance activity.

The PCC will have a core structure and a number of different cells for separate risk transfer contracts – assets and liabilities of the cells will be strictly segregated. Firms will have to apply to the Prudential Regulation Authority (PRA) as lead regulator for authorisation and can expect to wait up to six months for the process to be finalised although straightforward applications could be completed in six to eight weeks.

Consultations published by HM Treasury, the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA) last November outline what the regime will involve. Here are the most important features of the ILS regime.

Insurance Special Purpose Vehicles (ISPVs)

ISPVs are risk transfer vehicles through which insurance linked securities are issued from an insurer or reinsurer to the capital markets. They are often multi-arrangement (mISPVs) because although ISPVs can be created for the purpose of a single contract of risk transfer it has become common practice within the market for ISPVs to take on more than one contract for risk transfer, particularly for collaterised reinsurance. There are also significant administrative and time costs of having to set up a new vehicle for every new transaction.

The new Protected Cell Company (PCC)

UK companies legislation is expected to be amended to allow new protected cell companies (PCCs) to exist and operate in the UK. PCC will be a new corporate structure that will enable multi-arrangement insurance special purpose vehicles (mISPVs). ISPVs, created for the purpose of a single contract of risk transfer may use existing corporate structures.

The PCC will be a private company limited by shares. It will be able to issue equity and debt securities on behalf of its cells in order to fund the insurance risk that those cells takes on; however, those shares would be non-voting shares given the need for ISPVs to be operated "in a way which delivers reliable protection for cedants". The Financial Conduct Authority (FCA), rather than Companies House, will register new PCCs and store information on its website though Companies House will still record limited information.

The PCC itself enables mISPVs because its structure is made up of a 'core' and a number of individual 'cells' corresponding to the individual insurance risk transfer contracts. The PCC core only has an administrative function. There must be at least one cell on incorporation of the PCC however subsequent cells can be set up without any incorporation procedure. The FCA and PRA will need to be notified in advance however and a time period of at least 10 days will apply during which they can raise any objection. Assets and liabilities belonging to each individual cell, or risk transfer contract, will be carefully segregated from other cells so that the insolvency of one cell does not impact the solvency of remaining cells. Individual cells however will not have separate legal personality.

The new regulated activity of insurance risk transformation

Detailed draft regulations – The Risk Transformation Regulations 2017 – included with the government's November consultation create a new regulated activity of insurance risk transformation under reg.13A of the Financial Services and Markets Act 2000 (Regulated Activities Order). If the new ILS framework is enacted as planned those seeking to apply for authorisation will do so under this new regulated activity. The PRA will lead the authorisation process and FCA approval is required before finalisation. Alongside the government consultation, the PRA and FCA have also published detailed draft statements and guidance about the intended authorisation and supervisory process for ISPVs.

The authorisation process is likely to involve the completion of application forms for both the legal entity and for certain individuals occupying key senior roles. The PRA expects notification of at least three senior management roles: chief executive, chief finance officer and chairman. Requirements for authorisation are already detailed in Article 318 of the Solvency II Delegated Regulation as Solvency II had already created a bespoke authorisation process for special purpose vehicles.

One of the key requirements will be that the contractual arrangements in the special purpose vehicle will have to be consistent with Articles 319-321 of the Solvency II Delegated Regulation. These requirements relate to the SPV being fully funded; there being an effective transfer of risk and to the rights of the providers of debt or financing mechanisms. The PRA has said that it considers independent legal opinions may be a useful tool to use when applicants are considering how to demonstrate that the key contractual features of the transaction documents are consistent with these particular regulatory requirements.

Under the PRA's draft supervisory statement, mISPVs will have to fulfil an additional authorisation requirement of completing a business plan – called a Regulatory Business Plan (RBP) - with the following information:

  • maximum number of cells permitted;
  • maximum aggregate risk exposure;
  • classes of business;
  • nature and location of cedant;
  • loss trigger type;
  • method by which the requirement to be fully funded will be achieved at the outset and maintained;
  • eligible collateral criteria;
  • structure and key terms of the collateral and trustee arrangements; and
  • key clauses in the reinsurance or similar risk transfer agreement and shareholder/note purchase agreement which are needed to assess risk transfer - this may be by reference to a section of the application or a specific document.

The timing of authorisation

Parties seeking to be authorised can expect to wait up to six months for the process to be finalised according to the regulators. This timeframe could be reduced to six-eight weeks in circumstances where the application is relatively straightforward; the documentation is well-prepared; and there has been engagement with the regulators pre-application. The PRA will also have to be notified prior to the establishment of any new cells and firms will not be able to move forward until 10 working days have expired or until the PRA has confirmed its non-objection in writing. Commentators on the regulators' consultation have said that these timeframes do not support a competitive environment for the ILS market and may prove unduly burdensome therefore it remains to be seen whether any adjustment will be made in the finalised framework.

Governance of the PCC

As part of its November consultation, the government sought specific input on aspects of the governance of the PCC. These aspects in particular are not settled and include directors' duties; insolvency regime; reporting and accounts and audit requirements. On Directors' Duties, apart from an obligation to comply with the new Risk Transformation Regulations 2017, the government has not proposed any additional or different duties for the board of directors of a PCC. On the insolvency regime, the government has proposed dealing with individual cells of the PCC as separate legal entities for insolvency purposes in order to allow for their effective insolvency without affecting the remaining cells. On reporting and accounts, the government has asked if modifications to the Large and Medium-sized Companies and Groups Regulations 2008 are needed in order to make these applicable to PCCs and, under audit requirements, whether a reduced disclosure regime might be appropriate for PCCs. The government's final position on these aspects will only be known when the final regulations are published.


The Treasury intends to develop a bespoke tax regime for UK ILS activity, according to the consultation. This would include exempting the insurance risk transformation of ISPVs from corporation tax and a complete withholding tax exemption for foreign investors, while UK investors would be taxed as normal "according to their facts and circumstance". The government states that corporation tax and withholding tax exemptions are necessary for the UK to compete with the jurisdictions in which ISPVs are currently located.