In September 2020, the South African Financial Services Conduct Authority (FSCA) published the draft conduct standard for third-party cell captives for public comment.

The issuance of the draft conduct standard represents the culmination of a long regulatory journey for cell captives in South Africa, first via licence conditions placed on cell captive insurers under the ruling insurance legislation, followed by a consultative process lasting several years to formalise the provisions for cell captive insurance.

“Despite a strong rationale put forward by the regulators for the standard, it seems that the devil will lie in the details.”

With the passing of the new Insurance Act in 2018, the definition of cell captive insurers, cell structures, first-party and third-party risks were formalised in legislation. This paved the way for, first, prudential standards and, most recently, the (draft) conduct standards.

Thus the framework developed organically, through a consultative process, rather than through the issuance upfront of dedicated, standalone regulation.

Not limiting the playing field

The draft conduct standard reflects the regulator’s ongoing attempt to fulfil consumer protection objectives while facilitating market participation. It represents a departure from earlier regulatory proposals which would have overly narrowed down the playing field.

As highlighted in our 2018 analysis of third-party paper typer, cell captives are a powerful vehicle in diversifying participation in the insurance market, but only if who may be a cell owner and what products they may provide are not too narrowly defined. Earlier regulatory proposals would have restricted ownership of third-party cells to affinities and limited the range of products to be sold to those with a direct link to the underlying business of the cell owner.

The latter provision would have prevented, for example, a clothing retailer cell owner selling funeral insurance – the largest demanded retail product in South Africa – something retailers in the country have already started to do. In broadening the playing field, the regulator is showing its willingness to foster retail innovation and access to insurance in the market.

Protecting consumers against conflicts of interest

The draft conduct standard specifically deals with a long-standing market conduct concern for the regulator, namely the inherent potential for conflict of interest between the duty of an intermediary, where the intermediary is a cell owner or an associate of the cell owner, to act in the best interest of the client and the financial incentives that the cell captive presents.

As such, the draft conduct standard holds that cell owners marketing policies to the public (termed non-mandated intermediaries), whether directly or through associated entities, will not be entitled to have a cell with more than one life cell captive insurer and one non-life cell captive insurer and shall be restricted to rendering intermediary services (including advice) only in respect of policies underwritten in such cells. Therefore, the non-mandated intermediary must be a tied agent of not more than one life cell captive insurer and one non-life cell captive insurer.

Likely industry push-back

A number of industry players are likely to push back against this requirement. Current practice is often for cell owners to have cells with more than one insurer or to have a combination of cellular and non-cellular business. The practice has always been for products of a particular class to be placed in one cell while owners may also have noncompeting products in different product classes and with different branding.

The rationale for mandating that cell owners would need to be a tied agent to one insurer for all classes is therefore a contested topic. Industry argues that once adopted, the standard is likely to increase pressure for cell captive insurers to compete over cell owners, as long-standing clients are likely to be shopping around given the requirement to be tied to one insurer.

For cell owners already tied to multiple insurers, it may mean a tedious and costly winding-down process, particularly while there are still policies on the books of the various insurers. For smaller players, this may limit their ability to meet the solvency requirements of other insurers as they conclude the winding-down process.

What can other jurisdictions learn from the South African experience?

As we note in a previous article, interest in the cell captive concept is growing in the rest of Sub-Saharan Africa. Regulators pursuing a market development mandate have appeared open to the cell captive concept. In common law countries at least, the regulatory framework would lend itself to accommodating cell captives without the need for dedicated legislation.

As interest in cell captives grows in the region, more regulators are starting to pay attention to the South African example to inform their own approach.

In doing so, they are well-advised to heed the lessons from the South African process:

• Be open to adopt the cell structure, even if it is breaking new ground, using letters of no objection and/or licence conditions to ensure soundness and proper market conduct;
• Learn on the go and adjust the requirements as needed to gradually firm up the regulatory framework; and
• Proactively engage the market to ensure that the final positions are based on the underlying principles served, rather than merely extending legacy provisions.

The draft conduct standard, as the final piece in the South African puzzle, shows the intricacies to balance. Despite a strong rationale put forward by the regulators for the standard, it seems that the devil will lie in the details. As such, it shows the value of a transparent and consultative process to iron out the details.