OREANDA-NEWS. A recent court decision highlights the presence of multiple sources of credit risk in protected cell structures, according to Fitch Ratings.

Fitch has updated its views on protected cell companies (PCCs) following a federal court decision on a dispute that arose in a reinsurance contract involving a protected cell. The case illustrates the linkage between an individual protected cell and its PCC. The decision suggests to Fitch that the failure of a protected cell's PCC could potentially cause disruption or financial stress for the protected cells in that PCC; therefore, prospective cell sponsors should consider the creditworthiness of the PCC when forming a protected cell.

'Fitch believes the primary credit focus when the PCC structure was designed was the protection of each protected cell's assets from the creditors of the other protected cells,' said Donald Thorpe, Senior Director, Insurance.

'There are many linkages to be considered in a credit analysis of a protected cell besides the segregation between the individual protected cells. The weakest link often determines the final credit rating of an entity, and the weakest link in a PCC structure may not be the risk that individual protected cells pose to each other.'

'The ruling concludes protected cells are not separate entities from their PCCs. Additionally, the PCC is the actual holder of the insurance license. To Fitch, the case raises the question as to how the protected cell continues in the event its PCC fails.'

Previously, there has been a dearth of court cases on this or other aspects of the PCC structure. Therefore, Fitch believes this case makes a significant contribution to the history of PCCs.

Case Background: The dispute arose over a reinsurance contract between an insurer and a Montana-domiciled PCC. The PCC entered into the contract on behalf of one of its protected cells. The contract contained an arbitration clause and the insurer sent a demand for arbitration to the PCC. The PCC and the protected cell argued that only the protected cell, and not the PCC, should be a party to the arbitration. The judge ruled that a protected cell is not a separate legal entity that can sue or be sued. Therefore, the PCC, of which the protected cell is a part, is the proper party in an arbitration proceeding to resolve the dispute.

The case is Pac Re 5-AT v. AmTrust North America, Inc.

The full report 'Protected Cell Company Update: Court Case Adds Incremental Clarity' is available at www.fitchratings.com.