Life insurers will be impacted by Brexit first, warns AM Best

European life insurers will be the first to be impacted by the UK’s decision to withdraw from the EU but all parts of the insurance sector should prepare to adjust their group structure, according to a senior director at rating agency AM Best.

“Solvency II’s market-consistent approach to valuing the economic balance sheet means that financial market volatility will be closely reflected in European insurers’ reported solvency capital ratios,” Catherine Thomas, a senior director at AM Best told Intelligent Insurer.

“In the immediate aftermath of the vote, sterling and global equity markets fell sharply and there was a move towards safe haven assets such as gold and highly-rated government bonds. Life insurers are most vulnerable to the effects of financial market volatility due to their higher asset leverage, which is likely to be felt by insurers in both the UK and continental Europe,” Thomas said.

The rating agency had said previously that the financial market volatility following UK’s vote to leave the EU could have a material impact on insurers’ half-year results and balance sheets. In addition, Thomas expects slow economic growth to also have negative implications for the revenue and profitability prospects of UK insurers.

Other consequences on the UK’s insurance sector from the country’s decision to leave the EU will depend on the agreement that can be reached with the European Union particularly on passporting. The mechanism provides a company authorised in one member state the ability to conduct cross-border business without being required to apply for any additional authorisation or hold assets locally.

“The freedoms that we get with passporting right now to provide services and products across Europe and to establish businesses in other countries are incredibly valuable to our financial services firms,” said Laura Cox, PwC partner financial services risk and regulation in a panel discussion organized by the auditor.

A similar agreement to the one Norway has with the EU would come closest to the benefits the UK enjoys right now, she said. With a bilateral agreement option it becomes a “little less certain, but there’s a good chance that we could negotiate some passporting freedoms in that environment,” Cox said. A free trade agreement, on the other hand, would make passporting “much less certain,” she noted.

To operate without the EU financial services “passporting” scheme UK companies may need to establish an EU-domiciled subsidiary to continue to access EU business, Thomas said. “This is likely to have associated operational, regulatory and tax cost,” she noted. At the same time, insurers domiciled in other EU countries writing business in the UK will need to consider how they continue to access UK business, but the sector is expected to have at least two years’ time to adapt their operational structures.”

Insurance companies that use third country passporting through the UK may have to restructure their businesses, Cox said. While financial institutions that comply with Mifid II regulation (Markets in Financial Instruments Directive) benefit from “some really helpful provisions on third-country passports,” Solvency II and the insurance distribution directive do not include such provisions, she explained.

Because of the uncertainty around the future access to markets and passporting, financial services companies will be looking at their options and the effect of taxation should be included in these plans, PwC partner global insurance tax leader Colin Graham said during the panel discussion.

“Financial services groups will also need to look at their holding structures, because Brexit is likely to mean that there could be additional withholding tax costs on dividends and other payments from other operations in certain territories to UK holding companies,” Graham noted.

He stressed that the UK tax regime is attractive for financial services businesses and that the UK government may have more flexibility to adapt to the needs of the sector after the Brexit. Graham suggested that banks and insurers should engage with industry bodies and contribute to consultation processes.

Overall the financial industry may be in a good position to shape their own future: “One thing that’s been coming out of Brexit is that void of political leadership, and financial service leaders have a role to play in shaping the future,” PwC UK Asset Management Leader Mark Pugh said. “Being able to lobby both in Westminster and also in Brussels is going to be really important for financial services,” he said.

One topic that will be key in the UK’s negotiations with the EU is immigration, a topic of interest to UK’s financial services industry due to its international workforce. “At the moment it looks very unlikely that we’ll negotiate something that will include complete freedom of movement that we have at the moment, but people are talking about negotiating something with freedom of labour,” PwC partner legal markets leader and head of global immigration Juli Onslow-Cole, said.

This would mean that any EU national who has a job offer and is inside the EU would be free to move around, which would be “very positive,” she said. Meanwhile, companies should make an impact analysis on their workforce and also on their supply chain to see who could potentially be affected, Onslow-Cole recommended.

From a regulatory point of view little is set to change for financial services in the UK. “The EU legislation may continue to apply if we go for a Norwegian type model but even if we’re outside, the equivalence requirement means that we’re going to have to continue to replicate a lot of what’s in EU legislation right now,” Cox said.

Also, Solvency II is here to stay for reasons of equivalence, PwC partner UK Insurance Gavin Phillips said. A lot of time, energy and effort has been invested into it by all stakeholders and it is enshrined in UK law, Phillips explained. After leaving the EU there may be opportunities to tinker with it, he suggested.

But Cox warned that to keep business in the UK will require careful consideration. “I do think that the UK has got a challenge going forward around trying to balance concerns around financial stability, market integrity, consumer protection with being a competitive financial centre. The balance of the equation may shift going forward.”