A bumpy Brexit may bruise the UK’s re/insurance sector

This seems to be the consensus of commentators and experts in the re/insurance sector at the moment, all trying to second-guess both the exact nature of the UK’s exit from the EU and its implications for one of the most important sectors to the UK economy.

The insurance sector, the biggest in Europe with around 334,000 people according to latest ABI (Association of British Insurers) data, is not a fan of the idea of the country leaving the EU. Insurers generally like stability and predictability, and this is certainly not what it is facing with regards to Brexit.

UK’s Prime Minister Theresa May has recently, perhaps unintentionally, reminded the country’s businesses on the uncertainties that Brexit is bringing about.

In a long awaited January 17 speech, May said that the UK "cannot possibly" remain within the European single market. She has, however, promised to push for the "greatest possible" access to the single market following Brexit. Priorities in the negotiations with the European Commission include a tariff-free trade and a customs agreement with the EU. But she also said that she would rather do “no deal” than one which is a “bad deal for Britain”.

One major concern for UK’s insurance industry is that, as a consequence of the Brexit negotiations, the sector could lose their “passporting rights”, which allow them to underwrite business in the European Economic Area from UK-based subsidiaries. The EU financial services passporting scheme provides a company authorised in one member state with the ability to conduct cross-border business without being required to apply for any additional authorisation or incur further local operational costs.

“Whatever the precise outcome of negotiations, insurers won't wait-and-see,” says Ivor Edwards, corporate insurance partner at law firm Clyde & Co.

“Planning for Britain's exit from the EU is well underway as insurance carriers believe they need to take concrete steps for all eventualities by setting up carrier companies in EU27 countries,” Edwards adds.

To ensure continuous access to the EU market, UK-based insurers may have to take action now as it may take a while to get the required licences and approval by regulators to set up new operations. Especially non-EU re/insurers which use the UK as a hub to access the EU market will need to make sure they remain able to operate in the EU after Brexit.

Insurers are already assessing financial centres including Dublin, Paris, Frankfurt and Luxembourg, as well as other locations where they have branch operations, according to a January 19 AM Best report titled “Brexit Uncertainties Weigh on UK Insurers but Rated Entities Able to Withstand Pressure”.

Local brokers are well established in EU insurance and reinsurance hubs and a significant increase in accessing business in different cities by the overall financial sector could have longer-term implications for London as a financial centre.

Not all players are equally affected.

UK’s Aviva, which operates in retail life and non-life, has, for example, stated that it has limited reliance on EU passporting of services.

“The vast majority of our businesses are locally incorporated and regulated and we have limited reliance on passporting of services across jurisdictions,” chief executive officer Mark Wilson has said during the insurer’s 2016 capital markets day.

Catherine Thomas, senior director, analytics at AM Best, says that “the ability to continue to conduct cross-border business throughout the EU is principally a concern for Lloyd’s, the London market and other commercial insurers. To continue to underwrite EU business, these companies are likely to need to establish an EU-domiciled subsidiary, if they do not already have one. This would have associated costs, operational requirements and resourcing implications,” she adds.

Lloyd’s of London has decided to create a unit elsewhere in the EU, but has yet to select the location. The market needs to ensure it keeps access to the EU business. In 2015, the EEA (European Economic Area) accounted for £2.93 billion or 11 percent of Lloyd’s gross written premium. Lloyd’s has said that 4 percent of its £26.6 billion global gross written premium is likely to be affected by the UK’s withdrawal from the EU’s single market.

“Following the referendum we committed to looking at the options that would allow the Lloyd’s market to continue trading seamlessly with the EU. This included establishing a subsidiary model amongst others,” a Lloyd’s spokesperson has previously said. The move is set to cost Lloyd's tens of millions.

Synechron, a global consulting and technology provider in the financial services industry calculated that it may cost financial services companies an average of £50,000 per employee to relocate parts of their UK workforce to another European city in the wake or Brexit. The company calculated the figure using estimated relocation, hiring and redundancy costs, new building and rent costs and other infrastructure as well as some contingency costs.

Potential locations for a Lloyd’s subsidiary are the usual suspects such as Dublin, Frankfurt and Paris, all of which have been lobbying to attract business from the UK after the Brexit vote. So far, Lloyd’s has only ruled out Malta as a candidate. After a subsidiary has been created, syndicates will decide on how much business they will want to transfer to the new location and seek regulatory approval for the move.

The Chartered Insurance Institute (CII) had warned on a “widening wall of nervousness forming among businesses and professionals on the impact of leaving the EU.” Economic confidence across the insurance profession is at its lowest level since 2011 and nearly half (48 percent) of those working in insurance expect the economy to deteriorate in 2017, according to CII.

An Intelligent Insurer survey (180 participants) conducted right after Theresa May’s speech showed that a majority (67 percent) of participants believe that May's Brexit strategy will weaken the UK's position as a re/insurance hub.

Some respondents suggested the clarity that the UK will leave the single market will prompt more firms to set up elsewhere. Others said that the UK will isolate itself, boosting costs for companies and consumer. As Brexit is set to make the access to the EU market difficult and/or complicated, the UK re/insurance market is set to shrink and fewer senior jobs will be in London, some commented.

Not all segments are likely to be equally affected.

UK insurers may be able to continue to access risks freely across the EU for marine, aviation and transport (MAT) insurance, regardless of whether passporting rights are lost, according to AM Best. Under World Trade Organisation (WTO) rules, cross-border rights exist for MAT risks to be written by insurers and reinsurers operating in countries outside of the European Economic Area.

For large UK life insurers, a loss of the passporting rights is unlikely to be an issue as most write principally domestic business or have subsidiaries in both the UK and at least one other EU country, according to the AM Best report.

It is also expected that the impact on the retail non-life UK insurance sector will be minimal, as the majority of insurers are underwriting domestic business only.

Nevertheless, also local UK-focused insurers are likely to feel the consequences from Brexit.

The UK’s vote to leave the EU has resulted in considerable uncertainty regarding the UK’s economy, which could have a negative impact on domestic insurers’ premium volumes, AM Best says. Any decline in gross domestic product (GDP) would likely lead to a reduction in demand for both life and non-life insurance, analysts believe.

One important unknown is whether the insurance industry will be given a period of transition to adjust to new conditions in the wake of the U.K. leaving the EU, AM Best notes.

Prime Minister May has stated that she will seek a “phased process of implementation” to allow the UK, as well as EU institutions and member states, to “prepare for the new arrangements”, although the form and substance, and the extent to which it will cover the financial services industry, remains to be seen, AM Best commented.

As a consequence of the UK's exit from the single market, insurers domiciled in the UK would no longer be directly subject to Solvency II regulation. “Equivalence is likely to be granted,” says Yvette Essen, director, research & communications – Europe & emerging markets of AM Best. “The Prudential Regulation Authority has established itself as a strong regulator, and has been strict with its application of Solvency II. Without equivalence, reinsurers may have to post collateral to support EU-sourced business,” she notes.

But while keeping its equivalence, the UK might be able to make some adaptations to the regulatory standard which may benefit the country’s re/insurance hub.

Phil Smart, head of insurance of KPMG UK, says: “However the Brexit negotiations turn out, UK insurers need to retain an ability to operate in Europe and maintain regulatory equivalence. But leaving the European Union does give us an opportunity to make some adjustments to Solvency II that make the post-Brexit UK insurance market a more competitive one. There needs to be a balance between consumer protection and market competition and alterations can be made without moving away from the globally recognised regulation of Solvency II entirely,” he explains.

And the UK re/insurance industry could find other international markets to focus on and expand. May has said in her speech that the UK should “get out into the wider world, to trade and do business all around the globe. Countries including China, Brazil, and the Gulf States have already expressed their interest in striking trade deals with us."

Nevertheless, the negative consequences for the industry of Brexit are likely to prevail.

AM Best believes that in the medium term, Brexit could impact economic growth within the UK and the EU, and in the longer term, there may be implications for London’s position as a leading financial centre. The extent of the economic impact will depend on a multitude of factors, many of which lie outside of Brexit negotiations. Ultimately, the UK will be leaving the EU single market and the long-term impact on the insurance sector will be determined in the detail of the negotiated trade deal that will come into effect.

There are concerns that an economic downturn could impact capital adequacy if widespread corporate downgrades affect the credit quality of UK insurers’ investment portfolios.

Nevertheless, AM Best does not anticipate taking any rating actions as a direct result of plans for the UK to exit the EU.