Brexit: Preparing for uncertainty

Uncertainty regarding the UK’s demands in negotiations around leaving the EU may be an opportunity for the re/insurance industry to make sure its interests are included in a potential deal. While sector representatives have started lobbying for their demands, businesses are checking their options.

After a majority in the UK surprisingly voted in favour of leaving the European Union in June, the re/insurance sector in the UK has been particularly worried about the possibility of losing its passporting rights. 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.

Official Brexit negotiations with the EU are expected to start in 2017, but preparations for the talks are already in full swing. Core to the UK’s re/insurance sector is to secure access to the EU market which currently comprises a population of more than 500 million. But companies based in mainland Europe may also fret about their ability to operate in the UK.

“The UK government must secure an arrangement as quickly as possible which ensures that passporting by UK headquartered firms into the Single Market and by EEA [European Economic Area] headquartered firms into the UK can continue uninterrupted on the occurrence of Brexit,” the London Market Group (LMG), a lobby organisation, said in a statement.

In a letter to the government, the British Insurance Brokers Association (BIBA) made clear that passporting rights are particularly important for business that is brought into Lloyd’s and the London Market, but also for firms that have set up branches in EU states where they operate under the ‘freedom of establishment’ principle. In addition, some firms have their international headquarters based in the UK as the country acts as their gateway to Europe.

Insurance broker Marsh warned in a report that the right of insurers and brokers to passport into the EEA could be restricted in a Brexit deal, and the sector is preparing for such an outcome.

“We need to define the elements of passporting that we want to keep, and we need to work out, within those elements, what are the critical ones that we would want the government to include in any negotiation,” Malcolm Newman, CEO of SCOR’s Paris-London Hub, chairman of the International Underwriting Association, said during an LMG event.

ONE SIZE CANNOT FIT ALL

The activities that are ‘passportable’ are set out in EU Single Market directives, but firms can request permission to carry out additional activities with the relevant authority of the host state.

Passporting rights are country and advice-specific and cannot be used in a ‘one size fits all’ way, according to the UK’s Financial Conduct Authority.
Keeping the status quo in passporting would come at the potentially considerable cost of submitting to future regulations designed in the EU without input from the UK, according to the Institute for Fiscal Studies (IFS). The UK may have to make some very difficult choices between the benefits from passporting and the costs of submitting to external imposed regulation, the organisation warned.

But for the UK re/insurance industry, keeping regulatory equivalence with the EU in order to operate in that market may outweigh the drawback of not having a say on the design of the regulatory framework.

To continue the free flow of business between the EU and the UK, it is important that our regulatory regimes remain comparable, BIBA noted.
“People have this view that the UK can just roll back regulation,” Newman says. “They forget that we are the export-facing businesses in the UK and clearly the government wants us to expand our export activities,” he says.

UK service exports accounted for 44 percent of total exports in 2015 and the EU is the UK’s largest service export destination, accounting for 40 percent of service exports, according to the IFS.

Law firm Holman Fenwick Willan expects that not least because of the importance of the EU market to UK businesses, the UK will strive to maintain its equivalence under Solvency II for group supervision, group solvency and reinsurance. However, there may be some beneficial changes which do not affect the UK’s equivalence, the law firm notes. It would also not be surprised to see some “gold-plating” of UK rules which implement maximum harmonising directives, the lawyers add.

PREPARING FOR THE WORST

Some UK re/insurers are planning for the case that a potential Brexit deal fails to meet the sector’s requirements.

Bermuda-based Hiscox, a specialist insurer, is preparing to create a new EU-based carrier. “We are trying to prepare for the worst, for the most severe kind of Brexit which means that there is no single market,” says head of communications Kylie O’Connor.

“Hiscox’s business in continental Europe employs around 300 people and is currently structurally part of the UK business,” O’Connor explains. Hiscox does not expect the process to create a new unit in continental Europe to take a long time given that the insurer is “fairly established in France and Germany.”

Any changes in passporting rights may require re/insurers to redesign their corporate structure. If passporting rights were to be restricted, insurers wishing to carry on business in other EEA states could be required to obtain licences in each member state, or form a new legal entity based in one of them, according to Marsh. Similarly, an EU insurer could need an additional licence to carry on insurance business in the UK, or need to form a new UK entity. Writing business through local branches will require local authorisation and capital being deposited to support the branch, in some cases.
Marsh suggests that some insurers with UK operations may establish greater presences in continental Europe in order to more easily operate under the single licence, particularly those who currently make extensive use of the passporting rights. Among them are US giant AIG, which stated that it would consider establishing an operations centre within the EU. Lloyd’s of London also indicated it was investigating the possibility of negotiating passporting rights across the EU. In 2015, the EEA accounted for £2.93 billion or 11 percent of Lloyd’s gross written premium.

Businesses are also worried about a potential impact of Brexit on their access to talent if the UK restricts or drops out of the free movement of people agreement, a core element of the EU free market rules.

“We need to know if we can continue to move people from one office location to another,” SCOR’s Newman says. But because a major driver for the vote to leave was the view that a large number of people were coming to the UK in a short period of time, he is sceptical. “There’s clearly not going to be a lot of room for politicians to maintain the current system,” he says.

LOOKING ON THE BRIGHT SIDE

Some UK insurers are relaxed about the Brexit consequences because they already have units in mainland Europe. A case in point is Aviva.

“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 says.

To remain a relevant re/insurance hub in a post-Brexit era, the UK industry should accelerate insurance product innovation, according to TheCityUK, a lobby group.

As the world’s largest hub for specialty commercial insurance, the London Market can help businesses better manage emerging risks, such as cyber, longevity, corporate liability, giga loss and reputational damage—all areas where the lobby group sees significant opportunity to address a large unmet need. New capabilities and more robust data and analytics should be a priority, the organisation suggests.

Furthermore, the UK’s insurance industry may look to expand to new regions and reduce its reliance on markets in the EU. Brexit opens new opportunities, Newman says.

“We are now in a position to have bilateral trade deals which we couldn’t have while we were in the EU. So we could potentially target some of the markets we’d like to get into. Maybe the UK will be more successful in opening those markets to UK-based businesses than the EU,” he says.

Brexit: what re/insurers and intermediaries should do now

Re/insurers and intermediaries should plan at an early stage how to continue their business without interruption in case passporting rights are lost, according to law firm Holman Fenwick Willan.

The process of obtaining authorisation to establish a subsidiary in an EU member state, either in the EU or in the UK, is likely to be costly and time-consuming and should be commenced well in advance of the formal split.

UK re/insurers or intermediaries may consider migrating to another EU member state, for example by undertaking an insurance business transfer. This method may not be accessible after the UK leaves the EU, so it might make sense to make use of it while available. Considerations regarding the choice of a new country for headquarters should include the target state’s approach to Solvency II and the Insurance Mediation Directive, tax rates and the legal framework, particularly employment law.

Post-Brexit, judgements on claims-related or commercial disputes may be harder to enforce in EU member states. Re/insurers and intermediaries should aim for final determination of existing litigation as soon as possible and consider arbitration for new disputes.