Yesterday the UK voted to leave the EU. Many decisions will now have to be made by the UK and by the EU on what happens next. What Brexit will look like is still unknown, for the simple reason that the nature of the future UK/EU relationship still has to be negotiated. Insurers and reinsurers will need to navigate the uncertainties successfully to position themselves for whatever the future may hold.

In this briefing we focus on some of the key considerations for UK (re)insurers and other (re)insurers based in the UK.

Dealing with the uncertainty

Notwithstanding any political turbulence and market volatility which may now arise, yesterday’s vote to leave has not of itself triggered any sudden change to the status of EU-derived law in the UK. The UK will remain a member state until it reaches an agreement in relation to withdrawal from the EU, or the two-year Article 50 notification period (and any extension) expires, whichever occurs first. For now, we can only talk about the potential implication for insurers and, indeed, the Government has previously stated that ‘a vote to leave the EU would be the start, not the end, of a process. It could lead to up to a decade or more of uncertainty’.

What might the UK/EU relationship look like post-Brexit?

Model

Customs union

FTA with EU

Single market access

Single market power

EU-negotiated FTAs

Pay into EU budget?

Norwegian

✔(full)

✘(but EFTA FTAs)

Swiss

✔(some)

✘(but EFTA FTAs)

South Korean/ Canadian

✔(some)

Turkish

N/A

✔(not services)

✘(but must apply EU external tariff)

WTO rules only

N/A

We set out below some of the issues firms should be considering.

Passporting

The Treaty of the Functioning of the European Union (TFEU) provides, in general terms, for the creation of a common market in both goods and services, including insurance. Firms benefit from both a ‘freedom of establishment’ and ‘freedom of services’ which allow firms based in one member state to form a permanent establishment or branch in another member state and allow firms to provide services from one member state to another member state without the establishment of a branch. An authorisation to carry on direct insurance granted by the insurance regulator in the European Economic Area (EEA) state in which an insurer has its head office (home state regulator) is valid for the entire EEA. The exercise of the right of EEA insurers to use their authorisation in other EEA states (host state) is known as ‘passporting’.

The rights afforded to insurers to passport between the UK and the remaining EEA states may be lost on a Brexit and accordingly, UK insurers may need to apply for additional licenses to carry on business in the remaining EEA states. This may involve UK-based insurers considering how best to structure their European operations to continue to provide services in the EEA. EEA insurers who operate in the UK may also need additional licences to carry on business in the UK and may need to consider establishing UK subsidiaries in order to continue to operate in the UK.

Host state/home state regulation

At present, the prudential regulation of a firm is the responsibility of the regulatory authority in the state in which its head office is situated (the ‘home state’). This is a significant benefit that allows insurers in the EU to operate without dual regulation. Following a Brexit, UK insurers operating in the EEA may become subject to prudential regulation in other EEA states in which they operate (the ‘host state’) in addition to UK prudential regulation. Equally, EU insurers operating in the UK may become subject to prudential regulation in the UK in addition to their home state regulation. This dual regulation could create a significant burden on insurers operating in the UK and multiple EEA states.

Intra-group reorganisations

Firms will need to consider whether or not they need to re-organise their operations in order to maintain their access to the European market. Firms should start to consider the methods available in order to achieve any necessary group restructuring, including use of the Companies (Cross-Border Mergers) Regulations 2007 (CBM Rules) or the insurance business transfer rules under Part VII of the Financial Services and Markets Act 2000 (FSMA).

Both of these mechanisms are recognised throughout the EU. The CBM Rules enable mergers between companies in different EU member states and apply to public and private companies with limited liability and to mergers involving at least two companies from different member states. Any merger effected under the CBM Rules is recognised across the EU. Where an insurance business transfer is sanctioned in the UK this effects, in essence, a statutory novation within the EEA that is binding on EEA policyholders of the UK insurer. Following a Brexit, the CBM Rules may no longer be available and equally insurance business transfers may no longer be binding on EEA policyholders. Firms will need to consider the extent to which these mechanisms need to be used to effect any reorganisations before a Brexit.

Choice of law

Two EU Regulations set out the rules that the English courts currently apply to determine which law applies to obligations between parties. The Rome I Regulation covers contractual obligations and the Rome II Regulation covers non-contractual obligations. Under these Regulations, in most situations involving commercial parties which tend to involve a written contract with a governing law clause, the obligations are normally governed by the law chosen by the parties.

The Rome I and II Regulations may cease to apply in the UK. In these circumstances, a choice of English law to govern contractual obligations should still be recognised by courts in the UK and will still be recognised by EU member states. A choice of English law to govern non-contractual obligations would continue to be upheld by the courts of EU member states. However, the position under English law in relation to non-contractual obligations would be less clear as, before the Rome II Regulation regime came into effect, parties did not have an express right to choose which law applied to non-contractual obligations arising between them. Accordingly firms will need to think carefully about any non-contractual obligations that exist.

UK law derived from EU law

A large proportion of the body of law currently applicable in the UK consists of law derived from the EU, including of course the Solvency II framework. In the long-term, the European Communities Act 1972, which implements EU law into UK law, would need to be repealed or substantially amended so that UK law ceases to recognise any EU Regulations as being directly applicable in the UK, and to prevent the use of secondary legislation to implement EU Directives in the UK. The UK government would be expected to look at all UK primary legislation that implements EU law to determine if it needs to be repealed or amended. Judgments of the Court of Justice of the European Union and EU institutional acts would cease to be binding in the UK.

Although it is unclear to what extent the UK government would decide to retain EU-derived law as part of UK law following a Brexit, it is likely that the UK government would, as part of preparations leading up to a Brexit, enact legislation to maintain the effect of EU-derived law, subject to some selected repeals or modifications, at least for a transitional period following the exit. The UK is also likely to seek Solvency II equivalence and as such will maintain the existing Solvency II framework. The UK government could also decide to ‘grandfather’ pre-existing contractual arrangements, so that those arrangements are unaffected by any repeal of or modification to the relevant legislation. These mechanisms would decrease the scope for uncertainty in this area.

Strategic opportunities

The leave vote will strengthen some businesses and weaken others. The competitive landscape is also likely to change. There may be a strategic opportunity to take advantage of the weakness (perhaps temporary) of a competitor. Institutional investors and others confident of their analytical skills may see mismatches between market perceptions of value and their own assessment. There may be opportunities for acquisitions and disposals. Firms weakened by the vote will also need to consider their strategic response and whether they need to make any defensive preparations.

Impact on M&A

Firms should continue to conduct reviews of material transactions and consider the impact of Brexit on contractual provisions, particularly material adverse change (MAC) clauses. Although it is difficult to envisage circumstances in which the vote to leave of itself would immediately trigger such a MAC, economic repercussions in the medium-term may give grounds to argue for a material adverse effect on the parties’ business, financial condition or prospects. Each MAC clause must be interpreted on its own terms; although we have not seen many Brexit-specific MACs, any bespoke clauses should be checked.

MAC clauses are generally interpreted as requiring a high threshold to be met before they can be invoked. A determination of MAC is highly subjective and, as such, we would expect calling a MAC event of default to be a last resort.

Influence the future

Many firms will want their voice to be heard in the debate about what Brexit should look like and the process for getting there. Should the UK go for ‘independence max’ or economic pragmatism? Should the UK give an Article 50 notification and follow the official process for the Brexit negotiation or should it delay notification or not give it at all? Should the UK continue to comply in full with its EU treaty obligations, or should it ‘take back control’ as soon as possible? How far should the UK be willing to continue to accept EU rules for the sake of retaining access to EU markets?

The UK may need to adopt some basic policy orientations quite early if the EU takes a hard line negotiating position. Those favouring ‘independence max’ may see increased trade barriers (at least in the short term) as a price worth paying.

There will be a parallel debate in continental Europe and the EU institutions on the EU’s approach to the Brexit negotiation – whether the EU should take a tough negotiating position to discourage others from following the UK out of the EU, or whether it should seek a pragmatic solution that is most financially advantageous to the EU.

Firms that want to engage with these issues will need to consider how best to do so. Initially at least, the priority may be influencing the broad policy orientation – seeking to persuade people of the benefits of a pragmatic approach focused on obtaining the best result for business. In this, many firms will share a common interest, and there may be some scope for working collaboratively with others where appropriate. They will also want to consider how they might seek to persuade not just politicians and policy-makers, but the wider public also.

Coordinate thinking

Firms that do not already have a clear framework for coordinating their thinking about Brexit will need to establish one. Those that already have committees or working groups looking at these things will need to consider whether those structures remain appropriate now that the UK has moved onto a ‘leave’ trajectory.