With the UK electorate's narrow vote to leave the European Union, the UK and Europe are now entering a period of great uncertainty.
The initial reaction in financial markets (which had priced in a remain win) has been one of shock, with the Pound and Euro plummeting to historic lows against the Dollar and sharp falls in global stock markets. The immediate political fall out in the UK and across Europe is highly unpredictable, and the shape of the UK's future relationship with Europe is anything but clear. The Brexit vote is momentous in its consequences. The London market and the UK insurance industry will stay strong, but there are very real challenges.
Insurance industry players with operations in or business with the UK will now need to review their plans, to take account of the UK's post-Brexit future. The ability of UK based insurers (which includes reinsurers) and intermediaries to trade throughout the EU, and access by EU insurers and intermediaries to the UK, will continue under current arrangements until the UK actually leaves, but there is no doubt that the Brexit vote means difficulty and uncertainty for the sector in the short term, and a medium term regulatory environment that may look very different. We consider some of the challenges, and what market participants can do to address them, below.
Bumps in the road or serious obstacles - what do insurance groups need to consider?
Financial market and economic consequences
These may be the most significant immediate concerns - the initial reaction by the financial markets is striking. Although central banks and governments will seek to act swiftly to restore stability and confidence, insurers need to be braced for a possibly lengthy period of uncertainty, and further volatility may follow as the political and economic consequences, and negotiations for UK withdrawal, unfold. The UK's, and European countries', GDP may be affected - the Bank of England has warned of a post-referendum recession in the UK. Sterling and the Euro may be significantly weakened in the long term, and interest rates, and equity and other asset values will be impacted - listed insurers have already seen their stock prices hit. Insurers (and their regulators) will need to assess the consequences for their own, and counterparties' regulatory capital, liquidity and security ratings. New investment capital may be in short supply, and there may be significant capacity reductions and hardening of market conditions. In the short term some insurers may want to take steps to reassure policyholders about their capital position and stability. Policyholders will be dealing with the financial and economic shocks themselves, and, where they are able to, may look for cover in markets less exposed to Brexit fall out.
Market volatility, at least, can be expected to stabilise sooner or later, and despite the shock, we should say that UK insurers do look well placed to ride it out. Standard & Poors has said today that it regards UK insurers as less vulnerable to the pressures of Brexit compared with other financial services sectors, and that the leave vote is not expected to lead to rating actions on UK insurers as a result.
A new and uncertain regulatory landscape
The detailed prospectus for a post-Brexit EU/UK relationship remains unclear. The UK insurance industry will be keen to do what it can to maintain European market access. It will need to engage with the process of negotiating a new relationship, through direct lobbying, and via the IUA, LMA, ABI and other industry bodies. Different models for that relationship have been discussed in the run up to the vote. The UK industry may aim for a Norway style arrangement involving EEA membership and market access across all sectors, broadly equivalent to that which it currently enjoys. Something similar to the "Swiss model" with an insurance specific sector agreement allowing reciprocal rights to establish branches able to write certain lines of business could also be sought. Either model would likely come at a cost, possibly including free movement of people from the EU, which both Norway and Switzerland currently accept but which seems to be a redline as far as the UK public is concerned.
Whatever happens, the UK's government and regulators (and through them the UK industry) will lose the influence they currently have through representation on EU bodies (including EIOPA and the Commission) on the developing shape of regulation in a trading block which will remain a major market for the UK insurers (however they are able to access it). Like US insurers (and other third country), the UK industry will be now be reacting to developments in Europe, not shaping them from the inside.
What regulatory framework will emerge, and how can insurers shape their business to it?
As the negotiations progress insurance groups will need to review their corporate structures and operations to work out how they can continue business lines after the UK finally leaves. We do not yet have any certainty about the coming UK / European regulatory regime - but if Swiss or Norwegian options aren't obtainable, the following is likely :
- Services passporting and establishment rights will be lost - UK insurers will no longer be able to underwrite risks from EU and EEA states without authorisation.
- EU insurers will face difficulties underwriting risks from the UK - and it's likely they will be unable to do so either directly themselves, or through agents located within the UK.
- UK and EU brokers, cover-holders and other intermediaries will also lose reciprocal cross border services passporting and establishment rights.
- UK insurers should benefit from full Solvency II equivalence - post-Brexit, this seems likely given that the UK has already fully implemented Solvency II as an EU member state.
Presuming the UK is granted full equivalency, UK reinsurers will not be required to post collateral to EU cedants and UK insurance subsidiaries of EU insurance groups will be permitted to calculate their solvency for group solvency purposes on the basis of UK requirements. It is also likely that the PRA would be recognised as the group supervisor for EU insurance groups with ultimate holding companies in the UK. Of course, this could be challenged in circumstances where the EU group supervisor considers that group supervision by the PRA would not result in more efficient supervision.
Full Solvency II equivalence will put UK insurers on a par with Bermuda - the only territory which currently has that status - but it will fall a very long way short of the access to European markets the UK currently enjoys.
Industry players will need to consider how to reconfigure. What they do will be influenced by their current structures and operations, but various options may be open if UK / EU reciprocal market access looks set to end;
- If they use a UK entity to passport into other EEA territories, does the group include a regulated entity elsewhere that can apply for equivalent passports to continue the business? If not, can one be acquired or established?
- If they currently use an EEA entity to passport into the UK, can they register, or acquire, a UK insurer as a platform to underwrite UK risks?
- Is there scope for a UK insurer to re-domicile into an EEA territory? (Many insurers are considering relocating via an SE merger.)
- Will they need to move existing books of business under EU portfolio transfer rules as part of any reorganisation?
- Will UK insurance businesses be able to use, or acquire, a Lloyd's platform to trade in Europe? (Details of how the Lloyd's market expects to access EU territories have not been announced. However, Lloyd's has said it has been planning for post-Brexit contingencies, and that it is confident that it will be able to find a way through the uncertainty that will allow business to continue to flow to London and will continue to offer the opportunity to write business in local markets under the Lloyd’s structure.)
Whatever options insurance groups pursue, speed may be of the essence - they will need to balance getting their re-configuration right with the risk of running out of time. How much time is actually available will depend on how Brexit negotiations unfold, and when the UK government serves formal notice to leave. However full departure could happen as soon as 2018, which would leave a very narrow window for a portfolio transfer or SE merger. Regulators are likely to be very busy, dealing with similar applications, and will, no doubt be heavily committed to the renegotiation process, whilst also having to maintain "business as usual", so the regulatory approvals needed for any restructuring may be substantially delayed or disrupted.
The longer view
Once the UK's new relationship with Europe is resolved, and whatever that relationship looks like, we think the UK insurance industry will remain a strong global player. The modern insurance industry was born in the city of London. It has more than three centuries of history there, and a phenomenal amount of talent, technical and professional support, and risk capital, to draw on. The UK has a highly-respected regulatory system - Solvency II equivalence is likely to be secured, and the Lloyd's platform's network of international licences will continue to provide unparalleled access to global insurance markets. In or out of the EU, those fundamentals will endure.
The London market's global outlook will be key to its future. In giving reassurance today on UK insurers' ratings, Standard & Poors referred to their reliance on trade with non-EU countries - especially the US. Strong bilateral relationships with those countries can be expected to develop further. There may be a renewed focus on the relationship with the US, which was central to the London market's development, and existed long before the EU came into being. Differing outlooks of regulators in the EU and the US have caused problems in the past. Resetting UK regulation to align it closer to the US, could turn out to the UK's advantage if it helps trans-Atlantic relationships flourish post-Brexit.
London insurers will no doubt look to develop and grow their business in new markets, as the UK industry has done throughout its history. London is growing and will continue to grow its connections with developing economies and the centres of global growth in Latin America and Asia. Only yesterday Lloyd's opened its office in Bogota, Colombia, where it is now licensed to underwrite onshore reinsurance business, as well as cross border marine, transport and aviation risks.
Its resilience and creativity has enabled the London market to deal with shocks and crises in the past. It has traded on through world wars and catastrophic losses and has met evolving sources of competition with vigor . There will be serious issues to confront and the economic, regulatory, legal and political environment for the UK insurance will be in flux for some time, but the UK market can be expected to continue to prosper in years to come - albeit possibly without the advantages of easy access to European markets EU membership has brought, and against a different regulatory landscape.