It has become impossible to predict, but on Friday morning the insurance industry may wake up to find that Scotland has voted for independence. Hogan Lovells is politically neutral on the process and the outcome. But no one is in any doubt that there will be many legal and practical ramifications and complications for insurers to work through in the event of a ‘Yes’ vote. Below we have summarised some of the issues insurers may need to consider.

  • Location of assets – Scottish insurers who decide to re-register in the UK will need to review their continued compliance with certain parts of the FCA and PRA rules. This is particularly relevant in relation to the location of the insurers’ assets. If Scotland is not in the EEA then no more than 20% of the assets covering its technical provisions for business written in the UK (and the rest of the EEA) could be held in Scotland. This would be problematic for an insurer with a significant number of policies in England but most of its assets in Scotland. However, this problem would not arise if Scotland was in the EEA.
  • Currency matching – Whether or not Scotland is in the EEA, if it uses a different currency (such as the Euro or Scottish Dollar), and Scottish assets are redenominated out of sterling and into that currency, then a maximum of 20% of these redenominated assets will be able to cover sterling-denominated liabilities of the insurer. The impact of this rule would be mitigated if the insurance liabilities in respect of business written in Scotland were similarly redenominated into the Scottish currency. Again, however, for an insurer with significant liabilities remaining in sterling, this limit could be problematic. This problem would not arise if Scotland retained sterling as its currency or if the relevant assets were not redenominated out of sterling.
  • In relation to both the localisation and the currency matching requirements, the regulator will consider the resulting risks and would have power to impose a higher capital requirement on the insurer as necessary to address the risks as part of the Pillar 2 capital process. The relevant regulator for this purpose would be the UK PRA unless Scotland is in the EEA and the insurer has remained registered in Scotland (and even then it is possible that a shared regulatory regime might apply if that is agreed between the respective governments).
  • The localisation and currency matching requirements will be replaced under Solvency II (see below) by a “prudent person” investment principle, again supervised by the relevant regulator. This will mean that the specific 20% limits described above will no longer apply, but the insurer will have to persuade the relevant regulator that it’s holding of assets in Scotland, or denominated in the Scottish currency, is prudent.

Application of Solvency II if Scotland is not in the EEA– Solvency II is expected to come into force on 1 January 2016, a few months before the proposed date for Scottish independence.

  • If Scotland were outside the EEA and the insurer had not re-registered in the UK, then its branch in the UK would be treated as a “third country” insurer. A recent publication of the PRA has suggested that non-EEA business of third county insurers would not be made subject to the full Solvency II capital regime, so this might actually appear to be favourable for the insurer. In practice, however, we would expect Scottish insurers wishing to continue to compete in EEA retail insurance markets to have to demonstrate that they are as well capitalised as their EEA competitors, so it is unlikely that Scotland would adopt a materially less intensive capital regime than Solvency II. Moreover, Scottish-registered insurers would have to comply with Solvency II for their EEA business, and the additional burden of complying with two different regimes would be likely to offset the benefit of any leniency that was included in the Scottish regime.
  • If the insurer had registered as a UK insurer then it would be an EEA insurer, not a “third country” insurer, and Solvency II would apply to its worldwide business, irrespective of any more lenient regime in Scotland.

Insurance business transfer schemes – Under existing UK legislation, an insurer can use a court-approved process to transfer portfolios of business to another insurer that will carry on the business from an establishment in the EEA. An English insurer could therefore transfer business to a Scottish insurer to carry on from Scotland, and vice versa.

  • If Scotland were outside the EEA then a transfer from an English insurer to a Scottish insurer would no longer be possible under existing legislation. A transfer would be possible if the Scottish insurer was to establish a UK branch, but the business would have to be carried on through this branch, not in Scotland.
  • Scotland would need to enact replacement legislation if it wishes to retain this process (since the existing legislation is premised on the UK being in the EEA so could not apply to Scotland when it was outside the EEA) and that legislation would determine the extent to which Scottish insurers could transfer business to insurers outside Scotland. However, unlike the current position where other EEA states are required to have a legal process that would, subject to court approval, allow the transfer from another EEA insurer, there would be no requirement for their law to allow a transfer of business from Scottish insurers.