This article examines some potential issues for UK re/insurers following the referendum vote for the UK to end its membership in the EU.
Prolonged period of uncertainty but “business as usual”?
One of the most significant concerns is that Brexit will bring about a prolonged and indefinite period of uncertainty for the insurance industry. Pursuant to Article 50, the UK is required to give notice of its intention to withdraw from the EU and the withdrawal will be effective upon signing of a withdrawal agreement or, in the absence of such agreement, two years after the notification. There is little precedent for such a withdrawal process but when Greenland sought to withdraw in 1979, it took nearly six years to reach agreement with the EU and Greenland did not leave the EU until 1985. While UK representatives may elect to promptly begin negotiations, EU representatives recently emphasized that withdrawal negotiations will not take place until formal notice of withdrawal under Article 50 is provided by the UK. That formal notice could be months away. This indefinite and prolonged period of uncertainty may cause insurers to decide that it is more economical and a better business option to move certain operations to EU based countries where the business climate is more certain.
Insurers have already taken note of this uncertainty. For example, an Allianz commentary titled “Britain Votes to Leave: A Leap in the Dark” notes that Brexit “will sap the EU’s political energy for many years” and we can expect “severe financial market turmoil, compounded by political instability in the UK.” Notably, Brexit coincides with the U.S. presidential election in November, elections in France to follow in early 2017, and the potential for other EU countries to experiment with their own “leave” movements.
On the other hand, Lloyd’s CEO Inga Beale, in an open letter in the Financial Times, assured the market that it can retain its status as the global leader and adapt to the new environment. Beale noted that Lloyd’s and the London Market will retain “all current access” to the EU market for the next two years until the formal negotiations to leave the EU are concluded. Beale advised that no existing Lloyd’s policies will be affected and “business continues as usual” into 2017.
Access to the EU insurance market and “passporting”
The loss of the ability to do business on a passport basis could be one of the most significant negative impacts on the insurance industry in the UK. The EU membership allows insurers to write insurance on a cross-border basis while regulated by the Prudential Regulatory Authority (PRA), the UK financial regulator, without the need for further authorization from local regulators or the need to maintain localized funds in other EU jurisdictions. Any change to this system will, of course, be subject of the withdrawal negotiations.
If passporting is discontinued, UK insurers with EU operations may need to restructure, possibly even to set up the UK business as a branch of an EU based company. Another option would be to seek approval to conduct insurance business through local branches but this would require capital being deposited to support the branch in certain instances. In this regard, QBE Insurance Group announced that it will be reviewing its UK-based operations in light of the vote for the UK to withdraw from the EU. QBE reported that it may revise its approach to nearly £500m of insurance and reinsurance premium that QBE currently sources from EU member countries that is written via branches of UK regulated entities under current EU passporting rules. QBE reportedly is considering moving its continental European books to Dublin if Brexit puts an end to passporting rights but explained that it does not expect any material impact on its day to day insurance operations.
The withdrawal could affect other important business decisions with respect to M&A activity, including the need to consider the impact of withdrawal in conducting due diligence as well as considering contractual provisions such as material adverse change (MAC) clauses, illegality or termination triggers. There could also be issues with respect to enforcement of judgments in the EU depending on how the UK negotiates treaties on enforcement.
It is difficult to predict the regulatory arrangements that could be put into place following the withdrawal. Depending on the approach, the UK could become a member of the European Economic Area (the EEA), which would mean that it is bound by EU legislation, or, under another proposal, the UK would still need to maintain a regulatory regime similar to the EU’s in order to maintain status as an “equivalent” jurisdiction. It is also questionable whether, under either model, the UK would have any substantive influence on future regulatory developments.
In the meantime, EU regulations continue to apply. According to the Financial Conduct Authority (FCA), business must “continue to abide by their obligations under UK law, including those derived from EU law and continue with implementation plans for legislation that is still to come into effect.” With regard to Solvency II, the European-wide regulation that specifies capital requirements to be maintained by insurance companies, significant changes are not anticipated. It has been estimated that re/insurers have expended nearly £3 billion to prepare for Solvency II. While some things could be done differently, major changes are unlikely given the substantial costs already expended. Also, too many deviations from Solvency II could present a challenge to obtaining “equivalency” status with the EU. Additionally, portions of Solvency II were designed in the UK such that UK regulators may be reluctant to make serious amendments.
Another area of concern for regulatory change is in the development of data protection and privacy regulations post-withdrawal. There is a substantial interest in assuring that data sharing between the EU and UK is maintained but, to do so, the UK would need to maintain an adequate level of data protection. If not, the EU could require burdensome steps be taken in order to permit continued data sharing. Also, the UK may try to avoid setting different data protection standards in order to avoid dueling regulations that are too complex and difficult to apply. This suggests that the UK would adopt EU equivalent levels of data protection.
Conclusion – What happens next?
UK re/insurers will grapple with serious economic and regulatory issues in addressing the withdrawal from the EU. This will not happen overnight and the long-term effects cannot be known at this point. We will keep you informed as significant developments occur.