Article 50: What comes next for insurers?

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On 29 March, the UK served notice on the European Council under Article 50, thereby triggering the two year negotiation period for the UK's exit from the EU. DLA Piper's insurance team reviews the latest Brexit developments, what insurers should be doing to ensure that they are Brexit ready, and what the longer term implications might be for the London and European insurance markets.

The UK's vote to leave the EU in June's referendum sent shockwaves through the global insurance industry. In the months since the referendum, what Brexit means in practice for the sector and even when Brexit will happen, have been unclear. Insurance groups that rely on passporting rights to trade across the UK and the rest of Europe have had to plan for the future against a background of uncertainty.

Shortly after the referendum, the UK government announced that it planned to serve notice under Article 50 of the Lisbon Treaty in March 2017, thereby triggering the two year negotiation period to leave the EU. Despite "bumps in the road" with the UK Supreme Court ruling that a parliamentary vote was required, and the UK House of Lords initially seeking to make service of Article 50 subject to certain conditions, notice under Article 50 was served today and the two year period is underway.

What will the UK government seek in negotiations?

UK prime minister, Theresa May, has put some of her cards on the table. During her Lancaster House speech , she outlined the government's negotiating objectives. Most significantly for insurance groups, the UK government will not seek to retain full membership of the EU single market. Mrs May also said that she wanted to reach an agreement on the UK's future partnership with the EU within the two year period and, as a cliff edge was in no one's interest, she would seek a phased process of implementation.

Implications for insurance groups

The course and ultimate outcome of the negotiations is hard to predict, but it now seems likely that reciprocal passporting rights within the EU single market, on which insurance groups' European business models depend, will ultimately be lost. They will, therefore, need to have new structures in place for whenever any transitional arrangement expires - or as soon as March 2019 if there is a "cliff edge" Brexit because no transitional period is agreed.

Those insurance groups which do not already have advanced contingency plans in place should therefore be reviewing their options, given that the timing of Brexit remains uncertain. Groups whose contingency plans are already crystallised will now need to decide when to start the implementation process.

Insurance groups may need to restructure their operations significantly to ensure post-Brexit compliance. This could potentially involve the acquisition of or the establishment and authorisation of new insurers in Europe or the UK, re-domiciliations (eg by way of a cross border merger or SE transfers), and portfolio transfers:

  • UK based insurers need to consider how best to structure their European operations to continue to provide services in EEA States. UK insurers which currently passport into other EEA states will need to obtain additional licences to carry on business in those EEA states or may consider establishing new licensed companies instead, or re-domiciling a UK SE insurer to a continuing EEA state. Capital for these entities will need to be posted in the relevant EEA state.
  • UK insurers which have underwritten European insurance policies may need to run off that business pre-Brexit or transfer the business by way of Part VII transfer to an EEA authorised insurer pre-Brexit. If a UK insurer does not already have an EEA authorised insurer within its group it may need to set up an EEA insurer so that the UK insurer can transfer the business to that EEA carrier.
  • EEA insurers which currently passport into the UK will also need to consider how to operate in the UK going forward. It is possible that the UK will allow branches of EEA insurers to be directly authorised in the UK. If not, EEA insurers may need to set up separate insurance companies in the UK. Capital for such branches or companies will need to be posted in the UK.
  • EEA insurers which have underwritten UK insurance policies may need to run off that business pre-Brexit or transfer the business under the laws of that EEA state to a UK authorised insurer pre-Brexit. Therefore, if an EEA insurer does not already have a UK authorised insurer within its group it may need to set up a UK insurer so that the EEA insurer can transfer the business to that carrier.

Uncertainty about transitional arrangements means the timing for these reorganisations could be very tight. If Brexit is now only two years away there could be serious practical difficulties establishing a new compliant structure in time. Authorisation as an insurer in an EEA state, portfolio transfers, and other relevant processes (eg SE conversions and redomiciliations) can take 12 months or longer. Given the number of reorganisations which are likely to require regulatory engagement during the negotiation period, the timeline for such processes is likely to be significantly extended.

Where are insurers going

A common feature of many groups' Brexit plans is the need to establish an EEA insurer to underwrite European policies post Brexit and to which the European business of the UK insurer can be transferred pre-Brexit. A number of EEA States are being seriously considered, including Ireland, Luxembourg and Malta. Few insurers have publicly announced where they plan to set up their EEA insurer. Lloyd's of London has disclosed that Malta is not on its list. AIG have announced they will use Luxembourg as a post-Brexit EEA hub. European regulators, governments, and service providers have been active in promoting the merits of their respective jurisdictions to insurers since the referendum, in the hope of attracting business from the UK.

Insurance groups deciding where to site a European hub are taking a range of factors into account, including: the approach and reputation of local regulators; practical issues like local salary levels and office costs, availability of talent, the prevalence of English as a business language; how "business-friendly" local employment law is; infrastructure and accessibility, and tax issues. Of course, a key issue for many, is how the chosen hub fits with the existing geographies of their businesses - a UK insurer's first choice is very likely to be a jurisdiction in which it has an existing branch.

Solvency II equivalency for the UK post Brexit?

Like other EEA jurisdictions, the UK has now successfully implemented the EU Solvency II directive. The UK government's current plan is that when the UK finally leaves the EU, the existing body of EU derived law and regulation will remain in place, including Solvency II in as far as it applies to UK insurers. Consideration may be given to whether UK regulation should change post Brexit (and this is already being looked at by Parliament's Treasury Select Committee). However, assuming the UK continues with a regime broadly similar to Solvency II, the UK should have a compelling case to be granted full Solvency II equivalence by the EU. If this is granted, 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, although this could be challenged if the EU group supervisor considers that group supervision by the PRA would not result in more efficient supervision.

However, the timing of any equivalence finding may be a problem for UK (re)insurers and UK-headed groups. Unless equivalence is granted from the point Brexit occurs, there is the risk that there will be an interim period during which UK reinsurers could be treated less favourably than EEA reinsurers by EEA regulators. And, if Brexit negotiations go badly, it is possible that equivalency status will be withheld, whatever the merits of the UK's case.

The post-Brexit future for the London's insurance market

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 , 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 may not be inevitable, but is likely to be secured, and Lloyd'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.

As Brexit proceeds, there is likely to 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. UK insurers will also 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.

Its resilience and creativity has enabled the London market to deal with headwinds in the past. It has traded on through world wars and catastrophic losses and has met evolving sources of competition with vigour . There will be serious issues to confront and the economic, regulatory, legal and political environment for the UK insurance may be in flux for some time, but the UK market can be expected to continue to prosper in years to come - albeit probably without the advantages of easy access to European markets EU membership has brought, and against a different regulatory landscape.