Brexit and the UK insurance industry: Preparing for a worst-case scenario

With notice under Article 50 of the European Treaty having been delivered, the UK will leave the EU on March 29 2019. Negotiations on the terms of departure and any future relationship have at last commenced. The terms of negotiation are that, while the talks will focus on issues sequentially, any deal will need to be ratified not only by the UK Parliament but by all 27 remaining members, before it is operative. One veto of one element will mean no deal or, at least, that a deal will be delayed very probably beyond March 29 2019.

There is a very real possibility, given the nature of the negotiations, the volume of business to be discussed and agreed, the uncertainty as to the UK government’s aims and the uncertainty as to the approach that any one of the 27 countries may take to a deal, that in April 2019 and for some time afterwards, the UK will have left the EU in the hardest possible way.

This is a worst-case scenario but business planning necessarily must envisage and cater for the worst case, particularly when the probability that it will occur is as high as it is.

“Some of the impact of a hard Brexit is inevitable, even if a softer Brexit is ultimately negotiated and agreed”

The UK insurance industry is highly regulated. In January 2016, the European standard, Solvency II took effect after around 15 years of planning. Any planning for the effect of Brexit must take regulation into account. It will involve corporate restructuring. Corporate restructuring will require regulatory approval and therefore must start immediately. Indeed, it ought to have started some time ago.

Sadly, this means that some of the impact of a hard Brexit is inevitable, even if a softer Brexit is ultimately negotiated and agreed.

There are approximately 500 insurers authorised in the UK by the Prudential Regulatory Authority (PRA). Of these, a number are mutual or other insurers with a solely domestic agenda. Others are subsidiaries of multinational concerns which already have a presence in the EU. There are then around 100 insurers that operate from the UK and are passported into Europe. Some of these are the EU operating subsidiaries of US, Japanese or other international companies.

For this select group of companies, the solution that presents itself is very straightforward. A subsidiary needs to be incorporated and authorised in an EU jurisdiction and, ideally, EU business previously underwritten transferred using a statutory portfolio transfer from the UK entity prior to March 29 2019. Most companies in this category, as well as Lloyd’s itself, are already in an advanced state of preparation. Companies are being formed in Belgium, Luxembourg, Malta and Ireland. The regulators in those countries have, in some cases, recruited additional staff to deal with the extra workload. The one question that remains unanswered is how much control will have to be exercised from that new jurisdiction. There is concern that senior management will be required to place their feet and their underwriting staff firmly on the ground.

On the other hand, there are 703 EU and European Economic Area (EEA) companies who have passported into the UK. This is a significantly greater number but understandable as London is the global hub of the insurance and reinsurance world. When Brexit occurs, unless steps are taken, these companies will be left unregulated. Even if they cease accepting new business today, many will have policies that will continue post-March 2019 and all with have liabilities that extend beyond that point in time.

In an ideal world, those companies would do the reverse of what the UK companies are doing. They would establish subsidiaries in the UK, have them authorised and then transfer their UK business to them. A subsidiary rather than a branch is the only sensible way to operate in the light of Solvency II and the UK regulatory regime post Brexit which will be identical to Solvency II. A branch could attract double solvency requirements whereas a subsidiary will not.

“We are left with a position in which a significant number of EU and EEA insurers will have books of UK business and may well be operating in the UK without authorisation”

Sadly, this is logistically impossible. Only three new insurers have been authorised in the UK in the past four years. These each took between 30 and 36 months to authorise. The PRA, operating under budgetary restraints, cannot recruit additional staff. Until the company is authorised, a statutory portfolio transfer cannot occur into it. In any event, statutory portfolio transfers take time and can only occur within the EU or EEA. Once the UK is out of the EU, and presuming a worst-case scenario of no deal, there will be no transfers.

In early 2015, 12 months before Solvency II came into effect, the UK’s PRA wrote to insurers informing them that if they wanted to perform statutory portfolio transfers as part of pre-Solvency II planning and restructuring, they were already too late and that no new applications would be looked at until after the implementation of that regulatory regime. Brexit will create a far greater bottle neck than Solvency II.

So, we are left with a position in which a significant number of EU and EEA insurers will have books of UK business and may well be operating in the UK without authorisation. They will be acting illegally. It is very unlikely, however that they will be prosecuted. It is even more unlikely that anyone will seek to claim that their illegal operation renders any of the contracts that they have underwritten void.

It may be asked, why this should be a problem. These are all companies regulated under Solvency II. They all have sufficient solvency. Who suffers if they are not regulated in the UK?

“There is already evidence of companies offering policy periods of up to five years.” 

The problem is that the operation of passporting is predicated by the existence of reciprocal enforcement of judgments provisions which exist as a result of EU law. These treaties will disappear with Brexit. Without any agreement on the subject, it will not be possible to enforce a judgment given in the English court throughout the EU and EEA as though it was a judgment of the local court. Passporting requires that insurers maintain solvency in their home jurisdiction but reciprocal enforcement of judgments legislation allows that to be accessed as though it was help locally.

After March 20 2019, policyholders will be obliged to sue in England pursuant to the jurisdiction clause of the policy and then, once they have a judgment, sue again in the domicile of the insurer. An altogether more time consuming and expensive procedure which could throw any number of obstacles at the policyholder.

Of course, there are ways around these issues. A deal on Brexit or, at least, transitional arrangements would help considerably but until these are in place and ratified, the danger remains and it is a danger that will grow. There is already evidence of companies offering policy periods of up to five years. With the disorder anticipated at the time of Brexit coupled with the relatively soft nature of the market, one can expect renewals or replacements of commercial insurance policies to be offered with similar terms. Where these contracts are taken with passported companies, they may be being taken without the protections that regulation affords.

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