Lloyd’s assesses the impact of Brexit for insurers

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The United Kingdom is scheduled to hold a referendum on whether its citizens wish the country to remain a member of the European Union (EU) by the end of 2017. More recently, Thursday June 23 2016 has been mooted as the date on which the nationwide vote could take place.

Although that date is little more than four months away and recent opinion polls indicate growing public support for a ‘Brexit’, few companies appear to have made contingency plans for the possibility that the UK might leave the EU. The Financial Times last week reported that it had contacted every FTSE 100-listed company and found that only four confirmed that they were in detailed planning on how to respond to a Brexit.

The perspicacious four are budget airline easyJet, construction group Persimmon, engineering group GKN and insurer Standard Life. Edinburgh-based Standard Life is in fact considering the prospect of an imminent divorce for a second. In the run-up to the September 2014 referendum on whether Scottish voters wished it to secede from the rest of the United Kingdom, the company publicly stated that its head office could relocate to London if Scotland became independent.

Lloyd’s of London, the capital’s insurance market founded in 1688, does not qualify as a company because of special constitution which sees it operate as a market of members. However, it still wields considerable influence and chairman John Nelson has already spoken publicly on the importance of the UK remaining a member of the EU – both for Lloyd’s itself and the wider economy. Sean McGovern, its chief risk officer (CRO) and general counsel, has this week joined the debate.

In a widely-trailed speech, he said that a Brexit would create a level of uncertainty, for Lloyd’s, the wider London insurance market, as well as the UK and European economies that “we have rarely experienced”. The UK’s relationship with the EU had always been a pragmatic one, but this had generally served both parties well – particularly the financial services sector.

A closer call than 1975

While the relationship had often proved fraught, EU members recognised that the UK remains a major world economy and its membership strengthened the Union overall.

However, many Britons were less convinced. In a 1975 referendum, voters opted to remain in the EU by a margin of 2 to 1, but the 2016 polls were much closer with some showing a majority for leaving.

McGovern has been responsible for Lloyd’s engagement with Brussels for the past 10 years and said the EU was not perfect. “Over recent years the EU has been inwardly focused, shown an over-enthusiastic desire to regulate and paid little attention to ensuring that EU based businesses are positioned to compete around the world.”

Changes that improve competitiveness were therefore welcome. Under president Jean-Claude Juncker the European Commission aims to reposition the EU through initiatives to free up financial markets through the capital markets union (CMU), reduce regulatory burdens on financial services and focus more attention outside the EU through negotiating new trade deals.

The tone of the Commission’s interaction with business has changed, said McGovern. “There is an openness and willingness to discuss and debate that did not exist two years ago,” and it had obviously heeded politicians and business leaders’ advice.

Benefits of the EU

EU membership has also helped London’s insurance market develop into the largest global hub for commercial and specialty risk – controlling more than £60bn of gross written premium. It is a made of up over 350 firms contributing over 20% of the City’s gross domestic product (GDP) and employing 48,000. It also has “the expertise and the capacity to take risk within a regulatory framework and tax environment that has been attractive to the inward flow of capital.”

From the London insurance market’s perspective, UK membership of the EU confers three important benefits –
• Access to the European single market.
• Encourages foreign direct investment (FDI).
• Facilitating trade with countries outside of the EU.

The single market

McGovern stressed that the single market was the biggest benefit for the UN insurance sector, giving access to a market of over 500m people. The EU is the world’s largest insurance market with a world market share of nearly 33% and total insurance premiums of nearly €1.4 trillion. The London insurance market writes £6bn of premium income from the EU and can also “recruit the very best Europe has to offer.”

The single insurance market, confirmed in the Solvency II regime, enable Lloyd’s underwriters to write insurance and reinsurance from all of the other 27 member states on a cross-border basis and also locally in countries where it has branches.

McGovern admitted that the system of regulation which facilitates access “comes at a price and that price has gone up recently. I am of course talking about Solvency II. We know that its regulatory requirements are formidable and it is far from perfect.

“But let us not forget that UK regulators were at the EU table when the Solvency II regime was designed. Indeed the regime is built on regulatory concepts which our own regulators have supported and advocated.”

Investment

London is seen as an attractive destination for overseas investors thanks to its economy, skills, and taxation system, said McGovern.

“The UK attracts more foreign direct investment (FDI) than any other EU member state, and financial services attracts more than any other sector. Lloyd’s capital base is a testament to that attractiveness given that most of our capital comes from outside the UK.

“For Lloyd’s, further diversification is essential. If we want to retain our position as the hub of global insurance and reinsurance, it is because we can offer the best of all worlds in terms of London and single market access. “

Trade

McGovern noted that the debate typically focuses on the UK’s relationship with Brussels and the countries within the EU. “But that is too narrow a view and we must also consider how the EU, and therefore the UK is able to look out and interact with the wider world.

“Trade agreements between countries are a key tool for boosting trade and removing barriers to the conduct of business worldwide.”
Within the EU, the European Commission (EC) negotiates on trade agreements on behalf of EU member states and has concluded agreements with 55 countries worldwide. A further 87 are in progress, including the US through the Transatlantic Trade and Investment Partnership (TTIP).

Existing agreements to which the UK is a party via its EU membership cover 59% of the UK’s global trade and will rise to 88% if the EU is successful in its current trade negotiations, said McGovern. With 90% of global economic growth expected to be generated outside Europe over the next 10-15 years the importance of this trade activity cannot be under-estimated.

The bottom line

“We must recognise that, if the UK leaves the EU, other countries may show less appetite for making agreements with a UK of 63m customers than they do with an EU of 500m customers,” said McGovern. He quoted Michael Froman, US trade representative, who has said “We’re not particularly in the market for free trade agreement (FTAs) with individual countries.”

Among the other likely repercussions of a Brexit:

It would create a precedent for EU countries to leave the bloc: “Problems within the Eurozone and over migration from outside Europe have led to a surge in euro-scepticism across the Continent,” said McGovern. “It is quite possible that governments of other member states would come under pressure to follow the UK’s example and to hold referendums on membership. Europe is already under pressure in the Eurozone and with migration. Further instability caused by Brexit could be an unwelcome reality.
It would fuel European financial markets turmoil: International Monetary Fund (IMF) managing director, Christine Lagarde takes the view that a potential Brexit would cause turbulence for global financial markets and calls for a swift deal for the good of the European and world economies.
It would create uncertainty: In particular, uncertainty around the timescale of the negotiations between the UK Government and the EU “would put Britain in a limbo, making it less attractive to foreign investors.”

Even now, in advance of any referendum, the Bank of England (BoE) governor Mark Carney has warned of financial instability, higher interest rates and capital flight in the event of a vote to leave, “If we believe what we read in the newspapers the BoE is already building up its foreign exchange reserves,” said McGovern.

“I am not scaremongering. My job is to assess risk objectively and dispassionately and ensure that we are prepared. If our experience in the Scottish referendum taught us one thing, it is the potential flow of events will lead to more uncertainty for the UK, not less.”

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