The United Kingdom has been a member of the EU for 43 years and consequently, this membership has enabled businesses to trade openly across the entire EU market. For the insurance industry this has meant that UK insurers were able to write businesses in other EU countries without any further local capital requirements. Since Brexit is taking place, the UK is currently having to negotiate a withdrawal agreement which could mean that the UK loses access to trade freely in the future. In order to gain the right to underwrite businesses, UK insurance firms may be required to open EU branches which will result in resource and cost issues.
Furthermore, there are many other issues that may arise due to the UK leaving the EU. The UK may lose EU workers, thus reducing the talent pool. Other countries including the United States and China who currently view the UK market as a direct platform to conduct trading, may alter their view when Britain does exit the EU. The economy of a country has a direct impact on insurance companies within that country. For example, when the economy is down, fewer businesses will have the extra capital to spend on insurance.
To add, when the economy is doing well, investment returns will increase meaning insurance companies will be more likely to accept a claim. Sterling had a severe fall after the Brexit vote although now it is gradually recovering. On the contrary, Switzerland is the main example of a financially stable nation which is not a member of the EU. Also, the UK could be liberated from regulations such as Solvency II which could be argued to not impact the credibility of the UK but rather to eliminate the excessive costs. Insurers could also be freed from the EU Gender Directive which will then enable firms to factor gender into the pricing of insurance.
This report will investigate the different effects Brexit will have on the UK economy- specifically the insurance market, focusing primarily on the impact that EU membership has had on this market in the past. 72% of British people took part in a momentous vote and 52% of these people had voted for the United Kingdom to exit from the EU in a referendum which was held on Thursday 23rd June 2016. Shortly after the results were declared, the pound fell to its lowest level since 1985.
Furthermore, Britain lost its top AAA credit rating after the Brexit victory and economic shockwaves were sent through global markets. In order to stop the UK from slipping into a recession, the Bank of England decided to cut interest rates as well as undertaking other emergency steps. There has been and still is ongoing uncertainty over what will happen when Brexit takes place, as Britain needs to make new trade agreements with the rest of the world. Neil Woodford who is the head of investment at Woodford Investment Management, has stated that he can clearly see why the Brexit vote had been seen as an ‘existential shock’ to Britain’s economy.
Brexit supporters argue that the EU imposed tariffs for goods being removed will in fact reduce the cost of food by up to 40%, and the cost of clothing by up to 20%. It is believed that this will free up consumer spending, hence helping inflation. Nevertheless, despite the sudden fall in the pound, the UK economy is growing just slightly below its long-term trend and unemployment has fallen to a 42-year low. After the Brexit vote, most economists believed that a recession was imminent. However, there has not been a recession. The question is whether this unexpectedly good performance will continue.
Insurance Market and Brexit
The fact that the UK has been part of the EU for 43 years, highlights that Brexit will, without a doubt, have an impact on businesses and thus the insurance market within Great Britain. London is one of the hubs of the global insurance market. It is estimated that London branches underwrite almost £6 billion of insurance premiums. Chairmen of 36 FTSE 100 companies said Brexit would indeed ‘deter investment and threaten jobs’ as the UK would have to negotiate a withdrawal agreement which could then result in full denial of access to trade freely in the future.
In addition, UK insurance firms have direct access to single market across 28 countries; roughly half a billion people. Consequently, insurers can conduct cross-border business without requiring additional authorization. However, due to Brexit, insurance companies may be required to open up EU branches in order to conduct business more efficiently. Deutsche Bank, for example, is moving parts of its British division to German due to Brexit. Keith Richards, managing director at CII, claimed that ‘the economic confidence across the insurance profession is at its lowest level since 2011’.
Theresa May (2017) has proposed a ‘phased period of implementation’ in order to give firms breathing space to consider what the new EU-UK partnership could mean for them. She also is specifically focusing on maintaining the freedom to provide financial services across borders and talk of a phased approach will be welcomed by insurers. The ongoing uncertainty about Brexit means that investors should take precautions and possibly increase their exposure to non-UK investments.
OpenEurope (2016)- Initial impact of Brexit
18.4% of the insurance market is exported to the EU, nevertheless, from the table we can see that the risk of disruption is not as high as other sectors including cars, food and chemicals. This means that if there is an increased exposure to non-UK investments then risk of disruption could be kept to a minimal. On the other hand, opening new branches and subsidiaries to underwrite policies in EU member states will cost companies their time and money. Small companies who lack resources will be unfortunate when trying to provide coverages across multiple countries.
Market volatility will also effect insurers to a certain extent regardless of whether they are headquartered in the UK, EU or elsewhere. The Solvency regime came into effect in January 2016. Solvency II has reportedly cost the insurance industry over £3 billion. When the UK exits the EU, Britain will no longer need to comply with Solvency II, however, the FCA and PRA have already implemented the requirements of Solvency II and UK regulators have been involved with and influential upon the design of the Directive, therefore it is highly likely that a similarly high regulation will continue to take place in the UK. Solvency II is an integral part of the system in the country.
However, to maintain equivalence recognition, the UK will most probably need to track changes in the Solvency II regime as they are made by the EU, which may be politically unacceptable. Moreover, EU legislation includes the EU General Data Protection Regulation which demands for mandatory reporting of personal data breaches and cyber security incidents. Both developments certainly increase the uptake of cyber policies and as a result will also provide better data, enabling more accurate pricing of cyber risks.
However, following Brexit it will be questionable as to whether the UK will mandate reporting to the same level. Insurance contract law in England is not governed by EU law by rather has been shaped by UK derived law. For example the Insurance Act 2015 and the Consumer Insurance Act 2012. No changes to these regimes will be expected after Brexit takes place. Skilled labor from the EU countries make up a large percentage of the UK insurance sector workforce. If restrictions are placed on these EU workers, then companies will have to revise their workforce strategies.
This means there will be less freedom for labor movement and more difficulty in finding people with traditional insurance expertise such as underwriting and claims. It has also been confirmed that UK’s credit rating has been cut from AAA to AA and the credit ratings of some UK insurers have declined. This is due to the uncertainty within the market. The value of the pound against the dollar and euro has fallen which will indeed have an impact on claim exposures denominated in foreign currencies plus capital denominated in pounds.
In addition, in January 2018, news broke warning companies that the UK is set to become a “third country” as they will have no automatic right to operate in the single market and how this may provide a great opportunity to sell the pound against the dollar. Experts have warned that the UK could end up at the bottom of the growth table as the rest of the world’s bond yields are rising, however although the UK economy is not as bad as the people feared, it still seems to be “limping” along due to Brexit.
Bloombery Markets (2016) GBP to USD during Brexit
On the contrary, Brexit voters argue that the UK can in fact be a more attractive destination to do business when it is finally independent of the crisis and uncertainty of the Eurozone market. A key example of this is Switzerland, who is a financially stable nation despite not being a member of the EU. Switzerland does have access to the EU market however does not need to comply with the EU laws. Two of the world’s most reputable and successful insurers, are headquartered in Switzerland, thus avoiding the tough capital requirements of EU regulations.
It is difficult to say whether the overall negatives outweigh the positive effects of Brexit, again due to the uncertainty, however, it is fair to say the insurance industry will face more cost and complexity leading to Britain officially leaving the EU. Significant uncertainty within the insurance industry will remain. Leading up to Brexit will be troublesome for companies who need to consider several different matters. Several insurance companies have announced plans to set up new subsidiaries in other parts in the UK in order to access markets when the UK’s passporting rights disappear in 2019. If insurers do set up a subsidiary in the EEA to perform cross-border transactions, this will be time consuming and costly.
UK insurers will lose the solvency passport and therefore they have to make changes in their group structure to provide for a presence both within the EEA and the UK. The loss of easy access to the EEA market may make investment in such UK based insurance firms much less attractive, although a weak sterling may also contribute to this. Fundamentally, it is believed that London will remain at the heart of the insurance market, therefore companies should set out strategies that will limit the amount of disruption to the UK industry as firms should not wait for the outcome of Brexit negotiations to take action.
The ultimate outcome of the negotiations are hard to predict however insurance groups who do not already have advanced contingency plans should start reviewing their options. Furthermore, those companies whose contingency plans are set will now need to decide when to start the implementation process. UK based insurers will need to consider the best way to structure their European operations so that they are able to continue to provide services in EEA states. UK insurers who currently passport into EEA states will have to obtain additional licenses to pursue business in those states or may consider establishing new licensed companies.
UK insurers which currently have European insurance policies underwritten may need to run off that particular business before Brexit or transfer the business to an EEA authorized insurer. Many UK insurers have an EEA authorized insurer within its group, however, if it does not then they may need to set up an EEA insurer so they can transfer the business to them. EEA insurers who are passporting into the UK will also need to consider its operations. European regulators have been active in promoting their merits to insurers in the hope of attracting as many businesses from the UK as possible.
For example, AIG have announced that they will use Luxembourg as its post-Brexit EEA hub. Other companies which are currently deciding which EEA state to start operating in will need to consider practical issues such as office costs, availability of talent, tax issues and infrastructure. Ultimately, there is no point looking back since the UK will undergo Brexit. UK insurers need to find new opportunities as well as raising concerns. There will be a scope to do more business globally and insurers need to respond to customers’ changing needs. An example could be that there will be more demand for trade credit insurance as there are fewer EU protections.