The Intelligent Quarterly from the publishers of The Insurance Insider

Summer 2018

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All aboard for Brexit

Laura Board

Prime Minister Theresa May's January pledge to navigate the UK towards a "bold and ambitious free trade agreement" on Brexit rather than sail within the familiar waters of the EU single market might, for hard-line leavers, have evoked the pioneering spirit of 18th century explorer Captain James Cook.

For many in the insurance industry, already in the throes of contingency planning, it has confirmed that they too will need to plot a new course.

If generalisations are possible on such a divisive issue, it's fair to say that Brexit hasn't thrust the London market into the state of abject gloom engulfing many banks and fund managers.

That's largely because the EU, excluding the UK and Ireland, accounts for a relatively modest slice of London market premiums.

At Lloyd's, for example, 14 percent of the £26.7bn ($33.3bn) of gross written premiums (GWP) written in 2015 emanated from the EU outside the UK.

The Corporation estimates that up to 6 percent of Lloyd's premiums could be affected by the loss of the intra-European Economic Area financial services access rights known as passporting.

Neither is the EU generally cited as one of the London market's most promising growth markets, unlike China - where Lloyd's GWP surpassed 2bn yuan ($271.2mn) in 2016 - India or Latin America.

But that's not to say that Brexit won't stifle the way that many players do business. Worries include: reduced market access, increased capital and regulatory burdens, potential hiring restrictions, and the impact of the fracture on both UK and EU economic growth.

Restructuring options
Proof of how seriously insurers are taking the changes lies in the flurry of restructuring options under consideration.

Brexit preparations already in train include so-called Part VII portfolio transfers - court and regulator-sanctioned schemes that advisers say can take up to a year. At least one company is seeking to revive a mainland EU subsidiary currently in run-off, while others are considering swallowing the capital disadvantages and establishing EU subsidiaries for the first time.

Click to enlarge Beazley said on 2 February that its Dublin-domiciled reinsurance business filed a Central Bank of Ireland (CBI) application to become an EU insurance company in November.

Meanwhile, Chaucer filed in October last year to establish an EU subsidiary, while trade credit insurer Equinox is planning to establish a Hamburg-based German limited liability company, or GmbH.

And in February Hiscox said it had narrowed its choices for its EU-based insurance company to Luxembourg and Malta. The company said last year it generates GWP of £260mn in the EU; the 2016 group total was £2.4bn.

AIG Europe became the first major player off the mark when, on 8 March, it selected Luxembourg as the location for its EU subsidiary. QBE Europe said in February that it was close to making a decision after weighing locations including Dublin.

And many others are making preparations under the radar.

"People spent the fourth quarter of last year weighing up their options," says one insurance industry consultant. "In the first quarter you are going to see refinement, a narrowing down of options or companies selecting their preferred option, with applications going in during the second quarter."

The source adds that companies are "planning to have the model they need to have in place in two years' time" - before the expected end of Article 50 negotiations in March 2019.

And all are closely watching Lloyd's decision. The Corporation is understood to be veering towards a Benelux hub, though Ireland and Germany also made the shortlist. In January, Lloyd's CEO Inga Beale told a meeting of sister publication The Insurance Insider's London 100 forum that she favours a jurisdiction that would allow for an "infrastructure-light" operation, in part so Lloyd's can swiftly pedal back should the UK secure satisfactory market access rights.

On the move
Of the options under consideration for the (re)insurance sector overall, Luxembourg and Dublin have emerged as the frontrunners, with the latter arguably pulling ahead in recent weeks.

Dublin's appeal includes a common law legal framework that closely replicates the UK's. It already hosts the operations of US and Bermudian insurers, as well as of UK groups.

The CBI is an experienced regulator and oversees the second-largest number of internal models - or bespoke risk assessment structures - under Solvency II in the EU, after the UK.

However, the CBI's insistence that subsidiaries located in the Republic of Ireland have a significant on-the-ground presence appears to have dented its allure.

Alternatively, a brass plate on a door in Luxembourg City may afford Lloyd's and other restructuring companies greater nimbleness. Another point in the country's favour is the percentage of premiums the Commissariat aux Assurances will allow carriers to reinsure out of Luxembourg, sources say. It also has an attractive tax regime, even though its headline corporate tax rate is almost double Ireland's.

Germany's regulator, Bafin, isn't generally known for being accommodating. Indeed, it is one of the few in the EU that imposes collateral requirements on "third country" reinsurers.

For US carriers at least, this requirement will fall away if the covered agreement-in-principle struck between the US and EU last month becomes reality. However, insurance companies report that the German regulator has also been helpful to Brexit refugees.

And even the French regulator, the Bank of France's Autorité de Contrôle Prudentiel et de Résolution, has an English language section on its website to elicit queries related to Brexit.

Equinox CEO Mike Holley says he's observed a regulatory "window of opportunity, where if you are a British company in financial services the red carpet will be rolled out". Equinox's Hamburg unit will give it passporting rights elsewhere in the EU, where it has operations in France and Netherlands.

Passport control
Passporting, under EU treaties and Solvency II, gives an insurer in one EU or European Economic Area nation the right to either offer services elsewhere in the region or establish branches, depending on the type of passport it has. A single regulator vets the entire operation and a single balance sheet supports the risk.

A loss of passporting rights raises question marks over UK-based insurers' ability to write or control from London any non-marine, aviation or transport (MAT) risk emanating from Europe.

Particularly vulnerable to the loss of passporting, says Sidley Austin partner Michael Membery, are those "many insurers who engage agents/brokers/MGAs to act on their behalf in the EU - which has the effect of bringing the UK insurer onshore".

Some observers believe passporting rights could yet form part of the "transitional" arrangement the UK prime minister said she would seek from Brussels. Alternatively, something similar to passporting may be a component of "the freest possible trade in financial services between the UK and EU member states" that May said she wants in the UK government's 2 February Brexit White Paper.

However, one seasoned Brussels-based insurance representative calls such hopes "beautifully naïve", given the EU mood music.

What seems more achievable than passporting is a form of regulatory recognition known as equivalence.

Equivalence, as defined by Solvency II, has three planks. Two concern regulation and capital requirements for non-EU groups operating in the EU, and EU groups with subsidiaries in countries deemed "equivalent" from a regulatory perspective.

The third pertains to reinsurers and means that "third country" reinsurers from "equivalent" jurisdictions don't need to pledge collateral to write new business in the bloc. Direct insurers do not feature in this arrangement.

Since the UK's Prudential Regulation Authority is arguably one of the most enthusiastic - and hard-nosed - Solvency II watchdogs in Europe, it would be hard for even the most embittered of the UK's jilted EU partners to argue that its insurance regulations weren't comparable.

But it's far from ideal, not least because it would likely preclude the UK insurance industry's desired tweaks to the Solvency II framework. Equivalence can also be cancelled with 30 days' notice.

What many in the industry are rooting for instead, therefore - as is May herself - is something less "off-the-shelf".

"If you are looking at equivalence from where we are now - which is full compliance - it is likely to allow less flexibility in terms of what adjustments we can make for the UK market, but mutual recognition allows us to be more bespoke for the UK," says PwC's UK insurance practice leader Jim Bichard.

"We may not have passporting per se, but if we have the ability to still trade in a similarly competitive way as we could before, that is the right way to approach it," he adds.

Options open
A UK-based insurer that buried its head in the sand and did nothing between now and March 2019 would probably still have options after Brexit, even if the amicable divorce Prime Minister May is seeking is rejected by lawmakers at home or in the EU.

Solvency II rules already allow third country insurers to establish branches in Europe, albeit under the supervision of individual local regulators. And World Trade Organization regulations permit cross-border writing of MAT risk, both direct and reinsurance.

Some London market protagonists already have EU subsidiaries, while others have operations in the "equivalent" jurisdiction of Bermuda or in the US - which has a type of provisional equivalence and should begin to benefit from the reinsurance covered agreement struck last month with the EU well before the March 2019 Brexit agreement deadline.

Thomas Dawson, a partner at law firm Drinker Biddle, says: "Pending negotiation of a bilateral EU-UK (re)insurance trading agreement, many groups have options, perhaps multiple options, to continue to write European-origin reinsurance business."

And new options could be in the pipeline.

Marsh UK and Ireland CEO Mark Weil believes his firm has come up with a legally watertight "Plan B" alternative to the complex business of establishing EU subsidiaries. He notes that these licence applications risk being "timed out" by the two-year Brexit process, or falling victim to political interference or even to additional fragmentation of the 27-nation bloc.

His firm is offering what it calls a "bridge solution" that would formalise the type of fronting arrangements commonly used in Latin America into a defined structure. The arrangement, which Marsh may facilitise, offers what Weil believes is a means to achieving EU market access that "puts clients back in control".

Weil says he doesn't see Brexit as "existential" for the London market. "I don't think Brexit will be the issue that makes or breaks London," he adds.

Long-term play
Some Brexit optimists go so far as to argue that the global free trade agreements May is promising in addition to her Brexit deal with the EU could ultimately leave British insurers better off, while fewer rules could provide opportunities.

AM Best said last month it would take no ratings action on UK life and non-life insurers as a direct consequence of Brexit, although it acknowledged that the UK's retreat is credit negative.

And among the Brexit contingency planners it's notable that several, including Beazley, say they don't expect a major impact from the fracture.

Speaking in a private capacity last month at a Brexit event organised by insurance software group Sequel, industry veteran Michael Wade was sanguine about the opportunities for the London market - and noted that the fallout would cut both ways.

The former Besso chairman, who is now a senior adviser to the Cabinet Office and to Swiss Re, estimated that about £8bn of London market direct and reinsurance premiums are written from the UK in the rest of the EU. He said about £6bn is written by EU companies from outside the UK using passporting.

"We have an absolute commonality of interests," he said.

Wade, a "remainer" in the referendum, called for the London market and continental reinsurers to lobby for the UK to obtain equivalence - an effort he said doesn't need to be part of mainstream Brexit negotiations.

"My conclusion for the London market is one of considerable confidence and optimism," he said. "I think we are in quite good shape to carry on and expand our business interests."

And expansion - rather than the status quo - is the key, according to Beale. At the London 100 event last month, the executive dismissed the notion that that the EU wasn't terribly important for the London market.

"This is a long-term play," she said of Lloyd's Brexit preparations. "This will all be part of ensuring we can be around for hundreds of years to come."

This article was published as part of issue Spring 2017

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