Brexit: impact on insurance regulation

The post-Brexit landscape demands consideration in a number of business critical areas. In our latest report, we examine the outstanding issues around the mutual recognition of regulations, and the impact to UK insurers.

Negotiations regarding the mutual recognition of regulations and - if agreed - the possibility of equivalence in key areas of insurance remains ongoing. However, recent developments (such as the approval by EIOPA of the Packaged Retail and Insurance-based Investment Products Regulation and the UK Chancellor’s statements on financial services) serve to remind insurers that this evolving situation is prone to change, and sometimes more quickly than anticipated.

Key regulations for UK insurer market

The regulation of the UK insurance market is governed by a number of key regulations, many of which were affected by Brexit and yet were not covered in the TCA. Solvency II and the Insurance Distribution Directive are key to the day to day working of the London insurance market, and the struggling negotiations around mutual recognition and equivalence are likely to impact insurers for the foreseeable future

Under the Solvency II Directive, insurers authorised in an EEA member state (such as the UK pre-Brexit) were able to carry on insurance activities in another EEA member state on a cross-border basis or through a branch without separate authorisation in that other state. This was known as ‘passporting’.

This passporting right does not apply to UK insurers anymore. Even if negotiations on equivalence in insurance were to result in the European Commission deeming the UK’s regulatory regime to be equivalent to that of the EU under the directive, it would only cover certain activities, such as capital reporting and reinsurance, and there is no sign of the EU looking to agree any other regime to replace that level of market access.

As declared in the TCA, the EU and UK agreed in an Memorandum of Understanding (MoU) at the end of March to create “the framework for voluntary regulatory cooperation in financial services between the UK and the EU”. It will establish the Joint UK-EU Financial Regulatory Forum, which will serve as a platform to facilitate dialogue on financial services issues. It did not, however, include provisions on equivalence and the EU Commission has not yet made its decision on the equivalence of the UK’s Solvency II rules despite their current alignment. The EU may be waiting to see the outcome of proposed changes to the application of some Solvency II rules in the UK, which we have considered further below.

The Insurance Distribution Directive, which came into effect in the UK on 1 October 2018, deals with the authorisation, passporting and general regulatory requirements for insurance and reinsurance intermediaries/distributors. It also encompasses organisational and business requirements for insurance and reinsurance undertakings and the products they manufacture.

The directive has been enshrined in UK law and so continues to apply to UK insurers and distributors as it did before Brexit. However there is no provision for equivalence under the TCA for insurance and so the cross-border elements of the regime no longer benefit insurance distribution between the UK and EU.

The UK onshored the PRIIPs Regulation in connection with its departure from the EU. Both the UK and the EU are separately looking to reform the PRIIPs regime.

On 30 July 2020, HM Treasury confirmed the UK would diverge from the EU regime once the Brexit implementation period expired by amending the onshored UK PRIIPs Regulation. In the longer term, a broader review of the disclosure regime for UK retail investors is on the cards.

EU reform has been controversial, with the joint European Supervisory Authorities initially unable to agree among themselves whether to endorse their joint report, which proposed reforms to the regulatory technical standards relevant to PRIIPs.

Substantive reforms on either side will mean that, if products are being offered to investors in the EU as well as in the UK, key information documents will need to be produced reflecting both regimes.

On the face of it, there should not be any issues with granting equivalence. We are, after all, dealing with the implementation of EU law. The Commission has previously granted Solvency II Directive equivalence status to Australia, Canada, Bermuda, Mexico, Japan and Switzerland.

However, it is not straightforward. Any equivalence in insurance granted to the UK could only extend to limited aspects of the directive - capital reporting and reinsurance.

The UK declared the EU equivalent for Solvency II purposes on 9 November 2020 (in relation to the capital reporting and reinsurance elements to which equivalence can apply) and has granted EU financial services firms access to the market via a transitional regime, known as the Temporary Permissions Regime. This regime has allowed EEA insurers a lengthy transitional period to continue to operate in the UK, and to preserve contract continuity for those contracts written cross-border into the UK pre-Brexit.

Firms operating under this regime are permitted to carry on their regulated activities, including doing new business, for up to three years from the end of the transition period (31 December 2020). The related run-off regime also allows for the run-off of insurance contracts potentially for up to 15 years.

Even aside from the lack of equivalence decisions from the EU for insurance, transitional regimes are inconsistent between member states with significant, often adverse, differences between them. While the MoU sets the framework for future discussions, there is no suggestion that it would ever lead to access to the bloc for UK financial service providers without local authorisation and presence.

UK and EU political impact on future outcomes

The UK’s main concern is its economic interests, ideally to get access to the EU market under the most preferable conditions possible. Whilst the EU also has an economic interest in the UK market, it is likely to be concerned about other member states withdrawing from the EU if Brexit becomes a success for the UK. If the UK could obtain access to the EU market from outside the bloc, as if it were still a member, this might serve to encourage other wavering states to try to leave.

It is therefore always likely to be politically unacceptable to the EU to allow for a replacement regime to passporting for access by the UK to EU financial services markets.

It has always been the case that an equivalence decision can be withdrawn by the EU at any time for political (or other) reasons, and the EU was at pains to ensure that this unilateral ability was reinforced in the MoU discussions.

One sticking point is the EU’s uncertainty about how the UK intends to alter the rules in the future – a standard which the UK insists is unrealistic and would require the UK to change its rules in step with the EU. The UK considers this as a form of “rule-taking”, which it will not accept.

However the political issues extend beyond the UK’s regulatory regime. The UK’s priority is protecting the world-leading status of the City, while the EU is seeking to strengthen its own markets and financial infrastructure, possibly at the expense of London. The EU is only likely to grant access to its markets where it sees an advantage to its member states.

The UK is looking to reform Solvency II and potentially some of the insurance capital rules inherited from the EU. The Bank of England’s deputy governor and head of the PRA, Sam Woods, has said however, that this is unlikely to lead to fewer requirements, as there would be no interest in lowering levels of resilience or policyholder protection.

Ultimately there seems to be only limited appetite for material change to the overall rules that took so long to implement, but the PRA may look at making changes to tailor regulation to better fit the UK market.

Is the EU ready and able to grant equivalence?

In negotiations before the agreement on the TCA in December 2020, the Commission was reluctant to agree any framework governing equivalence in insurance and was wary of any UK proposal that it considered might limit its decision-making autonomy.

The EU envisaged a framework similar to that with the United States: "a voluntary structure to compare regulatory initiatives, exchange views on international developments, and discuss equivalence-related issues". Its preference was for discussions to be conducted through a general framework for dialogue between regulators and supervisors, which has now been established by the MoU.

The MoU will not be about restoring lost UK market access rights and it will not constrain the EU’s unilateral equivalence process.

The EU has consistently been reluctant to grant the UK any equivalence decisions in insurance. Such a decision may be granted where the UK’s regulatory regime is deemed sufficiently robust to ‘equal’ the EU’s. However, even where the UK meets all necessary criteria, the decision is ultimately at the EU’s discretion, which still shows no sign of being exercised in the UK’s favour. Recent political messages in the UK suggest that it is looking to take a more global approach as hope for any further equivalence from the EU in insurance (and other areas) wanes.

Challenges for the UK

The UK insurance industry will be at the receiving end of equivalence decisions by the EU Commission, whether positive or negative. The EU will only take decisions where they are in its interest and has commented that "The UK intention to diverge requires a case-by-case discussion in each area” which might mean that this will entail protracted negotiations and uncertainty as to timeframes.

As the EU Member States may benefit from reduced UK influence and scope of services provided from the UK in the EU, continued delay and possibly even refusal of equivalence may suit the interests of the bloc. The UK has already deemed the EU to be equivalent and so would have to withdraw that assessment if it wanted to use it in negotiation.

In addition, rules and regulations have to be changed to adapt to new circumstances, and the UK system based on common law will take a different approach than the EU, which is based more on a civil law approach.

Agreement on many aspects of the relationship between the EU and the UK are not expected in the near term. As the EU’s ambassador to Britain (Joao Vale de Almeida) recently said “Brexit is a living animal which may never be complete… [it is] done in a way, but not done in another way. It requires permanent attention permanent investment…trust, trust and trust – but there’s not trust right now.”

In light of this, UK financial services companies need to deal with the EU market requiring an authorised presence within the EU and that is unlikely to change in the near future.

State of play

Insurers who have set up a dependency in the EU before Brexit, such as Lloyd’s Brussels, are able to continue underwriting risks from all EEA countries, provided passporting within the EU has been set up appropriately.

Reinsurance back to London-based underwriters can help to allocate commercial value, although the lack of equivalence decisions by the EU may hamper these arrangements where local restrictions apply (for example in Germany).

Insurers need to ensure that wordings are clear and fit for purpose when underwriting risks from an EEA country; country-specific variations may be required, such as data protection notices, insurance product information and complaints notices for individual countries, pricing adjustments. Policies affected by Brexit will require special endorsements if, for example, there is reference in the policy to EU territorial scope or if coverage provided is defined in reference to EU law or regulations.

Intermediaries operating cross-border between the UK and EU will have to ensure that they have sufficient regulatory authorisation to operate in the relevant EU states as well as in the UK. They should not still be waiting for a replacement regime to replicate the pre-Brexit position.

This situation will remain for the foreseeable future as mutual recognition of insurance regulation between the UK and EU in a way that creates general access between these markets is unlikely to be resurrected in the post-Brexit world.

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