Brexit risks and issues for insurers

All eyes are now on the Leave campaign’s leaders and how the UK will enter an exit negotiation (once Article 50 is triggered).

The expectation is that the new government will either be led or strongly influenced by those who led the Leave campaign (assuming the new Conservative leader holds a general election and wins it). It is now incumbent on those leaders to explain how they will recast the UK’s relationship with Europe and the rest of the world.

Whilst we wait for that new landscape to be revealed, the insurance market is now faced with business uncertainty. Continuing access to the single market is arguably the biggest concern.

Additionally, there may well be fears about the impact on insurers’ ability to recruit and retain EU talent, as political focus is likely to shift to reducing the number of EU migrants coming to the UK.

The report on the referendum commissioned by Kennedys and published last month, Brexit: the insurers speak, found that most of the experts interviewed thought it would prove difficult for the UK to negotiate an exit that maintained full EU market access.

Larger global players envisaged a direct, negative effect on their businesses, while smaller domestic companies were worried more about the wider domestic economic impact of Brexit. The ratings agency have already downgraded the UK to a negative outlook with the UK’s GDP growth projection in 2017 slashed to 0.2%.

Based on the findings of our report, we provide a summary of key issues for insurers to consider following the Leave vote.

Issues for insurers

Issue	Outcome
Single market access	The UK will maintain market access in the short-term. In the medium-term it will have to renegotiate its access to the single market through a bilateral agreement with the EU. Firms in the UK operating Freedom of Services (FoS) provisions will need to consider how their current operations would be affected by any loss of the UK’s passporting arrangement. The potential for tariff barriers on insurance business would be very low under any alternative market access agreement, but non-tariff barriers (equivalence standards on UK regulations) would be a key area of concern.
Access to the rest of the world	Britain will be free to re-enter the WTO and commence work on its own network of FTAs. While this may create a period of uncertainty it is likely to have limited impact on cross-border insurance groups with local branch operations.
Business impact	All businesses are likely to feel the short-term impact of increased uncertainty and the prospect of market volatility. In the long-term any loss of passporting freedoms, and the ability of UK firms to freely access the single market, will be felt differently depending on the nature of the firms’ business. Domestic business only: low impact Cross-border business serviced via FoE provisions: low-to-medium impact Cross-border business serviced via FoS provisions: medium-to-high impact
Employment protection for workers employed in the UK	The UK will be free to withdraw from the European Social Chapter and disapply EU employment protection rules, such as the Working Time Directive. Rulings by the European Court of Justice (ECJ) will no longer apply to workers in the UK. This potentially enables the UK to benefit from more flexible labour markets.
Hiring skilled workers outside the UK	Political pressure to reduce net migration figures could result in potential constraints on ability to hire EU citizens. Firms which have workforces drawn from across the EU would need to consider potential visa arrangements. The uncertainty around working status of EU workers could also have an impact on firms attempting to attract workers from other EU countries. Conversely importing skills from the rest of the world may become easier.
Regulation	Firms may benefit from limited liberalisation of the UK market, particularly in wholesale markets exposed to more intense global competition. The overall cost of EU regulation – estimated by Brexit campaigners at £600m per week for the whole of the UK – could be reduced but the major elements of the legislative framework (e.g. Solvency II) would remain largely intact. Regulatory divergence between the UK and the EU could drive additional compliance and agency costs for cross-border insurers.
Cost of capital	A UK-styled Solvency II regime would remain broadly equivalent to EU rules. However, fulfilling the Solvency Capital Requirement could potentially become more expensive. Firms would need to consider the scale of such cost, and the likely impact on policyholder’s premiums.
Impact on Sterling	A further devaluation of Sterling would be predicted – potentially in the order of 15-20%. This would lead to a devaluation in UK assets. The insurance sector is a major holder of UK assets, equivalent to 25% of the UK’s total net worth.
Impact on bond markets	Spreads between the UK bond market and Eurozone would be likely to widen boosting returns to UK bondholders. The insurance (general and life) sector is one of the largest holders of UK bonds.

What happens next?

Formally, nothing in the UK’s relationship with the EU will change until the UK government decides to enact Article 50. Chancellor of the Exchequer, George Osborne, confirmed yesterday that this will not happen until a new Prime Minister is in place (by 2 September 2016) and an OBR (Office for Budget Responsibility) assessment of the UK economy is made. This will give the UK government time to prepare its negotiating objectives before setting in motion a deadline to complete what are certain to be highly complex, technical and politically sensitive negotiations.

It is likely that an incoming Prime Minister will wish to call a snap general election in the autumn in order to establish a personal mandate setting out the UK’s objectives for any future negotiations with the EU. Only after this point would Article 50 be triggered.

It is also likely that there will be pressure on the new Prime Minister to build a more inclusive politics involving as wide an array of views in the negotiating team as possible.

Negotiating a new trade deal is likely to be particularly difficult and time consuming. At this stage, the characteristics of a distinctively ‘British’ model of associate membership remain unclear. Donald Tusk, President of the Council, predicted that it could take seven years to agree a new relationship. The central trade-off is between the depth of access to the single market and the level of free movement of people that the UK is willing to accept. The EU would also press the UK to make a continued financial contribution to the EU budget in line with the existing European Economic Area (EEA) model as followed by Norway.

Whilst it is too soon to predict the longer-term economic impact of the Brexit decision, the vote to leave will cause significant concern as to what comes next for insurers, especially those operating cross border.

Kennedys’ risk management thermometer

Against the background of the key issues identified above, it is vital for insurance businesses to begin to consider the key risk management actions in order to firm up contingency plans. Insurers will need to assess each issue in order to place it against a suitable degree of risk.

Note: The Kennedys Risk Management thermometer can be found on page 7 of our report Brexit: the insurers speak.

Cold	Warm	Hot
Changes to Solvency II	Long-term policies e.g. life cover	Business cost
Short-term policies	Regulatory divergence? (possible light touch for commercial clients)	Dilute current EU legislation on data and cyber reporting
Health and safety law	Commercial contract review	Business uncertainty and added volatility
Insurance contract law	VAT and indirect taxes	Corporate restructuring
Direct taxes	Jurisrisdictional clauses and choice of governing law	Your people/talent
		Access to the EU single market

Overall, this is the time for careful thought and planning, and for insurers to have their say on what Brexit needs to look like to maintain the UK’s position as a global market leader.

Brexit risks and issues for insurers

Services

Sectors

Locations