On 23rd June, the British public voted by a margin of 52% to 48% to withdraw from the European Union. As canvassed in our previous Brexit article, this will have a significant impact on the Irish insurance sector and its relationship with its UK counterpart.

Having allowed time for the dust to settle, HOMS Managing Partner Harry Fehily and Associate Solicitor Michael Murphy recently travelled to meet with a number of significant insurers in the London market to engage in a collaborative discussion on the implications of Brexit for both markets.

The vote has undoubtedly come as an enormous surprise to the City of London (which unsurprisingly voted strongly in favour of remaining in the EU) and there is clearly a strong desire to continue to maintain the strong traditional relationship between Ireland and the UK going forward.

Equally, it is clear that the vote has created very real risks and uncertainties on both sides of the Irish Sea and the insurance sectors in both Ireland and the UK have a significant body of work to undertake in order to respond to the new post-Brexit economic and political realities.

Key issues include the nature and timeline of the exit agreement to be negotiated with the EU by the UK but the single biggest issue for UK insurers will probably be whether or not they will be entitled to continue to ‘passport’ into the EU member states.

No long term decisions will be taken until such time as that issue has been addressed. This issue may well require Article 50 to be invoked by the UK and the exit negotiations to be progressed substantially between the UK and the EU and it will be interesting to see if any of any further certainty can be brought to bear prior to that 2 year time limit.

The UK has voted to exit – what happens now?

The initial aftermath of the Brexit vote was likened by Mark Carney, Governor of the Bank of England, as being akin to economic post traumatic stress disorder as the UK was plunged into an unprecedented level of uncertainty amid turbulent market conditions, significant currency fluctuations and political and economic turmoil.

Now that Theresa May has been elected Prime Minister, some of the political turmoil may abate and the UK government can now start to properly focus upon the scale of the task at hand.

Whilst the outcome of the referendum is not binding, the new Prime Minister has already signalled that ‘Brexit means Brexit’ in terms of following through with the will of the majority of voters in the UK. As is laid out in the Lisbon Treaty, the formal mechanism for the UK to leave the Union is for the Government to give notice to the Council of the EU, which would be effective two years later unless the other members agree to a unanimous extension, the prospect of which appears unlikely.

The Treaty provides for negotiation of a withdrawal agreement which the UK will have to negotiate with the EU – from Ireland’s perspective, the German Chancellor Angela Merkel has already indicated that Ireland will have a voice at the table but individual entreaties and/or negotiations between the UK and individual member states will not be countenanced. Irish insurance companies will no doubt be calling for the EU to recognise Ireland’s special status with the UK as its main trading partner in the context of these negotiations.

This will entail lengthy negotiations as withdrawal would require the unravelling of countless budgetary, legal, political and finance rules. The ultimate economic impact of Brexit upon Ireland will be governed by the nature of that agreement – and the mixed messages from the UK political leaders on the potential shape and structure of any such agreement is only adding to the uncertainty.

All that can be said at this time is that the EU’s stated position is that it will not enter into any negotiations with the UK until such time as Article 50 is invoked and, once that step has been taken, the pressure of the two year window will be stifling in order to reach agreement to allow the UK to untangle itself from the EU without impeding the ability of UK companies to operate competitively.

Challenges for UK Insurers in a Post-Brexit Market

UK insurers will no doubt be pointing to the degree of specialism that they can offer, particularly via the London market which is currently the largest global hub for commercial and specialty risk, controlling more than £60bn of gross written premium. It is a diverse market made of up over 350 firms contributing over 20% of the City’s GDP and employing 48,000.

It 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. There will be a significant number of companies with UK headquarters (including insurers) who will be closely monitoring the UK’s exit negotiations with the EU.

London SkylineFrom the London insurance market’s perspective, there will be three key questions as to the composition of a post-Brexit UK which will no longer be a member of the EU, namely:-
• will UK insurers be provided access to the Single Market and, if so, on what terms;
• how will Brexit impact upon Foreign Direct Investment into the UK; and
• how will insurers be facilitated in terms of trade with countries outside of the EU?

UK insurers are understandably most concerned with the question of their accessibility to the 500 million potential customers within the Single Market given that the EU has a world market share of nearly 33% and total insurance premiums of nearly 1.4 trillion Euros.

The London insurance market will be concerned to know as soon as possible whether it will continue to maintain its status as the financial capital of the world and, from an insurance standpoint, whether it will still be able to write the estimated £6bn of premium income from the EU. The Lloyds market has already emphasised the strengths which it can draw upon, including robust financial security, global brand strength, and unrivalled underwriting expertise.

New capital efficiency rules, which make it easier for banks and insurers to access this market, will be a particularly tricky proposition for UK insurers to overcome now that the UK decides to leave the EU, irrespective of whatever withdrawal agreement is effected. UK insurers have warned that Brexit is unlikely to lead to a significant dilution of the EU’s rather contentious Solvency II capital rules. For UK insurers to continue to enjoy access to EU markets, UK regulations would be required which would be deemed equivalent to Solvency II rules. Solvency II is likely to remain, albeit some of the harsher elements could be restricted – for instance, the Irish Times has reported that the so-called risk margin could be reviewed ; this is an extra layer of capital that applies to some long term life insurance products and is a particular cause of consternation in the UK. Insurers complain that it is too volatile, especially when interest rates are low, and that it discourages them from writing annuities.

If insurance underwriters do not have the freedom to write cross-border business, as they have traditionally enjoyed, and have to set up local operations across the EU again, it follows that there will be competitive disadvantages for those located in London. British-based insurers (including those based in Gibraltar) are particularly concerned by the prospect of having to secure additional licences to carry on business in the 30 other EEA states which makes the prospect of forming a new insurer based in one of the other EEA states more attractive.

EUAn EU insurer will face challenges in the UK also as it may require an additional licence in order to continue to carry on its insurance business in the UK post-exit. If mergers are contemplated to address the contemplated loss of the right to passport business, insurers will most likely look to put such measures in place using the benefit and convenience of the EU rules before the 2 year window expires once Article 50 has been invoked.

UK reinsurers may also be concerned that EEA states might be able to restrict their ability to cover local risks, for example by denying local cedents credit for reinsurance unless collateral is posted in their favour. UK insurers might also be concerned that an insurance business transfer undertaken might not be binding on their EEA policyholders and may not be able to transfer business to a transferee elsewhere in the EEA.

Uncertainty as to the enforceability of judgments obtained in the UK in other EEA states and the protection of trade marks or other Intellectual Property in the UK in other EEA states may also be a concern for UK insurers. It is also unclear at this juncture whether the UK would necessarily be considered sufficiently safe for data to be lawfully transferred to it under current EU data protection legislation.

UK companies may also cease to be able to benefit from tax advantages currently available as a result of the EU’s fundamental freedoms, for example, those provided by the Parent-Subsidiary Directive, the Merger Directive and the Capital Duty Directive. Commentators have also queried how UK judges will interpret UK law derived from EU law in a post-Brexit scenario .

The pro-Brexit campaign emphasised the potential benefits of international trade for the UK in terms of being free to negotiate their own trade agreements directly with non-EU markets. Whether or not such purported competitive advantages will materialise remain to be seen at present; negotiating parties may have different economic concerns and priorities and, as the Lloyds market has pointed out, many countries are reluctant to open up their insurance and wider financial markets to outside competition.

Reaching meaningful agreements may pose challenging and time-consuming as there is no guarantee that other countries may strategically be slow to agree to work to the same time pressures that the UK will inevitably be operating under. However, the City of London is likely to look closely at developing stronger ties with the US to assist them in maintaining their status as the financial capital of the world, but will US insurers now look to other EU states like Ireland?

UK insurers may well be able to adapt to the new, post-Brexit landscape – Switzerland and Norway are examples of thriving and financially strong nations who are not members of the EU, both countries have access to the EU market on agreed terms but do not have to comply with all EU laws. Furthermore, two of the largest and most successful insurance companies globally are based in Switzerland; Zurich Insurance Group and Swiss Re.

However, the economic deterioration in the aftermath of Brexit will not aid UK insurers’ causes in trying to adapt to the new Brexit landscape and the fact that membership of the EEA would involve contributing to the budget of the EU, accepting EU rules and regulations that it will have no part in framing and agreeing to freedom of movement of persons may be difficult to palette for the pro-Leave UK electorate. It is also noteworthy that when the EU agreed a comprehensive trade deal with Canada, it did not include passport rights. The loss of being part of a trading bloc is unlikely to assist insurers’ interests.

Implications of ‘Brexit’ for the Irish Insurance Sector

The closeness of the links between Ireland and the UK, and in particular the City of London, will need to be stronger than ever in order to survive the challenges that Brexit will bring. The IDA has already trumpeted the competitive advantages that Dublin offers, namely its economy, skills, regulatory and taxation system, it operates a similar common law system and can boast a modern transport infrastructure whilst, from the perspective of US companies, it is the only other English speaking capital city in the EU.

More than 50% of the world’s leading financial services firms already have subsidiaries in Dublin, and such firms may well seek to utilise their Irish bases to minimise the ‘Brexit’ turmoil by ensuring that they will retain their ability to efficiently service European financial markets whilst continuing to write consistent volumes of EU business . The Central Bank has also addressed this point, noting that Irish insurers could face restrictions upon their ability to conduct cross-border insurance business into the UK, cautioning that:

“A disorderly ‘Brexit’ could be associated with a loss of access to European markets for UK-based financial services firms”

and agreeing with the analysis that this might lead such firms to expand / relocate / establish operations in Ireland. It is noteworthy that Beazley and Hiscox are already reviewing their operations .

The ESRI has considered Brexit:

‘Following the loss of the UK’s attractiveness to vertical FDI due to reduced access to the EU market, Ireland may attract additional FDI, possibly in … financial services. However, given large sunk costs, disinvestment in the UK is less likely, particularly in large fixed cost sectors … the UK might consider to further reform its tax system … to make its corporation tax system more competitive’.

Indeed, the ESRI ultimately concludes that, on the basis of patterns of the location choice of new FDI projects in Europe over the past ten years, the expected additional attractiveness of Ireland to new FDI projects should Brexit come to pass is likely to be small. Even outside of the EU, the ESRI believes that the UK’s attractiveness advantages over Ireland would continue to attract FDI to the UK, particularly in view of the UK’s stated plans to reduce its Corporate Tax rate to something closer to the Irish rate.

Concerns as to Economic Ripples of Brexit for the Irish Insurance Sector

We have already seen the challenges Brexit has presented for the Irish economy; despite a weakening Sterling, it is likely that Irish trade to the UK will suffer, especially the agri-food industry and the energy market could also be adversely affected. The domestic insurance sector in Ireland often operates as a microcosm of the larger economy and will not be immune from the harm that could be caused to the Irish economy post-Brexit.

The Central Bank has equally expressed caution as to the effect that the larger economic ripples of
‘Brexit’ might have upon the Irish financial sector:

“The impact on the Irish financial sector, including banks, insurance firms and non-bank financial intermediaries, could be significant if it occurred in a disorderly manner and/or had a large negative impact on the UK (United Kingdom) economy ” .

Likewise, the prospect of a weakened London insurance market might not ultimately be in Ireland’s long term best interests as Dublin-based insurance firms have tended to benefit from their proximity to the London market. Any downturn in the fortunes of the London insurance market could have a consequential impact in Ireland and the strength of the relationship between Dublin and London might well diminish. Deutsche Bank has already forecast Irish GDP growth slowing to 2.9% in 2017 as a result of Brexit. Irish insurers will no doubt agree that Britain is and should remain a friend of Ireland, politically and economically, going forward for whatever choppy waters lie ahead.

Conclusion: Entering into the ‘Unknown Unknowns’

The Brexit vote is likely to continue to have a very significant bearing on the operations of UK insurers and, in turn, upon the Irish insurance sector as the UK is effectively entering into uncharted waters.

The Lloyds market commented some 41 years ago after a positive referendum result in favour of retaining EU membership that it welcomed the result with delight, enthusiasm and, above all, relief. It is fair to say that, following the Brexit vote, UK insurers will still be reacting with dismay, nervousness and, to quote Richard Buxton, the chief executive and head of UK equities at Old Mutual Global Investors (OMGI), the after effects have been described to date as ‘horrible’. The former EU Commissioner Peter Sutherland has already stated that negotiating equivalent access appears in effect to be impossible for the UK.

EuropeFor its part, Ireland will be attempting to maintain a very delicate balance. On the one hand, Ireland will be looking to manage the economic (and indeed political) implications that we have already begun to see whilst trying to effectively exploit the silver linings to that cloud if the situation can be managed correctly. Cities such as Frankfurt – home to the EU’s insurance regulator – have already started to make their own pitch as to why they should be regarded as the ‘new London’; no doubt, London insurers will be hoping that, in Mark Twain’s immortal words, rumours of its death have been greatly exaggerated!

There are likely to be all sorts of unintended consequences to exploit, and, to quote John Lanchester in the London Review of Books, the:

‘City is full of people whose entire working lives revolve around exploiting unintended consequences… The City is creative, opportunistic, experienced and amoral; if any entity has the right ‘skill-set’ to benefit from the post-Brexit world, it is the City of London.’ .

Given the correlation between the respective sectors, Irish insurers will no doubt continue to work closely in conjunction with their UK counterparts as they both seek to navigate through the challenges of Brexit for both jurisdictions as the wider UK EU negotiations unfold.

Until such time as Article 50 is invoked and negotiations take shape, there will continue to be uncertainty which will inevitably lead to ongoing market instability for the UK and the wider EU region in all likelihood. The UK and Irish insurance sectors will be watching closely as Prime Minister Theresa May seeks to bring some much needed certainty to bear in her dealings with the UK and establishing the parameters of the exit agreement.

Until such time as the precise UK exit agreement is negotiated (probably 2018), insurers will not be making any long term decisions and likewise no definitive assessment can be made of the full extent of Brexit’s impact upon the Irish insurance market. For now, Yeats’ quote from his poem Easter 1916 appears apt when describing the general effects of Brexit in the month since the vote was passed:

‘All changed, changed utterly. A terrible beauty is born’.