The cost implications of the loss of passporting rights after the UK exits the European Union will weigh on re/insurers, as will any resultant economic downturn. However, A.M. Best does not anticipate taking any rating actions as a result of impending Brexit.

In a report titled “Brexit Uncertainties Weigh on UK Insurers but Rated Entities Able to Withstand Pressure,” A.M. Best said there are three key issues that could affect the UK insurance industry in the wake of Brexit: the ability to continue to access EU business following a loss of passporting rights, the economic fall-out and regulatory developments. A discussion of these issues follows.

Implications of Loss of Passporting

Currently, passporting rights allow insurers to underwrite cross-border business in the European Economic Area (EEA) from UK-based subsidiaries, without being required to apply for any additional authorization or incur further local operational costs, the report said.

Catherine Thomas, senior director, analytics, said: “The ability to continue to conduct cross-border business throughout the EU is principally a concern for Lloyd’s, the London market and other commercial insurers.”

A.M. Best noted that in 2015, 11 percent of Lloyd’s total gross written premiums (GWP) came from the EEA (excluding the UK).

Further, the report continued, £7.3 billion (US$9 billion) of premium currently written in the London company market by members of the International Underwriting Association (IUA), may be “directly affected by a change in rules governing UK participation in the EU single market and its passport regime.”

“To continue to underwrite EU business, these companies are likely to need to establish an EU-domiciled subsidiary, if they do not already have one. This would have associated costs, operational requirements and resourcing implications,” Thomas added.

“While there are infrastructure issues as to how these offices would be staffed, restructuring costs are unlikely to lead to any rating pressure for companies rated by A.M. Best,” the report said. “Any reduction in the fungibility of capital across an insurance group, due to the creation of an additional separately capitalized subsidiary, will be taken into account in the ratings of the group’s individual subsidiaries.”

Insurers are already looking at financial centers such as Dublin, Paris, Frankfurt and Luxembourg, as well as locations where they have existing branch operations, the report affirmed.

“Local brokers are well established in EU insurance and reinsurance hubs, and a significant increase in accessing business in different cities by the overall financial sector could have longer-term implications for London as a financial center,” it continued.

“UK insurers may be able to continue to access risks freely across the EU for marine, aviation and transport (MAT) insurance, regardless of whether passporting rights are lost,” the report confirmed. “Under World Trade Organisation (WTO) rules, cross-border rights exist for MAT risks to be written by insurers and reinsurers operating in countries outside of the EEA.”

The loss of passporting rights is unlikely to be an issue for large UK life insurers and retail non-life insurers, the report said, explaining that life insurers principally write domestic business or have subsidiaries in both the UK and at least one other EU country, while the retail non-life sector mainly writes only domestic business.

Economic Consequences of Brexit

“The UK’s vote to leave the EU has resulted in considerable uncertainty regarding the UK’s economy, which could have a negative impact on domestic insurers’ premium volumes,” the report said. “Any decline in gross domestic product (GDP) would likely lead to a reduction in demand for both life and non-life insurance.”

There are concerns that an economic downturn could impact capital adequacy if widespread corporate downgrades affect the credit quality of UK insurers’ investment portfolios, but A.M. Best does not expect a deterioration in the quality of investment portfolios in the short term.

A.M. Best said the depreciation of sterling against the US dollar could benefit sterling-reported results from London market insurers, which underwrite a large amount of US-dollar business and hold a surplus of US dollar assets over liabilities.

“Conversely, it could negatively impact the claims experience of domestic insurers hit by forex-driven price increases on imported parts,” the report said. “UK inflation is expected to rise, reflecting higher prices for imported goods. In turn, this would result in claims inflation with an escalation in repair bills as replacement parts are affected by rises in raw material costs.”

Regulation Post Brexit

As the UK exits the EU single market, it will seek new trade agreements with the EU and other countries. Consequently, UK-based insurers would no longer be directly subject to Solvency II regulation. A.M. Best anticipates that the UK will seek and be granted equivalence under Solvency II.

Transferring and incorporating EU legislation will be a huge task, A.M. Best said, noting that the Association of British Insurers (ABI), the insurance trade body, has identified 80 EU directives and regulations that will need to be assessed if the UK insurance industry is to ensure a broadly consistent framework of customer rights, legal responsibilities and financial stability.

Not all the rules may require transferring, which “could create some potential opportunity for domestic insurers, if they have fewer rules and are subject to less strict regulation,” A.M. Best said. “While a more liberal regulatory regime could result in increased global business, it may raise trade barriers with EU countries.”

Implications for Ratings

Considerable uncertainty remains for the UK insurance industry in the wake of the decision to leave the EU, the report said. Nevertheless, A.M. Best does not expect to take rating actions as a result of Brexit.

“However, increased economic and regulatory uncertainty, as well as the potential for higher barriers to trade, overall, is a credit negative for the UK insurance industry,” Thomas went on to say.

“As the terms of the exit are negotiated, A.M. Best will continue to discuss with rated companies what prospective changes will mean for their competitive positions and ability to continue to access business in the United Kingdom and the EU. Any impact on revenue or profitability will be taken into account in our assessment of a company’s profile and operating performance,” she added.

Source: A.M. Best