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The UK’s decision to leave the European Union will present many challenges for the captives sector—but the biggest could simply be managing the inevitable period of uncertainty during the waiting game before the details of a post-Brexit world start to emerge, EMEA Captive reports.
The shock vote in June 2016 by the UK electorate to leave the European Union has created a period of uncertainty for all sectors of the insurance industry—one that may well extend for some time.
The decision will have implications for many parts of the industry in many ways. The biggest initial consequence for insurers, for example, was the immediate fluctuation in currency exchange rates, which hit both the asset and the liability sides of the balance sheets of companies operating in sterling and/or euros.
Beyond this, there will be potential consequences regarding the free movement of labour once the exit process is complete and a myriad of potential complications around regulatory processes and procedures—for example, could the UK deviate from Solvency II?
But easily the biggest worry for re/insurers so far has been the potential loss of their passporting rights, which allow UK companies to freely trade, sell and distribute products in the EU and vice versa.
This issue is also an important one within the captives sector, as it could have implications for where companies choose to base their captives.
In the aftermath of the vote, trade bodies were keen to get their point across to the UK government: that the re/insurance industry needed to be front and centre of considerations around negotiations and the exit settlement. A number specifically mentioned the importance of the captives sector in such correspondence.
The British Insurance Brokers Association (BIBA), for example, asked the UK government to consider 11 points affecting brokers and their customers post the vote. In this, it mentioned the captives sector, specifically stressing the importance of some of the facilities brokers have created.
“The impact on captive insurance companies writing for European operations from the UK, or vice versa for a UK operation from a European base needs to be considered,” BIBA said.
“Some brokers have created specific captive insurance arrangements for customers in order to place risks they are unable to place competitively in the UK. These arrangements will be put at risk where access to the EU is restricted and we may also see job losses for staff in the business units that focus on helping customers with these arrangements.”
How long is that string?
"It is reasonable to expect that cross-border passporting rights between UK and EU will cease and alternative arrangements will need to be put in place." Malcolm Cutts-Watson, Cutts-Watson Consulting
The problem with much of this is that it remains very difficult to predict what the outcome of Brexit negotiations will be.
The UK government has now said it will trigger Article 50, the process by which the UK will formally leave the EU, by March 2017, which means the divorce would formally happen two years later. But there is little indication so far as to what form the negotiations will take, never mind a settlement.
The one thing businesses and the financial markets hate is uncertainty. In preparation for an outcome that would involve the loss of passporting rights, a number of re/insurers including the Lloyd’s market have instigated plans to form subsidiaries in the EU.
Robert Geraghty, vice president and business development manager for the EMEA and Asia-Pacific at Marsh Captive Solutions, stresses that there should be no panic in the captives world just yet. He notes that captives resident in the EU, and captive domiciles in the EU, will be able to continue to do business as usual until final decisions and agreements have been made between the UK and the EU member states.
But he acknowledges this could be a problem in the longer term, depending on how negotiations progress.
“Brexit could impact captives’ passporting rights and their financials, which could in turn affect the domiciles that they chose to operate in. Once the UK is no longer part of the EU, UK residents insurers’ right to passport—providing insurance services in the EU member states from a single country licence—may be restricted,” Geraghty says.
“The same is true for EU resident captives which may now need an additional licence to conduct business insurance in the UK. Either a UK insurer would be needed to front risk, or firms may need to form a UK branch or a new UK entity to insure compulsory classes such as employers’ liability and third-party motor liability risks.
“As much is still uncertain, it’s important to review your captive risk profiles and insurance programmes, as well as monitor the markets closely to ensure solvency obligations can be fulfilled.”
Malcolm Cutts-Watson, managing director of Cutts-Watson Consulting and a specialist in captives, agrees that companies should consider and plan for the worst case scenario when it comes to accessing the EU.
“It is difficult to accurately assess this until full details of the UK’s exit are known. However, it is reasonable to expect that cross-border passporting rights between UK and EU will cease and alternative arrangements will need to be put in place,” he says.
He notes that data published by the Financial Conduct Authority illustrate the scale of the potential problem. They show that 5,476 UK-registered firms hold at least one passport to do business in another EU or European Economic Area member state. And just over 8,000 companies authorised in other EU states use these rules to do business in the UK—which demonstrates that the passporting rules are also important to non-UK firms.
Cutts-Watson notes that there are other ways to solve this problem if passporting rights were lost—but no solution is ideal and this would involve using offshore domiciles unaffected by Brexit.
“The use of a fronting insurer would seem to be the obvious solution, which will add cost and complexity to any pan-European insurance programme,” he says. “We don’t see the offshore captive domiciles being affected by Brexit, and in fact they may seek to market themselves as a secure and unchanging place to do business.”
The waiting game
As this publication went to press an uneasy calm seemed to have settled over the market for the time being, as executives awaited news or direction from the UK government. But this could not last forever, as Geraghty at Marsh Captive Solutions points out.
“Since the vote to leave the EU, we have been monitoring the situation and have not seen any major changes as yet. Keep in mind that when the UK government formally notifies the European Council about its decision, it will trigger Article 50 of the Lisbon Treaty, which will start a transition period that is expected to last up to two years,” he says.
“The effects of Brexit on captive owners and EMEA domiciles will become more apparent during this transition as negotiations conclude and the terms of the UK’s relationship with the EU become clearer.”
David Kirkup, chief operations officer and chief financial officer of Captive Alternatives, agrees that the industry faces a period of uncertainty. But he predicts that there will be winners and losers in terms of domiciles as the negotiations and wider fallout from Brexit pan out. Domiciles such as Puerto Rico could benefit in the long term, he believes.
“Brexit has led to a good deal of uncertainty and speculation about the future. Some observers believe that increased regulation is likely if the ability of UK insurers to write business in the EU is impinged,” he says.
“Others note that European domiciles such as Dublin, Malta, and Gibraltar may find themselves subject to increased investment and exchange rate volatility that may have knock-on effects on solvency.
“The biggest issue remains uncertainty about the process and timing of the UK’s exit. We are not yet certain what benefits may flow to western domiciles such as Puerto Rico, but increased exposure to Puerto Rico’s International Insurer rules and operational efficiency may lead to new opportunities for business from both European and UK companies.”
Looking to the future of the industry in a post-Brexit world, Cutts-Watson believes that it will have little to no effect on the wider captive markets. It may, however, have an impact on certain domiciles such as Gibraltar, which will lose the ability to write directly into the EU.
“We see Brexit (and the possible exit of other countries from the EU) as further evidence that the most efficient means of captive participation in a global insurance programme is through the tried and tested model of fronting into an offshore reinsurance captive,” Cutts-Watson says.
“Gibraltar will have the opportunity to remarket itself as a non-EU domicile. Will the UK seize the opportunity as Ireland did to re-energise its financial services by creating an International Finance Centre (with reduced regulation and corporate tax) to encourage inward investment and establishment of UK-based captives?
“It amuses us to consider the irony of the UK becoming an offshore finance centre after its political establishment’s previous attacks on these jurisdictions,” he adds.
He also notes that although Brexit presents great uncertainty and many challenges to captives, there are issues that are more of a threat.
“Our biggest concern to the sustainability of the captives industry is not Solvency II or Brexit, but base erosion and profit-shifting (BEPS),” he says, which he claims has the potential to fundamentally alter the business model of the captives industry.
“The European Captive Insurance and Reinsurance Owners’ Association (ECIROA) and other industry players are highlighting the issues, and it would appear that the captive model is set to be challenged,” he says.
Brexit, UK, Europe, Captive, EMEA, Solvency II, BIBA, Cutts-Watson Consulting, Marsh Captive Solutions, Malcolm Cutts-Watson, Captive Alternatives