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The UK-EU trade deal and the end of the Brexit transitional period: Implications for insurers and reinsurers

  • United Kingdom
  • Brexit
  • Insurance and reinsurance
  • Financial services - Insurance market

11-01-2021

It may not have been on everyone’s Christmas gift list, but on 24 December 2020 the UK and EU Brexit negotiators delivered the gift which both sides have been working towards since the UK voted to leave the EU in June 2016 – a bilateral free trade agreement, the Trade and Co-operation Agreement or “TCA”. The timing of the TCA dovetails neatly with the expiry of the current transitional period (the “TIP”), which ended at 11pm on 31 December 2020. During the TIP, EU laws and regulations continued to have effect in the UK. From 1 January 2021, though, that all ends and the relationship between the UK and the EU is governed by the TCA, and any subsequent and subordinate agreements or declarations.

In this article, we will examine the implications for insurers and reinsurers of the move out of the TIP and the new framework being established by the TCA.

TCA and financial services - What has been agreed

Despite the TCA coming in at a weighty 1,250 pages, financial services is dealt with in a more-than-succinct three pages. The TCA secures continued access for financial services firms (including insurers, reinsurers and brokers) to UK and EU markets, but on the prevailing rules and regulations in those markets. In other words, for UK (re)insurers seeking to do business in the EU, they will have to do so in compliance with EU legislation. The passporting arrangements on which UK insurance participants have relied are no longer available - the UK becomes a ‘third country’ for the purposes of EU law.

The TCA was accompanied by a joint declaration on regulatory co-operation on financial services. According to the declaration, it is the intention of the EU and the UK to work together to “establish structured regulatory cooperation on financial services, with the aim of establishing a durable and stable relationship between autonomous jurisdictions.” The parties intend to enter into a Memorandum of Understanding by March 2021.

The declaration also states that “the Parties will discuss, inter alia, how to move forward on both sides with equivalence determinations between the Union and United Kingdom, without prejudice to the unilateral and autonomous decision-making process of each side.

Equivalence

This reference in the declaration to equivalence indicates the key principle on which the future financial services relationship between the UK and the EU will be founded – on each party providing a finding of equivalence for the other’s financial services industry (or parts of it). The UK has found the EU equivalent in respect of 28 areas.  The EU has found the UK temporarily equivalent in respect of only central counterparties (for 18 months) and central security depositories (for 6 months) and had said that there will be no extensions.

Very broadly, a finding of equivalence reduces the regulatory obligations on businesses which seek to operate in an ‘equivalent’ jurisdiction. Equivalence regimes arise out of specific statutes, and in the case of insurance and reinsurance, the equivalence regime is codified within the Solvency II directive.

Under Solvency II the Commission can determine that the UK regime is ‘equivalent’ to the Solvency II regime in three specific cases, for reinsurance, group solvency calculations and group supervision:

  • Firms can provide reinsurance from an ‘equivalent’ jurisdiction, and reinsurance contracts will be treated the same as reinsurance contracts written by EU reinsurers (Article 172)
  • When calculating group solvency or EU (re)insurers, any subsidiaries in an ‘equivalent’ third country can use local rules to calculate their solvency and capital positions (Article 227)
  • Where an EU (re)insurance undertaking is owned by a parent company in an ‘equivalent’ third country, the local EU regulators can rely on the group supervision exercised by the home regulator of the parent (Articles 260 and 261).

This means that, for the (re)insurance industry, a EU-UK relationship founded on the equivalence regimes of the respective parties only provides some limited benefits. Any benefits will mainly be of use to groups which have both a UK and EU presence – allowing them to be more streamlined in terms of group solvency and supervision. It also assists reinsurers looking to access either market.

Even after the narrow scope of the Solvency II equivalence regime, there are still potential issues to an arrangement based on equivalence. The first is that, whilst the UK has found the Solvency II regime to be equivalent for the purposes of UK regulation, the EU have not made a corresponding equivalence finding in favour of the UK. In a set of Questions and Answers published by the Commission and accompanying the TCA, the Commission stated:

“The Commission has assessed the UK's replies to the Commission's equivalence questionnaires in 28 areas. A series of further clarifications will be needed, in particular regarding how the UK will diverge from EU frameworks after 31 December, how it will use its supervisory discretion regarding EU firms and how the UK's temporary regimes will affect EU firms. For these reasons, the Commission cannot finalise its assessment of the UK's equivalence in the 28 areas and therefore will not take decisions at this point in time.”

The second issue arises from the phrase ‘without prejudice to the unilateral and autonomous decision-making process of each side’. Equivalence decisions are unilateral and can be revoked without cause at any time. The only requirement is that the relevant party gives 30 days’ notice of its decision to revoke the equivalence decision. If the planned MoU does include a consultation process on the withdrawal of equivalence decisions, this risk will be reduced but not eliminated.  Businesses seeking to rely upon equivalence will still need to ensure that they have alternative plans in place which can be activated swiftly in order to avoid a withdrawal of the equivalence regime they rely upon disrupting their business.

For the UK insurance industry, any finding of equivalence will, in all likelihood, be too little, too late. For insurers wishing to continue to do business in the EU, they will have to find (and in most cases have already found) an alternative way to maintain their business presence/ access. On top of that, the ability for the EU to revoke any equivalence finding on short notice, potentially, makes it an unreliable mechanism on which to base a long-term business plan.

How the TCA and future relationship will affect insurance business

New business

If a UK (re)insurer wishes to do business in the EU27, it will need to do so in accordance with EU27 law and regulation. This means that, to continue to write new business into the EU, a (re)insurer will need to comply with local requirements, including the establishing of a local establishment (whether this needs  be a branch or an entity will depend on the local rules) and obtain local regulatory authorisation. We note that the vast majority of UK (re)insurers with any EU business have already gone through the process of establishing underwriting entities in another EU jurisdiction.

For EU (re)insurers wishing to continue to write business into the UK, the UK has put in place extensive temporary transitional regimes, including a 15-month transitional period for insurance firms previously exercising their Solvency II passport. To participate in the Temporary Permissions Regime, EU insurers needed to apply to the regulator ahead of the end of the TIP and set out whether the period would be used to either run off existing business, or to bridge across to a more permanent presence – which will require full UK regulatory approval.

Run-off

The TCA does not make any allowance for ‘grandfathering’ of existing insurance business, either in the UK or in the EU. For UK insurers who have previously written business in the EU, this presents a problem because, by continuing to service existing insurance policies from the UK, that (re)insurer will likely be in breach of EU law and regulation (depending on the specific activity and member state). Conversely, by ­not continuing to service those policies, the (re)insurer might be in breach of UK law and regulation. To avoid the regulatory Catch-22, UK (re)insurers have, in the main, already taken steps to transfer EU business, by Part VII arrangements, to local EU insurance subsidiaries.

For the very small number of UK (re)insurers who haven’t transferred EU business to an EU insurer, there is some hope in the form of recommendations, published by the EU insurance and pensions supervisory authority, EIOPA, in February 2019. The key recommendations were that local EU regulators should:

  • minimise detriment to policyholders and beneficiaries, based on the applicable EU and national laws (the “General Objective”);
  • apply a legal framework to facilitate an orderly run-off of business which become unauthorised; 
  • avoid prejudicing policyholder rights to exercise an option or right in an existing insurance contract to realise their pension benefits;
  • take a risk-based approach to supervision and take into account proportionality;  and
  • where a UK policyholder changes their habitual residence from the UK to an EEA state, member states should consider that the relevant contract was concluded in the UK.

Whilst not a complete fix, for those (re)insurers who operate in jurisdictions which have (or intend to) implement the EIOPA recommendations, there is at least the possibility that UK (re)insurers will not face sanction if they are only running-off existing business (and it is proportionate). However, it will depend on the relevant member state. The one wrinkle to this, though, is that the EIOPA recommendations were published with a focus on a hard Brexit, not in the context of the TCA. Our understanding, immediately prior to the end of the TIP, is that in the current circumstances only around 50% of member states now intend to operate in line with the recommendations. This means that, for firms looking to run off European business, it is vital that they understand what the position will be in the jurisdictions in which they have business.

The ‘ex-pat’ factor

The other area where the EIOPA recommendations and the consequent implementation might be of significance is for life insurers who have issued policies to individuals, through bulk annuities, unit-linked policies or other life insurance policies, who are either located in or relocate from the UK to an EU country after the end of the TIP (i.e. ex pats). Depending on how local regulators choose to interpret and apply the EIOPA recommendations, there is a chance that continuing to service policies, for example continuing payments, permitting switches/ top-ups, will be treated as run-off business. However, as mentioned above, we understand that around 50% of member states are intending not to implement the recommendations. In those jurisdictions, firms would need to look to the local rules to ensure that any continued payments/ top-ups are made lawfully.

Equally, depending on the relevant jurisdiction, the issuing of new individual policies under an existing bulk annuity to members who are based in an EEA state could be interpreted as effecting new business, with the same caveats for the 50% of states who aren’t implementing the recommendations. Bulk annuity providers in the UK continue to be cautious about the best approach to going to buy-out for individuals that are located outside the UK and various ‘workarounds’ are being considered as the guidance and legislation in key member states develop.

The UK being found to be equivalent may assist in some workarounds for these kinds of arrangements – where a UK life insurer could look to a fronting life insurer in the EEA to issue policies to any individuals actually located outside the UK and then the UK reinsurer reinsure the EEA insurer (however, this is not without its complications). Bulk annuity providers may nevertheless face questions from pension scheme trustees as to whether such workarounds offer the same protections to trustees and their beneficiaries as individual policies issued by UK insurers. For instance:

  • UK pensions legislation allows pension scheme trustees to be discharged from their liability to provide pensions (or other benefits) to members if it provides for such discharge through a prescribed method. Currently, purchasing an annuity (which satisfies prescribed requirements) from an insurer carrying on long-term insurance business in the United Kingdom or any other EEA state is one of these methods. The requirements that such an insurer needs to meet, and the ability of EEA insurers to continue meeting such requirements, may change in future.
  • Pension scheme trustees may also have reservations about accepting individual policies issued by EEA insurers which are not regulated by the Prudential Regulatory Authority – and therefore are not covered by the Financial Services Compensation Scheme (“FSCS”).

For EU (Re)insurers running-off UK business, the UK has put in place a Financial Services Contracts Regime (“FSCR”) to allow EEA-based firms to run-off existing UK contracts and to conduct an orderly exit from the UK market.  Unlike the TPR, the FSCR does not allow EU (re)insurers to write any new business in the UK.  The FSCR provides that a firm is able to carry on a regulated activity only where it is necessary for the performance of a contract entered into prior to the end of the TIP, along with certain other specified activities.

The FSCR provides a run-off period of 5 years for non-insurance contracts and 15 years for insurance contracts.

The future

Despite the cliff-edge nature of the immediate changes for the EU-UK insurance industry, there are some areas of opportunity and reasons for optimism. As mentioned above, the UK insurance industry has already made the majority of the changes required to adapt to the new relationship with the EU. In that light, any finding of equivalence by the EU for the UK insurance regime would be an extra benefit.

Whilst it would seem unlikely given the context, there is a chance that an equivalence finding by the EU might not be forthcoming, or might not be a long-term solution for the UK insurance industry in the EU. A finding of equivalence relies on the third country’s insurance regime satisfying certain criteria, set out in the Solvency II delegated regulation – the key determination being whether the regime provides a comparable level of policyholder and beneficiary protection as the Solvency II regime.  There are different criteria which apply to be found equivalent for reinsurance, group solvency calculations and group supervision, which generally focus on the sophistication and capability of the local regulator and the scope of the local insurance regime. Given that, initially, the UK has adopted the Solvency II regime, one might hope that a finding of equivalence might be relatively easy.

To date only two countries have to date been found to be equivalent across all three areas – Bermuda and Switzerland. Bermuda’s status as an equivalent jurisdiction is relatively unsurprising from a technical point of view, given how closely Bermudian insurance rules are modelled on the Solvency II regime. However, Switzerland is an example of a jurisdiction with a more distinct regime which was nevertheless found to be equivalent, because its regime was deemed to provide a comparable level of policyholder and beneficiary protection. In particular, the Swiss regulator was deemed to have the necessary financial and human means, expertise, capacities and mandate to effectively protect all policyholders and beneficiaries, the solvency test was found to be based on sound economic principles, and solvency requirements based on an economic valuation of all assets and liabilities, and the regime required (re)insurance undertakings to have an effective system of governance in place, imposing on them in particular a clear organisational structure, fit and proper requirements for those effectively running the undertakings, effective process for transmission of information within the undertakings and to the Swiss regulator.

The current and ongoing reviews of the Solvency II regime, both in the EU and in the UK mean that, despite the current close alignment, the two regimes are likely to start diverging. In December 2020 EIOPA published its opinion on the 2020 Solvency II review, in which it identified three areas of potential improvement. In the UK, HM Treasury published its own Call for Evidence in October 2020, starting a separate UK-specific review of the onshored Solvency II regime. Assuming that the output of the EIOPA review differs from the HM Treasury review, than there is a likelihood that the UK Solvency II regime will begin to deviate from its EU equivalent, potentially as early as this year. What will be interesting to see is if the UK can strike a balance between departing from key areas of Solvency II that might be perceived to benefit UK life insurers (for example, the risk margin or  elements of the matching adjustment) but still maintain equivalence.

Another area of potential opportunity for UK (re)insurers lies beyond the EU. With the end of the TIP, UK (re)insurers with the appetite have potentially greater scope to explore other overseas markets. For example, the UK and the US have already negotiated and agreed a US-UK covered agreement. This mirrors the EU-US covered agreement but it leaves the door open to further agreements with the US and other states around the world which may assist access to these markets for UK insurers (and vice-versa).

Implications for other areas of the UK Financial Services industry

For more information on how the end of the TIP and the TCA will affect the UK asset managers, see our briefing “The UK-EU trade deal and the end of the Brexit transitional period: things asset management firms should think about”.

Our Financial Services Brexit tracker “Helping you through changing times - Our European Brexit tracker for financial services institutions” provides a quick overview of the current position in relation to UK funds and UK fund managers seeking to sell services into EU27 countries after Brexit.

How Eversheds Sutherland can help

If you need help assessing how Brexit may affect your firm, we are able to help. Our lawyers and consultants have advised various institutions passporting into the UK from EU27 Member States and passporting from the UK into the EU27 on Brexit planning and Brexit related issues. We would be happy to discuss how we can help you with your Brexit planning, the execution of those plans and the communication with your clients about the affect of your plans upon them. For further guidance on the impact on your business, please get in touch.

To find out more on the implications of Brexit on your business, visit our Brexit hub.