The UK’s decision to leave the EU, made on 23 June and handed down on 24 June, has shocked the world, with many not expecting such a decision. The vote, at 52 percent for and 48 percent against, showed that it was too close to call, so whatever your business, you could be forgiven for not planning ahead.
The UK’s decision to leave the EU, made on 23 June and handed down on 24 June, has shocked the world, with many not expecting such a decision. The vote, at 52 percent for and 48 percent against, showed that it was too close to call, so whatever your business, you could be forgiven for not planning ahead.
The initial reaction of the captive insurance market was mixed. The vote to leave the EU could affect UK-based parents with captives in Gibraltar or EU states. Meanwhile in non-EU states, such as Guernsey and Bermuda, there is likely to be no direct impact on the captive.
According to Martin Le Pelley, finance director at Artex Risk Solutions, UK companies with captives should conduct a review of the location and risk it is insuring.
Le Pelley notes that some risks can be written on a non-admitted basis, meaning that the insurer does not need a licence in the jurisdiction where the risks are located in order to insure them.
He says the prospect of Brexit will have no impact on business written on a non-admitted basis.
For captives located in Gibraltar, he says, there will be no impact on a captive’s activities if it has a UK owner with only UK risks. However, the captive may need to redomicile or seek an EU licence to continue writing EU risks directly, at least until a trade deal is established between the UK and the EU.
Le Pelley says: “If the captive is located in Malta or Luxembourg, then it may need to obtain a licence to continue to write UK risks, in the absence of a trade deal. It would seem unlikely that the UK would finalise its exit from the EU without these trade deals in place.”
This means that in the short term, there is likely to be no impact on captives.
From a practical perspective, Le Pelley says it is possible that certain risk may become more expensive to insure in the traditional market, such as credit risk or trading risks. This is due to the downgrading of the UK sovereign credit rating and the uncertainty over trading relations with the EU.
Immediately after the results of the referendum were finalised, the value of the British pound fell to a 31-year low against the dollar. Le Pelley suggests that the foreign exchange volatility is of a concern to companies that are writing business in more than one currency.
He says: “The investment landscape has been depressed for some considerable time now, and most captives have become used to low investment returns. In fact, as most captives are designed principally for risk management purposes, the key focus of boards is the underwriting performance of the company, and not the investment return.”
Gibraltar
Nigel Feetham, a partner at Hassans International Law Firm, suggests that Brexit could bring opportunities for Gibraltar’s captive insurance market.
Feetham says that the higher capital requirements for captives in the EU, under the new Solvency II regime, mean that EU-based captives have become capital-inefficient for some owners.
This means captive owners have either chosen to relocate their captives outside of the EU or use fronting arrangements.
Feetham claims that a post-Brexit scenario therefore could give rise to an opportunity for Gibraltar in an area where, under current EU rules, it would not have been able to compete for business.
He explains: “For this to happen Gibraltar would require a new legislative framework to permit captive owners to set up captives in Gibraltar with less burdensome capital requirements similar to, say, Guernsey. The current legislative regime in Gibraltar is wholly unsuitable for this.”
However, Le Pelley suggests that Gibraltar is keen to maintain its market access to the EU, and will be pushing the UK to maintain its freedom of services access, perhaps through an European economic area-style trade agreement.
In this case, Gibraltar will have no flexibility to change its regulatory regime, as Solvency II equivalence would be a requirement for such a deal.
If the passporting rights come to an end, Le Pelley advises that Gibraltar would still need to maintain equivalent regulation to the UK in order for Gibraltar companies to insure UK-wide risks.
Feetham predicts that Brexit will trigger a boost in the use of Gibraltar protected cell companies by captives in such a scenario. He says: “In this regard, the sooner the UK negotiates with the EU the better it would be for Gibraltar, as it would end any uncertainty and both the UK and Gibraltar can plan accordingly.”
Feetham notes that the existing trading relationship between Gibraltar with the UK will not be directly affected by Brexit, however, he recommends captives that write EU business to consider their positions in the same way as any other companies writing EU business should.
Guernsey
In Guernsey, the situation is completely different, because the island, although a British crown dependency, is not in the EU. This means that it does not have freedom of service access to EU markets, and gives it the freedom to implement regulations to suit its markets.
Guernsey captives can only write business directly into other jurisdictions on a non-admitted basis, meaning rules are structured to suit market participants. Le Pelley reveals that this was achieved in the Insurance Business Rules 2015, which are fully compliant with Insurance Association Insurance Supervisors (IAIS) core principles, but are not necessarily Solvency II equivalent.
According to Guernsey officials, the island is well placed to ensure any impact Brexit might have on its trading relationships is minimised. They have also assured that Guernsey will put in place any alternative trading agreement required.
Gavin St Pier, Guernsey’s chief minister, said: “Following the UK decision to leave the EU in this referendum nothing will change overnight in the relationships Guernsey has with the EU, or the UK for that matter.”
He added: “We will be monitoring the economic impact of this significant constitutional change for the UK and we will be engaging with business and with the Committee for Economic Development to understand this knock on effect to our economy.”
Dominic Wheatley, chief executive of Guernsey Finance, commented: “We note the decision of the people of the UK to leave the EU. However, although the decision is clear, we have yet to see how it will be implemented and the new world that will be formed in this process.”
“We will be monitoring developments closely to assess the impact of this on Guernsey and the financial markets in which we operate.”
Solvency II
Since the out-vote was announced, UK companies have been speculating about whether the vote to leave will have any effect on the Solvency II regime, launched on 1 January this year.
Given that the UK is currently an EU member state and is currently in the process of applying Solvency II, Le Pelley questions why the UK would not continue to be Solvency II compliant after finalising its exit from the union.
One benefit from exiting the EU, Le Pelley notes, is that the UK may have greater flexibility to amend its insurance regulations, and perhaps implement a bifurcated regime, similar to Bermuda’s, which would allow for a different regulatory approach for captives.
He said: “If the UK is also able to maintain passporting rights through a trade agreement with the EU, this would ensure that the UK’s insurance industry would remain relatively unchanged by Brexit.”
Jonathan Howe, PwC’s UK insurance leader, argues that Solvency II will almost certainly remain.
He suggests that too much time and effort has been invested into the regulation, adding that it is already enshrined in UK law.
Many non-UK insurance companies from areas such as the US and Asia currently use the UK as their European headquarters and as a ‘gateway’ into Europe through passporting, says Howe.
If the UK chooses not to continue to be Solvency II equivalent, Le Pelley insists there would be a negative impact on the counterparty credit rating of unrated insurers, which would put them at a disadvantage when trading with the EU.
Le Pelley says: “It is hard to see why Brexit will damage the captive insurance industry as a whole.”
“Most parts of the industry will be unaffected by the UK’s exit from the EU,” Le Pelley explains.
“Depending on the terms of the exit, it may be the case that the industry will be enhanced by the decision, rather than damaged by it.”
