The impact of Brexit on insurers – A status quo

The United Kingdom (UK) is the first country to leave the European Union (EU). The UK had massively shaped the European Community and later the EU in its political and economic development for 47 years. Their departure is therefore not only a fundamental loss for the EU, but also affects cross-border business. In particular, insurers domiciled in the UK and/or Germany or those that operate in the other country only through branches or by way of the freedom to provide services will be affected by the consequences of Brexit. In addition, there is the free trade agreement still to be negotiated between the EU and the UK, the content of which may have a significant impact on the business of such insurers. Against this backdrop, this article looks at the status quo of Brexit and the associated consequences.

A look back
On June 23, 2016, Great Britain and Northern Ireland decided to leave the EU in a referendum. Although the then Prime Minister Theresa May wanted to go down in history as the minister who saved the UK from the EU with her words “Brexit means Brexit,” she failed several times with her agreement negotiated with the EU because of the approval of the British House of Commons. She resigned on June 7 last year. She was succeeded by Boris Johnson, who negotiated a deal with the EU on October 17, 2019, to allow the UK to leave the EU in an orderly fashion after all. Instead of voting on this agreement, Boris Johnson, under pressure from the House of Commons, asked the EU to postpone Brexit, which was originally scheduled for Oct. 31 of last year. EU member states agreed to a delay until January 31, 2020.

As a result, the British House of Commons called for new elections. A new British House of Commons has now been elected on December 12, 2019, from which the Conservative Party led by Boris Johnson emerged as the clear winner, which means it now has an absolute majority with 365 of 650 seats in the House of Commons. Although the bill to ratify the Brexit agreement (European Union Withdrawal Agreement Bill 2019-20) was passed by the House of Commons on Jan. 9 of this year by a vote of 330 to 231, it was not passed by the House of Commons. However, the House of Lords did not initially approve the bill on January 21. The House of Lords demanded some changes, but yielded to pressure from the House of Commons a day later and gave its approval. The EU Parliament then ratified the Brexit agreement, as a result of which the UK left the EU on January 31, 2020, as scheduled. The EU and the UK now want to agree a trade deal within the defined transition period ending December 31, 2020. If no agreement is reached, a “hard Brexit 2.0” may occur at the end of the transition period, with consequences for the insurance industry.

Principle of cross-border insurance activity
If an EU/EEA state grants an insurer permission to conduct business, the permission is valid in all EU/EEA states (so-called European passport or single-license principle). In order to be able to conduct insurance business in Germany, an insurer already licensed in another EU/EEA state thus only has to go through the notification procedure and not a separate licensing procedure. Here, the insurer notifies the supervisory authority (BaFin or, in the UK, the Prudential Regulation Authority (PRA)) that it wishes to expand its business operations to another EU/EEA state. The formal requirements to be met subsequently differ according to whether the activity is carried out by way of trade in services or by way of establishment. The situation is different if a German or (currently still) an English insurer wishes to operate in a third country. The latter would have to apply for a permit, depending on the regulations applicable there. Conversely, an insurer from a third country is not allowed to operate its business in Germany without further ado, but must apply for a permit from BaFin. The single-license principle does not apply to third countries.

Currently, 34 insurance companies domiciled in the UK (hereinafter referred to as UK insurers) maintain a branch office in Germany; in addition, there is one subsidiary with majority owners from the UK. In addition, 162 UK insurers are registered for the free movement of services in Germany. Conversely, two German insurers have a subsidiary in the UK and 13 German insurers maintain a branch in the UK. There are 29 insurers from Germany registered for the free movement of services in the UK.

Effects of the Brexit
For a long time it was completely open whether a Brexit deal would be accepted by the House of Commons and whether there would be a regulated (so-called “soft Brexit”) or an unregulated (so-called “hard Brexit”) or even a “no-deal Brexit”. In contrast to a “hard Brexit”, in which the UK would have left the EU without a treaty, a “no-deal Brexit” is a scenario in which the UK has concluded a withdrawal agreement but becomes a third country after the transition phase without a free trade agreement. The German legislator has already made provisions for the first two variants. In the event of a soft Brexit, the Bundestag passed the Brexit Transition Act (BrexitÜG) with the approval of the Bundesrat on April 3 last year. The Act provides for a transition period up to and including December 31, 2020, during which the UK will continue to be considered a member state of the EU under federal law. This phase is also specified in the UK as a “time-limited implementation period” in Article 126 of the European Union (Withdrawal Agreement) Bill 2019-20.

During this time, a free trade agreement must be negotiated between the UK and the EU, setting out the terms of the future economic relationship. The transition period may be extended by one or two years if the UK and EU decide to do so before July 1, 2020. Such an extension should be considered especially if the intended FTA would not be finally negotiated within the original transition period. Even though Boris Johnson’s government already wants to rule out a request for the extension of the transitional period, this possibility of extension is still included in the aforementioned bill, however.

Necessity of a free trade agreement with the UK
As a result of leaving the EU, the UK will become a third country. A free trade agreement would be able to secure certain regulations, such as on trade in services, bilaterally. In order to be internationally competitive, the EU Commission has been striving since 2007 for free trade agreements with important trading partners that no longer focus only on tariff issues, e.g. customs duties, but also include regulations on services and other trade-related aspects, such as competition issues.
The model for this could be the agreement between the EU and Canada (so-called. Comprehensive Economic and Trade Agreement (CETA)) serve. Among other things, CETA creates simplified market access for services, especially for financial institutions and insurance companies; in addition, CETA gives insurers the opportunity to offer insurance products and services across borders in each other’s markets. Likewise, under CETA, the regulatory measures of the other party are mutually recognized. However, CETA also shows how long it takes to negotiate and ratify such an agreement: The technical negotiations on CETA, which began on June 10, 2009, were not concluded until August 2014. The legal formalities alone took up to and including February 2016 before it was published by the EU Commission and signed by the EU member states. It was not until a year later that the agreement received the approval of the EU Parliament and has since been in the ratification process, which must be carried out by all EU member states.

The EU-Japan Free Trade Agreement (FTA), which entered into force on February 1, 2019, is a similar instrument. JEFTA, Japan-EU Free Trade Agreement or Economic Partnership Agreement (EPA)), which was negotiated from 2013 to 2017 and is considered the EU’s most comprehensive bilateral trade agreement. However, the framework conditions for services are still being negotiated. In this respect, the content of JEFTA has not been completely finalized either.

The same applies with regard to an agreement with Australia, which is in its infancy. Here, on May 22, 2018, the trade ministers of the EU member states first decided to start free trade negotiations with Australia, which they began in June 2018.

Given the long negotiation periods for CETA and JEFTA alone, it is difficult to implement a free trade agreement with a UK that has left the EU within the transition period, especially since the negotiations on such an agreement are not scheduled to begin until March. It is therefore questionable whether it will be possible to agree on a free trade agreement by December 31, 2020. If no agreement is reached and the transition period is not extended, there is still a threat of a “hard Brexit 2.0” in 2021.

However, the UK is optimistic. According to Boris Johnson’s statement on February 3, the choice is not between a “deal or no-deal brexit,” but whether there will be a model based on the EU-Canada free trade agreement or the one between the EU and Australia. While the latter does not even exist at present, the former model might be more likely to be considered for the UK because of the ties between the two states in the Commonwealth Confederation of Nations, especially since the British Queen also holds the role of Canadian head of state. By his own admission, it is more desirable for Boris Johnson to copy and adapt most of an existing free trade agreement anyway. Another argument in favor of Johnson’s interest in concluding a free trade agreement as quickly as possible is that he wants to prevent an extension of the transition period at all costs.

“Hard Brexit 2.0” as of 2021
If, contrary to expectations, a free trade agreement between the EU and the UK is not reached, the UK will become a third country without a free trade agreement. The consequences would be that basically all EU regulations, both primary law and directly applicable secondary law directives, would no longer apply. This results in an uncertain legal situation both for German insurers in the UK and for UK insurers doing business not only in Germany but in the European Economic Area (EEA).
If the UK becomes a third country, insurers would not be able to invoke either the freedom to provide services or the freedom of establishment, as the fundamental freedoms only apply within the EEA. For these insurers, a situation would arise in which – without an authorized branch or subsidiary – no new contracts would be allowed to be concluded or existing contracts extended or expanded. The single-license principle no longer applies, UK insurers would be required to provide a license under section 67 para. 1 VAG, apply for permission from BaFin before entering into new business relationships.
For insurance contracts that have already been concluded, there is clarity at least to the extent that existing insurance contracts with UK insurers generally retain their validity under civil law. However, insurers will have to take further steps to ensure that this remains the case after the transition phase. Similarly, regulators in the UK will need to put regulations in place to allow contractual obligations to continue to be met after the transition period. How exactly these regulations are to be designed to enable both sides to fulfill the agreements even after the transition phase must become part of the future free trade agreement. Here, too, the free trade agreement (CETA) negotiated with Canada provides a preview of how corresponding regulations could look with regard to the cross-border sale of insurance and financial products, market access, regulatory requirements, etc. In this respect, the negotiation process for a free trade agreement remains to be seen.

Possible courses of action
As a result of the situation just described, insurers in both countries now find themselves in a situation where they would not be allowed to enter into new contracts, but must honor existing liabilities. There are several ways insurers can deal with this.

Business closure
One possibility – and for many also a “worst-case scenario” – would be for insurers to give up their new business. What is required for this is to properly wind up its existing business and then liquidate the company. To do so, they would have to cancel existing policies, where possible, or transfer them to licensed insurance companies within the respective country (so-called run off). According to an EIOPA recommendation, the competent authorities should allow this procedure. For German insurers in the UK, supervision by BaFin must also be ensured in the course of winding up and liquidation (Section 294 (7) VAG). This is necessary because even pure portfolio management is still considered insurance business. Cooperation between the German and UK authorities is crucial for this.

Third country approval of an existing EU/EEA branch office
If the insurer has previously operated cross-border through an EU/EEA branch, it would be possible to have this approved as a third country branch by the PRA and BaFin. English law, like German law, provides for possibilities to license insurers from third countries to conduct their business in the respective country. The approval of the already existing branches would have certain advantages. Business could continue under the same name without the need to transfer existing contracts.

Business operations could therefore continue (almost) without a hitch. In terms of licensing law, the following problem has arisen to date, which has made it difficult for insurers to take action at an early stage: Until the UK left the EU, it was still an EU member state, which meant that insurers did not yet meet the requirements for licensing outside the EU. It was not until the UK withdrew on January 31, 2020 that it became a third country and thus eligible to apply. For affected UK insurers, EIOPA recommends that national authorities take into account when granting authorization that UK insurance companies were subject to Solvency II requirements prior to UK exit. In terms of time, the transition period provides relief. At least those insurers who wish to operate a licensed branch in Germany should now use the transitional period to apply to BaFin for a license.

Establishment of a third country branch
If the insurance company has previously only been active across borders in the freedom to provide services, it can no longer invoke this fundamental freedom upon withdrawal. In Germany, an insurer from a third country cannot offer its insurance products on the German market without a German branch. UK insurers would thus have to establish a branch office and apply to BaFin for a license for it. The prerequisite for this is that it must be managed in such a way that it could be continued at any time as an independent business, i.e. independently of the head office abroad. In addition, a principal representative must be appointed, who must be domiciled and permanently reside in Germany. However, he does not have to be in possession of German citizenship. The regulations for the licensing of a third-country branch – in contrast to the EU/EEA regulations – do not contain an inspection period by the supervisory authority, after which the branch can be established and the business activity can commence.
This circumstance and the fact that a large number of applications can be expected as a result of Brexit mean that insurers should start now at the latest to initiate all the steps necessary to set up a branch office and to take advantage of the short transitional period for setting up and licensing.

New establishment of a subsidiary
Another option would be the far more complex establishment of a new subsidiary based in the respective country and its licensing as an insurance company with subsequent portfolio transfer. The registration of a subsidiary is possible in the UK as well as in the EU regardless of the Brexit, but it is very time-consuming. The approval process alone can take up to a year. In this respect, re-registration is associated with high costs for insurers in addition to the considerable administrative effort. In order to keep these formation expenses as low as possible, it is tempting to merely maintain a registered office in one country, but to continue to manage the business operations from the respective home country. However, the establishment of so-called “letterbox insurances” is to be prevented. Therefore, EIOPA has set initial minimum requirements to the effect that the professional knowledge and organizational structure requirements set out in the IDD should be met.

Seeing Brexit as an opportunity
Like the economy as a whole, insurers will feel the effects of Brexit or already have. On the one hand, much depends on whether there will be a free trade agreement and how it is structured. On the other hand, various options for action remain open. Arrangements should be made and prepared to maintain a steady business depending on the outcome of the case.
A possible determination of equivalence by the EU Commission for the UK as a former EU member and thus previously subject to Solvency II could bring some relief.
For life insurers, there is also a fund in the UK, the Financial Services Compensation Scheme (FSCS), which is comparable to the “Protektor Fund” established in Germany in 2002. Its purpose is to keep life insurers from going bankrupt. In this respect, at least life insurers can breathe a sigh of relief with their business activities in the UK.
Even if Brexit brings new challenges for insurers, with timely action this can also be seen as an opportunity.