Contingency Planning for a Hard Brexit Scenario
Global Benefits Vision: Now that Brexit seems to be upon us, let’s talk about how you see it impacting Lockton and the insurance world in general.
Ian Cooper: It has been quite fascinating. Insurance providers, as we know, within the single market, can passport regulatory permissions and trade across Europe. Consequently for capital efficiency purposes many insurers consolidated their capital into a single entity in Europe, and all of their other operations became branches of that single entity. So many insurers found themselves on one side or the other of the future border, and either consolidated in the UK or they consolidated in another member state of the EU. Brexit has forced insurers to adjust their operating models accordingly and establish capitalised vehicles on both sides of the future border. Given the time frames to move capital around, establish new entities, and get them regulated, insurers had to make those moves and reorganise their operational structures well before there was any certainty over the political outcome of Brexit, so they had to Brexit-proof themselves, which involves setting up a new entity, capitalising it, and transferring business to that entity.
The ways in which insurers responded has depended on their operating structure and where they were capitalised. Many of them are starting new operating models as of January 2019 and the vast majority will be ready well in time for 29 March when the UK exits.
There’s an added complexity in that it is illegal in some EU countries to execute a claim payment from outside the EU. Therefore, there is a big debate at the moment in the insurance industry about the so-called ongoing contract continuity. This means that even if the contract was legitimately and compliantly entered into when the UK was a member of the EU, the mere payment of a claim from a third country is an illegal act and liable to criminal prosecution. In many cases, the compliant contract will have expired before Brexit but claim payments often occur much later, and obviously some will have to be made post-Brexit. So we have seen a number of insurers, as part of their reorganisation plans, having to move legacy books of business into the EU under a legal process known as a Part VII Transfer, which is hugely expensive. Our estimate is that the insurance market in London has spent US$300-500 million in Brexit preparations to date.
Those are the most significant consequences for the industry at large and it has an impact on the way in which multinational insurance programmes are administered and delivered. We are starting to see these changes taking place because insurers are now operationalising their new post-Brexit or Brexit-proof structures.
GBV: Over and above setting up fully-fledged subsidiaries in continental Europe, did you see any other actions, and would you recommend any specific actions?
IC: In employee benefits, the way multinational companies buy their programmes tends to be more regionalised or country-specific compared to other lines of general insurance, so the effect is somewhat dampened in benefits compared to the general insurance world. We see examples multinational expat programmes where the UK client buys its expat programme from an EU based insurer and the insurer needs to deliver the programme from the UK going forwards. So yes, we are starting to see how Brexit impacts the way some of these programmes are delivered.
Jon Green: That in itself starts to open up a potentially new set of challenges. For example, with a IPMI contract that is written with a UK legal entity, where does that leave payments that might relate to a Belgian national receiving medical treatment in France? A No-Deal Brexit means that would potentially be an illegal payment from a UK insurer to a French hospital to fund medical expenses for that Belgian national who would otherwise be covered under a single contract. Nevertheless, a number of insurers appear to be adapting a system that is routinely used in the Middle East by potentially splitting the contract so there will be one contract with the UK legal entity for the UK expats and a secondary contract between the client’s office in one of the European member states and a European-regulated insurance vehicle to cover the European population. We see this in Saudi Arabia and the United Arab Emirates typically, so it is something that is evolving as one problem solved, but it opens up another.
IC: There is a real ‘aggravation factor’ to all of this as we like to say in the UK: potentially simple EU-wide insurance programmes administered by a single insurer via a single intermediary with a single contracting party now have to be split. And we end up with a separate contracting party in the EU to the UK, a separate intermediary in the UK to the EU, and a separate contracting party as far as the insurer is concerned within the EU and the UK.
This affects individual employees within multinational organisations by generating and administering new policy documents, new membership numbers, and new contracts. Then there will be the question of will the terms of the contracts and the insured benefits remain consistent, because there is a potential for gaps and different levels of cover inadvertently being delivered. It just seems to be an additional burden imposed on these multinational organisations in advance of any clarity around what Brexit is actually going to mean from a political perspective.
GBV: Does that apply as well to global underwriting or captive arrangements – or not at all insofar as they tend to be composed of local policies, and then it is arguably not an insurance contract that brings it all together?
JG: I think the global underwriting arrangements – whilst they have yet to gain huge traction because of the complexity of getting them away and the sometimes lack of competitiveness of those arrangements – potentially come into play as a much stronger solution because the locally contracted insurance agreements get around a number of issues that would otherwise be there under a central policy. So, it could add fuel to that market but it is a challenge in that global underwriting solutions are in their infancy from a benefits perspective and commercials are often prohibited.
IC: If it is a reinsurance captive then you will probably need a different fronting entity in the UK as opposed to the rest of the EU. The captive will still be able to operate, providing it has a willing and compliant fronting insurer in each jurisdiciton . The question is whether having two fronters as opposed to one will mean greater security required of the captive and greater frictional costs for the parent of the captive in the delivery of the program, but you are probably talking about incremental impacts rather than anything substantial.
JG: The pooling structures obviously would normally be locally structured contracts with a locally admitted insurer. I guess the question is, if you have a situation where the profits were being generated by European insurers and the UK insurer is losing money, would it be feasible for profits out of Europe to come back to a UK legal entity through a profit- sharing mechanism?
IC: Then there is the broader issue of whether established market practices are legally compliant in the post-Brexit world. For example, under the aforementioned IPMI example would the insured entity be deemed to be the individual in the EU or the employing entity that may be resident in the UK, and what is the post-Brexit legality of such a structure?
GBV: What about travel assistance? Do you see it impacted just like IPMI?
JG: Travel assistance is probably impacted in a very similar way, especially with the medical expense component and travel accident plans. It’s the same challenge.
IC: And then there are EHICs (European Health Insurance Cards) and the reciprocity of hospital treatment being paid and how all that is going to work. At the moment, as everyone says regarding Brexit, “nothing is agreed until everything is agreed”. There are further potential impacts for general European travel with changes in visa requirements, documentation, motor insurance green cards, and the whole aggravation factor around travel but that is not really an insurance issue, which is more concerned about the legality of delivering cross border insurance programmes that affect travel in the same way that it does other elements. Regarding EHICs, if there is not a reciprocal agreement around payment for hospital treatment, that will potentially have an impact on the pricing and administering of travel insurance.
GBV: So are we correct if we say that IPMI, travel, multi-country plans that include the UK and continental Europe countries will be affected but on the other hand, local plans with local employers in the UK and continental Europe will not be affected; pooling may or may not be; reinsurance-based captives probably will not; and global underwriting is a theoretical more than a practical issue?
IC: I would agree with most of that. The only thing we are watching very closely is the single country arrangement. There are quite a number of examples where a European entity may be insured with a UK insurer and vice versa, so if you have a single-country programme but the insurer is cross border, then it’s an issue.
GBV: How do you see the broker-consultant to client relationship being affected by Brexit?
IC: It’s all about how much cross border activity is taking place. Where there are multinational programmes, or sometimes we have clients from a different part of the EU administered from the UK and we are able to passport our regulatory permissions as consultants or brokers, there is clearly a risk that, in the absence of a political agreement, passporting will not be allowable going forward, so the client-consultant relationship gets disturbed in that situation. Then, having another party in the chain increases costs and then the question is who bears that cost? The consultant or the client?
GBV: Would you like to comment on the broker/consultant to carrier relationship and how that is going to be affected, and how you see that affecting Lockton?
IC: Both brokers and insurers are having to change their organisational footprint and there will be disturbance at every level of the chain: between the client and the consultant, and between the consultant and the insurer. If we eliminate the inability to cross border trade, we have to make sure all the links in the chain are legally compliant.
We are working at Lockton to ensure that we have taken a risk managed approach to Brexit ever since the referendum. We looked at our client and insurer relationships to understand which relationships are at risk of disturbance and how we would manage in a worst-case scenario. We have planned for a worst-case scenario with a No-Deal Brexit in March. As the phrase goes, ‘plan for the worst and hope for the best’. So, we have drawn up our contingency plans and have engaged the Board throughout and we are running multiple scenarios at the moment.
Even in a harmonised market, regulatory bodies do not operate consistently around Europe. In the EU, harmonisation ensures a minimum standard but many of the regulators have enhanced and gold-plated those standards; so there is opportunity for regulatory arbitrage, or different structures in different domiciles, as we have seen in Belgium with Lloyd’s and its model. Lockton is running multiple tracks at the moment to make sure we have a number of options available to our clients and all of them ready for 29 March.
There are also some really interesting regulatory debates that are linked to the insurance distribution directive (IDD) at the moment. They are unintended consequences which have not yet been resolved by EIOPA at the moment, but we are aware that discussion is taking place. European insurance regulation was not drafted with the idea that the UK would leave the EU so it leaves a number of grey areas when scrutinised under the microscope of Brexit. To that end, there are a number of brokers and insurers who are actively engaged with lawyers presenting arguments to regulators about the legality of their proposed post-Brexit operating models. That would typically involve, for example, the legalities of cross border branch and outsourcing structures due to the reliance on existing underwriting expertise. Because underwriting expertise may have been consolidated along with the other elements of operational structure of insurers, in a post-Brexit world they may not sit in the right place.
This is the human element to Brexit: making sure everybody has the right expertise in the right place; and this is one of the biggest challenges of Brexit for financial services businesses.
GBV: How is Lockton organised as far as global employee benefits is concerned. How did it organise itself to handle Brexit?
IC: Lockton itself is quite decentralised. We have a large US benefits business and as well as an International presence in Latin America, the UK, Asia, and the Middle East. All of the International benefits businesses report to London and myself. From a benefits perspective across Europe, we rely heavily on our Lockton global partners. This is a collaboration of independent benefits consultants across Europe who are all licenced locally. This collaboration makes it easier for us organisationally from a Brexit perspective, because we have local expertise throughout Europe and therefore don’t need to be distracted by having to adjust our operating model. However, we do have general insurance businesses in the EU and will be adapting to ensure they can deliver continuity of service post-Brexit.
GBV: Did you also set up a task force to handle that?
IC: We formed a core team in 2016 and focused on three elements: overall strategy; regulatory compliance and legal; and client and insurer considerations. We identified all cross-border trading whether at client or insurer level very early on, so we understood our exposure. We looked at our organisational structure and how to passport regulatory permissions and we feel we have dealt with those well ahead of time.
For example, our Irish business, which is a general insurance business, was a branch of the UK entity with passported regulatory permissions from the UK. We decided to capitalise the Irish entity and secured local regulatory approvals enabling us to convert our business from being a branch of the UK business to being a separately regulated entity. Then we looked at our cross-border business to insure continuity of service and considered how we would reorganise ourselves if we do have a hard Brexit. From a benefits perspective we do very little cross border business because we have partner brokers or partner consultants across Europe that we would typically engage in any kind multinational client servicing work so from that perspective it’s relatively straightforward.
We also took a decision not to communicate speculative or generic messages that added little value. The situation is complex, fluid and demands bespoke, client by client advice and that’s exactly what we have focussed on, and the feedback we have received from clients has been overwhelmingly positive.
GBV: Do you plan to do anything specifically to help your clients in case of a hard Brexit?
IC: The situation is so complex, given that the operational structure of insurers differs from insurer to insurer, and clients engage with multiple insurers. Coming up with a simple, one-size-fits-all communication just does not work, so we have engaged with all of our key insurance partners to understand their Brexit contingency plans as well as how they will ensure continuity of compliant coverage, from which location, and what are their time frames. We risk assessed all those insurer plans and then we have held a series of internal education sessions with our colleagues to make sure they can articulate those positions to their clients. We are also supporting that process with some internal written material.
In terms of general client communications, we took the approach that there is so much noise surrounding Brexit that we did not want to add to it unless there was something worthwhile to add to it besides conjecture and speculation. So our general Brexit communications to clients have been limited for that very reason and we have instead focused on bespoke consultancy on a client by client basis.
GBV: Let’s conclude by recapitulating what steps you should take if you are a global C&B manager or a global mobility manager in case of a hard Brexit.
IC: One thing I’d like to mention is citizens’ rights from an HR perspective. It was only recently that the UK published its future immigration policy, and I suppose that affects our industry, which has been affected by people taking pre-emptive moves – whether it be to cement their employment status and right to continue to work in the UK or Europe as an expat, or to make the decision to go back to their home country. We have seen a number of people opt to relocate in advance of Brexit.
The UK has suggested it will have its ‘settled status’ scheme where EU citizens working in the UK can apply for ‘settled status’ in the UK. HR professionals need to be well versed in this new regulation, and understand who their expats are, whether they be in the UK or UK citizens working in Europe. We see the need to offer support and guidance to these people and make sure they are aware that they have support available to ensure they are on top of those issues and able to continue to work and gain comfort from their employer.
JG: I think that is the biggest, and more strategic issue to face. Beyond that, I think the majority of clients have been inwardly focused on their own business and trading issues flowing out of Brexit so there has not been a huge groundswell of questions to date about how the insurance industry is facing up to a hard Brexit.
I think the best advice to the clients is to be asking the same type of questions we are answering here to make sure their advisers and insurers have appropriate plans – the best they can have – to protect them going forward.
GBV: So, what do you see as the biggest challenges we face if there is a hard Brexit?
JG: Definitely, the human side and having resources in place is the biggest challenge.