A ‘hard’ Brexit will hurt insurers, but could also bring some benefits

Despite the ongoing lack of any detailed plans, the signals coming from the Conservative party conference are that the UK is heading for a ‘hard’ Brexit. Although this might not be the news insurers wanted, there could be some potential silver linings to soften the impact of the regulatory fallout.
We won’t know what kind of deal the UK will strike with the EU for some time to come. But although Article 50 has yet to be triggered, the tone of Theresa May’s speeches at the Conservative party conference – particularly her insistence that the UK would not give up control of its borders – suggests we are more likely to be heading for a ‘hard’ than a ‘soft’ Brexit. This could mean a loss of many of the benefits that come from the UK’s current single market membership.
From a regulatory perspective, this is obviously not good news. The loss of passporting rights would be costly and disruptive. Insurers wanting to do business in the EU would need to acquire or establish a separate regulated legal entity (e.g. a subsidiary of the UK insurer) in a member state in order to gain a passport enabling it to do business across all the others. The new entity would have to comply with the Solvency II directive on a standalone basis, which means it would need to meet at least the minimum solvency requirements of the chosen member state, incurring increased costs of capital, as well as having to meet local governance standards. The alternative, becoming regulated in each member state where the firm wants to operate, would be even more burdensome.
Thinking ahead
Some insurers are already starting to consider their options. Choosing the preferred member state will require the consideration of a range of factors. The regulatory environment will clearly be one important issue. Not all regulators take such a gold-plated approach as the UK’s tend to do, but a regulatory framework similar to that of the UK’s, as is found in Ireland, for example, could be attractive.
Tax considerations will also enter the equation, including the local personal tax and social security arrangements. The location also needs to have the commercial infrastructure to support an insurance operation and be sufficiently attractive to UK staff to persuade them to relocate there, if necessary.
We think it likely that many insurers with established businesses based in the UK, but writing risks across Europe, will probably wish to retain the UK as their headquarters. The question then is, what sort of operation will they need to establish in their chosen EU member state to gain their passporting rights? Key decisions concerning strategy, underwriting, claims approval, investment and finance will almost certainly need to be made from an office within the chosen member state, which may involve the relocation of senior underwriters, claims handling, finance and governance personnel, but who else? How substantial a management operation will be required on the ground in the EU base? Might some staff be able to divide their time between the UK and the EU office? How many back office services can be supplied from the UK?
Tax questions also arise. For example, what will the transfer pricing model be? How will services provided by the UK to the EU subsidiary be priced? If the EU subsidiary is resident in the EU member state for tax purposes, is there a permanent establishment in the UK? From a VAT perspective too, insurers face some uncertainties. Will services supplied be deemed insurance related and so VAT exempt? Or will there be a taxable reverse charge? This may well vary by country.
Silver linings
Finding the best solution for securing passporting rights will be a challenge post Brexit. But if the UK does go for a ‘hard’ option, there could be some more positive repercussions to soften the blow. For example, insurers insuring EU customers could gain a significant financial boost through reclaiming more of their VAT. At the moment, VAT costs incurred by UK-based insurers writing business with EU customers cannot be reclaimed. When we leave the EU, if we are outside the single market, that could well change. Significant figures are involved here, so this would represent a major cash boost to the industry.
A hard Brexit would also mean that insurers would not have to implement European case law. This would mean an escape from the impacts of two severely restrictive insurance-related VAT cases – those of Andersen and Aspiro.
There could be some advantages from a direct tax perspective as well. The EU has been pushing towards the introduction of tax avoidance directives, so a hard Brexit would save the UK from associated implementation headaches (although EU-based operations would be affected). Similarly, the UK won’t have to sign up to any common consolidated tax base, which has been on the EU agenda. So this is also good news.
It’s worth remembering too that the UK does have an excellent tax treaty network, many of which provide for nil or very low rates of withholding taxes. So no longer having the benefit of the EU’s withholding tax directives need not be as serious an issue as might initially appear.
Establishing a regulated entity in another member state will be time consuming, not least the task of applying for and obtaining local regulatory approval. This alone could take up to 12 months. With Brexit negotiations possibly being complete in just over two years’ time, UK insurers should be thinking about their strategy for the loss of passporting rights from the UK sooner rather than later.

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