brexitThe historic June 23, 2016 vote by a majority of voters for the United Kingdom to leave the European Union has dominated the headlines and roiled financial markets around the world – and for good reason. The U.K.’s withdrawal from the E.U. will have an enormous impact on the U.K itself, on the E.U., and on the rest of the world. Many of the consequences of Brexit will only become apparent as the long process that is about to commence unfolds over the course of the next few years. But while all of the consequences of Brexit will only become fully apparent over time, many of the likely effects can be predicted or at least anticipated now.


Among other things, because the financial services sector is among the industrial segments to which E.U. regulations have most extensively been applied, the financial services sector is among the segments that will be most significantly affected. In the following post, I review some of the ways that Brexit will impact the insurance industry, and discuss the implications for the industry, as well.


What is the Immediate Significance of the Brexit Vote?

As dramatic as the Brexit vote outcome is, it doesn’t immediately or by itself change anything. The U.K. remains a member of the E.U. and there are no immediate changes to either U.K. law or E.U. law as a result of the vote.


As discussed in a very interesting and succinct June 24, 2016 post by Ben Perry of the Sullivan & Cromwell firm on the Harvard Law School Forum on Corporate Governance and Financial Regulation blog entitled “Brexit: Legal Implications” (here), what the “leave” vote does is trigger a lengthy, multi-track process under which (1) the U.K. and the E.U. must negotiate the terms of the U.K.’s withdrawal from the E.U.; (2) the U.K. must enact legislation to implement the withdrawal from the E.U. and to replace E.U. laws that currently cover a wide range of topics and activities in the U.K.; (3) the U.K. must negotiate treaties and trade agreements to replace the E.U. treaties and trade agreements that currently regulate the U.K.’s relationships with the various counterparties.


What Happens Next?

The terms for the U.K.’s withdrawal from the E.U. are defined in Article 50 of the Lisbon Treaty (as the international agreement that provides the constitutional basis for the E.U. is commonly known). Under Article 50, an E.U. member wishing to withdraw from the E.U. must notify the European Council of its intention, upon which the E.U. will negotiate the terms of the member’s withdrawal. The withdrawal will take effect on the effective date of the withdrawal agreement, or failing that, two years after the notification.


Because the provision of notice sets the clock ticking on the two-year period, the timing of notice is important. British Prime Minister David Cameron has suggested that he thinks the appropriate time for the U.K. to provide the Article 50 notice to the E.U. is sometime after his successor has been selected, presumably in October (or later). On the other hand, in a meeting on June 25, the leaders of several of the E.U. member states suggested their view that the process should get underway immediately.


Given the uncertainty and volatility that will prevail until the U.K’s withdrawal is complete, you can certainly see why the leaders of the various European countries want to get this process underway and completed as quickly as possible.


However, there is arguably a very practical reason for the U.K. to hold off for a while before giving Article 50 notice; that is, because notice triggers the 24-month time-clock, it probably makes sense to try to do a significant amount of preliminary work before the notice is provided, to maximize the likelihood that a withdrawal agreement can be negotiated, rather than to have the withdrawal effected by the lapse of the two-year time limit. The U.K.’s withdrawal is much more likely to be completed in an orderly and reasonable way if it is the result of a negotiated withdrawal agreement rather than by operation of a time limitation trigger.


(Significantly, however, the representatives of the member countries and of the E.U. that met over the weekend have asserted that there won’t be a “middle way” and that they won’t talk until the U.K. has provided Article 50 notice.)


How Long is The Withdrawal Negotiation Process Likely to Take?

Although it is in everyone’s interest that the negotiation of the withdrawal agreement moves quickly, the reality is that it is likely to take a long time. The only precedent does not bode well for a quick process. When Greenland (an autonomous country within the state of Denmark) voted in 1979 to leave the E.U., mostly because of disputes involving fishing rights, negotiations dragged on for six years, and Greenland did not leave the E.U. until 1985.


Article 50’s procedural requirements contribute to the difficulty of completing a withdrawal agreement. Under Article 50, in order for the withdrawal agreement to go into effect, the agreement must be approved by the remaining 27 E.U. member states and the European Parliament (by a simple majority). Given the high profile and fraught nature of Brexit, these votes could prove to be troublesome.


A practical consideration will likely complicate the negotiations and draw out the process. The remaining member states have every reason to be concerned about preserving the remaining union. Political elements in several other European countries undoubtedly will seize on the outcome of the U.K. vote and start agitating for their own country’s withdrawal. The E.U.’s negotiators will have a huge incentive to avoid agreeing to anything with the U.K. that will suggest to other potential leave-takers that their country would be better off outside the E.U. In other words, the negotiation of the withdrawal agreement is going to be a tough test of wills.


How Has the London Insurance Marketplace Benefited from the U.K.’s Membership in the E.U.?

As detailed in a February 10, 2016 speech by the then-Chief Risk Office of Lloyd’s, Sean McGovern (a speech that was interesting at the time and that is even more interesting now), the U.K.’s E.U. membership has conferred three very important benefits on the London insurance marketplace: it allowed access to the Single Market; it encouraged Foreign Direct Investment; and it facilitates trade with countries outside the E.U. I discuss below the potential impact of Brexit on each of these aspects of the relationship.


There is another important benefit that the London insurance marketplace has derived from the U.K.’s E.U. membership and that is that it has been able to attract talented personnel from around Europe to work in London. As AON’s CEO said in a statement in the days prior to the vote, the withdrawal of the U.K. from the E.U. could discourage the flow of talented professionals from the E.U. into the U.K.


One other benefit to consider has to do with the regulatory process. Prior to the vote, Brexit advocates bemoaned the onerous burden the U.K suffered as a result of regulations from Brussels. However, as a member of the E.U., the U.K. at least had a seat at the table and the ability to try to negotiate the details of the regulation. Depending on the nature of the U.K.’s post-Brexit relationship with the E.U., the U.K. could find itself subject to the burden of the regulations but without any ability to affect the content of the regulations.


The way in which all or parts of these three models are adopted, and how they are adopted, could have very different implications for the insurance industry.


How Will Brexit Alters the Benefits that the London Insurance Market Enjoys from Access to the Single Market?

As a result of its E.U. membership and access to the single market, underwriters at Lloyd’s and in the larger London market are able to write insurance and reinsurance from all of the other 27 member states on a cross-border basis  (and also locally in those countries where Lloyd’s or the other London underwriters have branches). The underwriters operate under a “passport” system, pursuant to which they are able to conduct business throughout the E.U. while regulated and supervised by the Prudential Regulatory Authority (PRA), the U.K. financial regulator. The underwriters are not required to localize funds or to report to local regulators. The underwriters are, however, subject to E.U. requirements, including in particular the Solvency II Directive requirements.


Access to the single market also benefits the London brokerage community, as they are able to operate throughout the EU on the basis of their home state passports and subject only to home state regulation. This in turn benefits the entire London insurance marketplace as it enables business from across Europe to flow to London.


How Brexit will affect London’s ability to operate in the single market remains to be seen. Depending which of the various models identified above, the possibilities range all the way from total loss of ability to operate in the single market, to possibly no change in the access (as for example, under the Norwegian model). Not only are the implications for access to the single market unclear, but it could be a considerable time before the answer is clear. While access to the single market will continue in the interim while these issues are sorted out, that does not mean that nothing will change. I suspect there will be very little hiring in the London insurance market until these issues are sorted out. There likely will be very few new ventures started, at least with respect to ventures focused on doing business in the E.U.


The E.U.’s withdrawal agreement negotiators’ incentives to try to avoid agreeing to anything that might encourage other member states to consider leaving likely will militate strongly in favor of trying to cut off the U.K.’s access to the single market. If the U.K. withdrawal establishes a precedent that a member state can withdraw but retain the benefits of access to the single market, other current member states might be drawn to seek to withdraw. If on the other hand, the precedent established is that withdrawal means loss of single market access, other potential leave-takers might be likelier to stay put.


Of all the changes that might arise as a result of Brexit, loss of access to the single market and the ability to do business on a passport basis would be the ones that would affect the insurance industry most significantly – and most negatively. But while the U.K. negotiators might want to find some Norway-like approach whereby the U.K. could continue to have access to the single market, the fact is that maintaining single market access would almost certainly also entail allowing free migration from EU member states and accepting EU business regulations — in other words, maintaining single market access would require the very things that the Brexit advocates sought to reject with a “leave” vote. In the end, it may prove to be very hard for the U.K. to achieve continued access to the single market as part of the final withdrawal arrangements.


How will Brexit Affect the London Market’s Attractiveness to Investment and Benefits from Trade Arrangements it Now Enjoys in the E.U.?

The London financial services industry, including the insurance services industry, is an attractive destination for global investment capital. Most of the capital invested in London comes from outside the U.K., and much of the capital that comes from outside the U.K. comes from the E.U. This investment capital comes to London for many reasons – the U.K. legal system, the globally central location, the English language basis on which business is done. But among the reason the U.K. attracts capital are the benefits it enjoys from its E.U. membership, particularly its access to the single market. The ability to participate in the London marketplace while enjoying access to the single market is among the important reasons, for example, that international insurers and reinsurers from emerging markets are attracted to the London insurance marketplace.


In making itself an important part of insurance business around the world, the London insurance marketplace enjoys the benefits from treaties and trade agreements that the E.U. has negotiated with 55 countries around the world. The E.U. is seeking to complete deals with another 87 countries. These deals open up countries and, for example, allow foreign insurers to operate within the trading partner countries.


E.U.’s size gives it substantial weight when it negotiates with these counterparties. There are negotiating advantages that the E.U. enjoys when negotiating on behalf of a trading block that represents (without the U.K.) about 430 million people, certainly by comparison to the 63 million people that a U.K.-only negotiator would represent. Moreover, as the U.K. seeks to negotiate on its own behalf to replace the treaties and trade agreements that are in place with the E.U., it will vie for attention not only with the E.U, but China, Japan, India, and the U.S. The ease with which the London insurance marketplace competes for business in the various other countries around the world will be substantially affected by this process.


There is another very practical problem for the U.K. as it readies to try to negotiate its own treaties and trade agreements with the rest of the world. That is, the U.K. has not negotiated its own trade agreements since 1972. There is no reserve squad of talented international trade negotiators hanging out in Whitehall. The country’s coming trade negotiating efforts are going to involve a great deal of on the job training.


How Will All of This Affect the U.S. Insurance Marketplace?

The only honest way to answer this question is that it remains to be seen. However, there are at least two distinct ways the U.S. marketplace could be affected – the ways the U.S. insurers will be affected as a competitor to the London marketplace, and the ways the U.S. insurers will be affected as participants in the marketplace.


First, the domestic U.S. insurers are in competition with the London insurance marketplace in many ways. It potentially could be helpful to the U.S. insurers, to the extent they are competing with the London marketplace, as any detriments the London marketplace experience could create opportunities for the domestic insurers.


However, the fact is that many domestic insurers are in fact active participants in the London marketplace. Many domestic insurers have substantial operations in London, in large measure because the London location and the U.K.’s participation in the single market allow the qualifying insurers to operate efficiently in London. (Indeed, one U.S.-based company, AON, relocated its headquarters from the U.S. to London in 2012 for that reason.)  At least one large domestic U.S. insurer said prior to the vote that it might relocate its operations from London to a continental European location if the “leave” vote prevailed.


Until it is known which model will prevail for the U.K.’s post-Brexit relationship with the E.U., there arguably would be nothing forcing these insurers to make a change; however, the uncertainty that will prevail until these issues are resolved and the desire to avoid actions that later might have to be undone may cause these and other London market participants to decamp to the Continent. While many things remain to be seen, there could be a slow but steady movement of jobs and operations from London to the Continent. Also, this movement might not be slow.


How Should Policyholders With (or Considering) Policies from the  London Insurance Marketplace Think About These Issues?

Notwithstanding the impending withdrawal of the U.K. from the E.U., the London insurance marketplace retains and will retain many of its hallmark strengths. The market’s capital strength, underwriting expertise, and ability and willingness to underwrite complex or hard-to-place business will remain unchanged, regardless of how the Brexit process plays out.


Even if it turns out there are substantial changes ahead for the London insurance marketplace, these changes likely are some way off and there likely will be plenty of advance warning before those changes kick in. In the meantime, there is certainly no reason for any policyholder whose best available insurance solutions are through the London marketplace to reconsider its insurance position. Even after the Brexit vote, London remains and will remain the best place in the world to get certain kinds of insurance business done.


That said, it is going to be very important for those of us providing insurance advice to clients to monitor events very closely. Among other things, it will be important to keep an eye on whether there is a drain of personnel or operations from London as market players anticipate events or try to hedge their bets by adopting a Continental base for E.U. business. Similarly, it will be important to watch whether London continues to be able to attract the top talent from Europe or loses top talent as E.U. resident employees head home in the belief that their long term best interests lie elsewhere. There is a very real possibility that the London marketplace could change as its personnel relocate.


Along with watching personnel and operations, it will also be very important to monitor the withdrawal negotiations as they unfold. Depending on how the U.K.’s post-Brexit relationship with the E.U. is defined, the post-Brexit structure could have very important implications for the London insurance marketplace.


Among the most important things to watch will be the U.K.’s future relationship to the single market. If as a result of the withdrawal the U.K. were to lose access to the single market, without even a Norwegian-style way to continue to participate, the London insurance marketplace could change significantly. Similarly, if the post-Brexit structure does not allow the London marketplace to be able to continue to attract talent freely from around the E.U., the London insurance marketplace might well lose its preeminent underwriting expertise.


What Could Go Wrong?

As a result of the outcome of the Brexit vote, the U.K. must now go through an extended period of uncertainty and, ultimately, change. Many U.K. voters obviously decided it would be worth it for the country to go through these changes. In the end, the U.K. could well be better positioned than it would have been remaining in the E.U.  The hard part is that it is so difficult to know now how long the process will take and how it will turn out.


The protracted period of uncertainty would be hard enough if all that were happening is the resolution of the U.K.’s withdrawal. The problem for everyone is that there will be lots of other things besides the negotiations going on in the meantime, any one of which could create further turbulence for the withdrawal negotiations.


Among other things, there is a U.S. presidential election in November. That would be a potential complicating factor in any election cycle, but the extraordinary nature of the current U.S. Presidential election cycle introduces a whole new layer of risk and uncertainty.


In addition, France has Presidential and parliamentary elections scheduled in April and May 2017 as well. It could well be that certain political elements in France, encouraged by the U.K.’s Brexit vote, will campaign on a platform calling for “Frexit.” Political players in other countries could similarly try to jump on the “leave” bandwagon and start agitating for their own country’s E.U. withdrawal.  Geert Wilders, the head of the Party for Freedom in The Netherlands, has already launched calls for “Nexit.”


A significant withdrawal movement in other countries could significantly complicate the negotiations of the U.K’s withdrawal — and indeed could threaten the continued viability of the European project itself. We may need to be prepared for Grexit, Departugal, Italeve, Czechout, Oustira, Finish, Slovakout, Latervia, Byegium, and more besides.


The European Union is not the only union that the Brexit vote threatens. The long, historic union that is the basis of the U.K. itself is in peril as well. Nicola Sturgeon, Scotland’s first minister, has already called for another Scottish independence referendum, with the goal of moving Scotland (whose voters overwhelmingly voted against Brexit) into the E.U.  Various politicians in Northern Ireland have also already raised calls for a referendum to have Northern Ireland leave the U.K. and join Ireland (an E.U. member).


And here’s another interesting thing to consider – the U.K. is scheduled to assume the rotating Presidency of the counsel of the E.U.  from July to December 2017. (There are signs that other E.U. member states may move to cancel this scheduled rotation.)


Uncertainty will be the watchword for some time to come. As is well-known and understood, the financial marketplace does not like uncertainty. What is true of the financial marketplace is also true of the insurance marketplace. The insurance business consists of an entire industry built around principles of predictability. When uncertainty rather than predictability governs, times are tough for the insurance industry. And that is where we are today.


I know that many readers will also have their own perspectives on these issues, particularly those in the U.K. and in Europe. I encourage readers to add their thoughts to this blog post using the blog’s comment feature.