Lloyd’s CRO urges insurers to contingency plan against the risk of Brexit. Was he right to do so?

Lloyd’s Chief Risk Officer, Sean McGovern, spoke to the Insurance Institute of London yesterday about the impact of a possible Brexit on insurers, reinsurers and brokers. The speech was delivered at a sensitive time, and with some urgency: most commentators expect UK / EU negotiations to finish next week; with the UK’s referendum to follow three months later. And the opinion polls suggest the result is too close to call.

It is perhaps for these reasons that McGovern drew our attention to the many benefits that EU membership brings:

it provides us with access to the Single Market; it encourages Foreign Direct Investment; and it facilitates trade with countries outside of the EU … benefits [that] are … critical to the success of the London insurance market …”.

Before speaking about the risks of leaving the Union:

A vote to withdraw would raise many questions … A vote to leave would fuel European financial markets turmoil … Uncertainty around the timescale of the negotiations between the UK Government and the EU would put Britain in a limbo, making it less attractive to foreign investors … the Governor of the Bank of England has warned of financial instability, higher interest rates and capital flight in the event of a vote to leave … So what can we, as businesses, do …? … we all have to be prepared for all possible scenarios and this is what Lloyd’s has been doing … working through every eventuality … I am confident that … we will be able to find a way through the uncertainty …

But is this right? Do we all have to be prepared for all possible scenarios, as McGovern suggests?  In our view, the answer is probably not.

It makes sense for Lloyd’s, other markets and regulators, for Government departments, and some trade bodies, to contingency plan like this. But, two points aside, for most businesses, it makes no sense at all.

If the UK votes to leave the EU, and the Government chooses to act on that vote, it will need to give the EU two years’ written notice of the UK’s intention to leave, and the Government might not be willing and able to do that for some time. When the two years’ written notice is (eventually) given, exit negotiations will begin. But those negotiations can only begin in earnest when the UK has decided what “leave” really means. It could be the Norway option, the Swiss option, the Turkish option, the Commonwealth option, or something else. At this stage, we don’t know how this choice will be made, let alone when, or by whom. What we do know is that when Greenland voted to leave a much smaller and simpler Union in 1979, its negotiations took almost six years to complete … and ours are likely to be longer still.  This seems strongly to suggest that it would be better for most businesses to start their contingency planning when the referendum result is known; and we have a better idea what “leave” really means.

If that’s right, what are the two exceptions?

The first is market disruption. At the moment, the markets are volatile for many reasons. This volatility is likely to increase as the referendum approaches, especially if the polls suggest that Brexit is more likely than not. More volatility is likely to follow if the UK votes to leave. But it’s not just market volatility that insurers, reinsurers and brokers need to worry about. Some international insureds might also start to select against UK insurers, to protect themselves against Brexit risk and uncertainty. It probably makes sense to contingency plan against these risks now, if you can.

And the second: it is perhaps surprising that the UK’s PRA and FCA aren’t already requiring insurers, reinsurers and brokers to contingency plan against some or all of the risks associated with Brexit. Perhaps that will come. In the meantime, insurers, reinsurers and brokers should at least contingency plan against the risk that the regulators will increase the frequency and detail of their requests for information, so they can measure, monitor and manage financial stability, sectoral and other risks, as they emerge.

Oh. And one last thing. If you were hoping that Brexit would deliver regulatory nirvana; don’t. (As we’ve been saying for some time), during the negotiation period, Solvency II (and perhaps IMD2) will be just as much a part of the regulatory landscape as they are now. Regulatory standards won’t slip if the UK regulators’ hands are un-tied by Brexit. In fact, they’re more likely to rise as the regulators get their chance to lawfully “gold plate”. In other words, if there’s regulatory nirvana to be had,  it will be in the regulators’ offices; not yours. Perhaps we should contingency plan against that as well, or instead.

For more information about this, contact: Mark Deem, Chris Finney, and/or David Kendall. 

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