London falling?

The decision by UK voters to exit European Union sets the stage for short-term economic strain on the US insurance industry, but could benefit the market in future

London falling?

Business strategy

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In 1688, a gathering of shippers and investors at Edward Lloyd’s coffeehouse in London laid the groundwork for what would become Lloyd’s of London – the most powerful player in the most powerful insurance market in the world. More than 325 years later, voters in the UK have seemingly threatened that business primacy by voting to exit the European Union.

The surprise decision in late June, popularly known as Brexit, raised questions for the global insurance industry and set the stage for some short-term economic strain on businesses in the US. The vote quickly sent shockwaves through global markets as the pound plunged to $1.35, its lowest level since 1985.

Yet despite that initial cratering, the stock market has quickly recovered. The S&P 500 hit a new record high in mid-July, and investors are again deploying capital in seemingly risky assets. What’s more, thanks to the fallout from the global financial crisis, the US economy is now better insulated than most for the risk associated with market turmoil.

“It doesn’t have that much impact on us – the investment portfolio has held up very well,” says Mark Watson, CEO of Argo Group in San Antonio. “For us, it’s probably going to be business as usual in the short run, and then we’ll figure out if this presents opportunities or not in the long term.”

That leaves US insurance firms with relatively minor logistical concerns like relocating offices. Enticed by the attractions of the London market and access to Europe, a rising number of companies have opened branches and moved major parts of their operations, even whole headquarters, from the US to the UK. As the UK loses the ability to passport services into Europe, a new base will be vital.

Both Aon and AIG have said they will consider establishing an operations center beyond the UK as a result of the vote. “In our world, risk is inevitable, and we manage it accordingly,” said Aon CEO Greg Case in a statement. “But leaving the EU is an unnecessary gamble.”

Still, the US is not seeing “that much impact from Brexit in the mega sense,” says David Snyder, vice president of policy development and research for the Property Casualty Insurers Association of America. Instead, Snyder sees an opportunity for US insurance firms to solve problems caused by Solvency II, an EU regulatory regime that exercises risk-based capital requirements over companies doing business in the EU. Meant to protect insurance buyers, the rules manage capital, governance and reporting for insurers.

Yet Solvency II has deemed the US a “non-equivalent regulatory environment,” closing markets like Germany that have traditionally been open the US. Now that the UK – a prominent player in the drafting process of Solvency II – plans to exit the EU, there’s a chance to revisit effective regulatory regimes. Without commenting on whether this may dislodge the UK as the most prominent force in the market, Snyder says it “does offer the US an opportunity to show some leadership.”

“Now might be a very good point for major players in the US financial services industry to emphasize that international standards need to be flexible and that there are different, but equally effective, ways to deal with things,” he says. “This could be a chance to push through an approach of true mutual recognition in place of the controversy created by Solvency II.”

To accomplish that, regulatory groups like Congress and the National Association of Insurance Commissioners need to be on board. But there are “hopeful signs that that is occurring,” Snyder says, particularly with the June passage of the Transparent Insurance Standards Act of 2015, reaffirming a national commitment to the state-based regulatory system.

Others in the industry are less enthusiastic about this ‘bright side’ of Brexit. Economist and Insurance Information Institute president Robert Hartwig has said that while there is a window to push through regulatory standards more favorable to the US, it’s “unclear how big that window is.”

“There is some possibility that EU regulations will have less sway in the future, but at the end of the day, the US will adopt the regulatory environment that’s best for the US,” he says. “Whether or not the Brexit vote has a material effect on [Solvency II] is unclear at this point.”

Other uncertainties relate to how exactly the UK will withdraw from the EU. Though there has been talk of a second vote that may reverse the original decision, Hartwig believes this is unlikely, and the UK’s new prime minister, Theresa May, has been adamant that “Brexit means Brexit.”

Under those terms, the UK must renegotiate hundreds of trade agreements and create an arrangement allowing it to remain a base for passporting throughout the EU. May has signaled this may take as long as six years, and until more concrete positions are taken by her government, US insurers are on standby.

“I think it’s really unclear how the UK is going to withdraw. It’s going to take time, and time is years, not quarters,” Watson says. “Until someone in government steps us to tell us what this is going to look like, we don’t really know.”

Though there remains much to be seen in the wake of the Brexit vote, there is one company Hartwig believes will remain an institution to be reckoned with.

“I think Lloyd’s has positioned themselves so that the market remains the most important in the country and one of the most important in the world, irrespective of the EU vote,” he says. “Lloyd’s of London will not become Lloyd’s of Dublin any time soon.”

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