Brexit – PRA issues guidance to insurers with legacy business

This post was first published on our Insurance Notes blog.

The PRA has published guidance for UK insurers on their ability to service EEA liabilities once the Brexit transition period (called the “implementation period” in UK legislation) comes to an end on 31 December 2020.

In our view, the guidance is consistent with the view that “expat business” (where policies were written in the UK but the policyholder subsequently moved to the EEA) can continue to be serviced from the UK without an EEA authorisation. It does, however, highlight some important points for firms that do need an EEA authorisation to service their cross-border business (i.e. policies where the risk/commitment was situated in an EEA State at inception) once the transition period ends and passporting rights fall away.

Key points for firms are as follows:

• Run-off regimes established by various EEA States to mitigate the impact of a “no deal, no transition” Brexit may not apply from the end of the transition period following the UK’s EU exit on terms agreed in the Withdrawal Agreement.
• UK insurers intending to rely on those regimes, as a permanent or temporary measure, should take steps to address this risk, including contacting relevant EEA authorities.
• The PRA will not guarantee that Part VII transfers of policies to EEA-authorised insurers will be effective before the end of the transition period.

Firms must confirm to their PRA supervisor that they have engaged with all relevant EEA authorities by Thursday, 30 April 2020.

The problem

Given that any future trade deal which is agreed by the EU and the UK before the end of the transition period is unlikely to address ongoing passporting rights, UK insurers need to be prepared for the loss of those rights from the end of 2020.

For UK insurers with policyholders in EEA States, this creates a particular risk that they will no longer be licensed to service those policies, including paying claims, unless they go through the onerous process of establishing an authorised branch in each country. An alternative approach, adopted by many insurers, is to transfer the policies to an EEA carrier.

The risk to EEA policyholders of being unable to claim, post-Brexit, under policies held with UK insurers highlights the importance of understanding limits on individual state discretion in this area.

EIOPA recommendations – February 2019

EIOPA recommendations published in February 2019 provided some helpful guidance (see our blog post dated 21 February 2019 for discussion). In summary:

• EEA States were encouraged to apply a mechanism for the run-off of EEA business by UK insurers who lose their authorisation or to require those insurers to take immediate steps to become authorised.
• EEA States were also encouraged to recognise that, whilst UK insurers should not be able to write new business (including any renewals, extension or increase of cover) without obtaining a suitable EEA authorisation, policyholders who exercise an option or right in an existing policy to start taking their pension should not be prejudiced.
• Where a policyholder is habitually resident in the UK at the date of entering into a life insurance contract but moves to the EEA afterwards, national authorities should take this into account in their supervisory review.
• National authorities should take the same approach to those classes of non-life business where the risk is treated by Solvency II as situated in the state of an individual’s habitual residence (or the state of a legal person’s establishment).

These recommendations suggest that a distinction should be drawn between legacy business that was written from the outset on a cross-border basis (“cross-border business”) and policies that were sold in the UK to policyholders who subsequently move to the EEA (described above as “expat business”).

Expat business

It is implicit in EIOPA’s recommendations that the state of the risk/commitment under an insurance contract is fixed from the date a policy incepts and does not change if a policyholder subsequently moves his habitual residence (or establishment) from the UK to an EEA State. Applying this approach, a UK insurer that continues to pay claims after a UK policyholder relocates from the UK to an EEA State is not carrying on cross-border business and (currently) does not rely on passporting rights to make those payments. Post-Brexit, the same insurer should, therefore, be able to continue to pay claims into that EEA jurisdiction without needing to obtain a local authorisation.

Equally, a UK insurer that meets its obligations to expat policyholders who exercise an option existing under their policy e.g. to exercise drawdown rights should not require an EEA authorisation to do so.

In our experience, most, if not all, UK insurers take the same view on this as EIOPA. They have not, as a consequence, included policies held by UK expats in any Brexit-related Part VII schemes transferring policies to an EEA carrier.

Cross-border business

By contrast, EIOPA’s recommendations suggest that the servicing of policies that were written before Brexit on a cross-border basis will require an EEA authorisation to replace passporting rights that are currently relied upon. In practice, consistent with this view, we understand that most policies in this second category have been, or are being, transferred to an EEA insurer before the transition period comes to an end.

Where a Part VII transfer completes before the end of the transition period, a UK insurer has no need to rely on any of the run-off regimes that were put in place by a number of EEA states in the lead-up to the UK leaving the EU. The transitional relief provided by these regimes may, however, be important for:

• firms who have begun the Part VII process but not completed the transfer of policies before 31 December 2020; and
• firms who have decided not to transfer their cross-border business to an EEA-authorised insurer, perhaps because the policies have a very short tail.

The immediate concern for the PRA appears to be that firms falling into these two categories will end up with a “gap” in authorisation arising from the limited nature of the run-off regimes established by EEA authorities to date.

PRA guidance – February 2020

On 28 February 2020, the PRA published a template version of a letter from Anna Sweeney, Executive Director of Insurance Supervision, to PRA-regulated insurance firms with outstanding EU liabilities following the UK’s withdrawal from the EU. The letter warns that run-off regimes established by a number of EU authorities to ensure ongoing service continuity in relation to EU liabilities in a “no deal, no transition” scenario may not automatically apply from the end of the transition period. Firms who are intending to rely on those transitional regimes (as a temporary or permanent solution) are, therefore, advised to undertake a thorough analysis of their expected run-off profile, and to discuss their proposed approach with the relevant EU authorities. (The letter expressly refers to EU authorities and EU liabilities but should, in our view, be assumed to apply more widely to EEA authorities and EEA liabilities, consistent with the scope of the Solvency II regime.)

For firms seeking to transfer their EU liabilities to an EU-authorised insurer, the PRA has also said that it cannot guarantee that any Part VII transfer will be sanctioned by the Court or that it will be sanctioned within firms’ intended timeframes. Again, the PRA recommends that firms proactively contact the relevant EU authorities to ensure that contingency plans, and any associated risks, remain satisfactory to them.

Insurers are advised that they should have obtained appropriate legal advice when finalising their contingency plans. Further, their plans should have been discussed and approved at an appropriate level within each firm. Clearly, the consequences that may flow from conducting business in an EEA jurisdiction without the necessary authorisation support the need for Brexit contingency plans, and risks associated with their implementation, to be fully understood by senior management.

The PRA expects firms to confirm that they have engaged with all relevant EEA authorities by Thursday, 30 April 2020. The PRA has also indicated its willingness to discuss the issues raised by its letter further.

Summary

In summary, run-off regimes established by EU authorities to mitigate the impact of a “no deal, no transition” Brexit may not also apply from the end of the transition period. UK insurers intending to rely on these regimes, either temporarily while they complete a transfer of their EEA liabilities to an EEA-authorised firm or permanently until their EEA liabilities have all been extinguished, will need to check that they will hold the authorisations needed to service their EEA liabilities from the end of the year. In our view, however, the view that “expat business” is not cross-border business remains a valid one, which means that an EEA authorisation should not be required to continue servicing this type of policy.

Other important points are that, to the extent that EEA states do decide to introduce run-off regimes for cross-border business, they are all likely to be different, requiring specific legal advice to be taken in each case as to their effect. Further, EIOPA’s February 2019 recommendations are not binding, leaving it open to individual states to apply the rules differently, to the extent that it is possible to diverge from other states under EU law. For example, see our blog post dated 15 November 2019, describing the approach taken by France to the post-Brexit servicing of policies held by UK expats.

If you would like to discuss arrangements for support on any of the issues raised by this article, please do ask your regular Herbert Smith Freehills relationship contacts, or one of the following members of our insurance team.