Now that the dust has settled a little following the decision by the UK to leave the European Union (EU), where does that now leave UK insurers and what issues are they likely to face over the coming months and years as a consequence?
There seem to be three main areas that are likely to be affected:
- Business confidence
The result of the referendum has sent shockwaves throughout the country. In such times people may be less confident about making long-term financial commitments. Anecdotal evidence suggests that sales of investment related products have suffered following the vote but that protection related contracts have not been adversely affected.
We will find out what the longer term implications of the Brexit vote will be in time, but much will depend on the general level of confidence investors have that the financial products they buy will provide a positive return. This may be a challenge for savings related products in such a low yield environment.
One of the surprising aspects of a decision to leave the EU was that markets were not spooked by perhaps as much as many commentators might have expected. Whilst some investments have taken a hit there are many that have rallied and the FTSE100 Index is now well above pre Brexit levels. Even the FTSE250 seems to be recovering some lost ground. Equity losses may also have been limited by the fall in the value for pound.
However, there remains significant uncertainty over the future of interest rates and what the future of the UK economy will be both during this transitional extraction process as well as in a truly post EU world.
There are also uncertainties around the liquidity of some commercial property funds, with a number of them suspending trading as some investors withdraw funds in anticipation of potentially falling values.
This uncertainty is not helpful and firms may well need to resign themselves to a period, potentially several years, of very low returns indeed.
This brings with it another risk in that firms may well seek alternative investments to compensate the effects of low yields. But as the saying goes: “There is no such thing as a free lunch.” Investments offering greater returns are likely to carry greater risk. This is not an argument for saying firms should not pursue such options but it is likely to require them to undertake more due diligence and ensure that the capital they set aside to cover the risks of the investments are appropriate.
The introduction of Solvency II this year marks a remarkable change in the regulatory approach to monitoring insurers’ financial strength – its implementation has been a real achievement.
Whilst there are many aspects of the new regime that many may grumble about, it is undoubtedly a much more robust approach than the previous regime:
- Realistic reporting enables a much more transparent analysis of insurers’ performance.
- Capital requirements more accurately reflect the specific risks facing their business.
- The focus on effective risk management means that firms are now much more aware of the risks in the business.
This has taken insurers many years to implement and has cost the industry, as a whole, many billions of pounds. As such we do not expect the decision to leave the EU to have any short to medium term impact on regulations. Longer term, however, the PRA may well wish to review aspects of the rules and change them so that they are more appropriate to the UK.
Don’t think that this is necessarily bad news for insurers. The PRA has already noted the industry’s anxiety over the calculation of the risk margin component of Solvency II, especially in the light of falling interest rates. This is one example of an area that could be reviewed in a post EU world.
The decision to leave the EU has not had the immediate shock that many were expecting. However, the longer term consequences are more uncertain and it is likely that this will be in combination with a sustained period of low yields and returns. This undoubtedly creates a difficult environment for insurers to thrive.
Quite what the longer term consequences in a post EU world will be are unknown, but it is to be hoped that the regulatory framework will be reviewed to make the rules more relevant to UK insurers. My hope is that the regulations can, over time, be adapted to help promote creativity and opportunity for insurers to meet the ever changing insurance needs of the UK. We shall see!
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