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Brexit Part VII Transfers – Now the dust is settling

Insurance
Ed Gaughan
Ed Gaughan Associate Consultant
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The last few years have been a very busy time for Part VII transfers, primarily in response to Brexit, with over 20 Brexit related transfers having completed.

Now that the majority of transfers are complete and the dust is starting to settle, we’ve reviewed the transfers completed so far, looking at both emerging themes from the Brexit transfers and key future questions around the Part VII landscape.

Destinations

The Brexit transfers went to a range of locations across Europe, with a particular focus on Luxembourg and Ireland. Roughly half of firms chose these locations, with an almost equal split between the two.

There are still some further Brexit driven transfers in the pipeline. There are also some remaining questions around some insurers’ new target operating models – eg, the Belgian regulator requiring Lloyd’s to rework its European underwriting approach.

Reinsurance

The Brexit Part VII transfers have been mainly intragroup, where the business has remained within the Group but transferred to a different regulated entity. Intragroup reinsurance has therefore played a critical part in the new target operating models.

In nearly all cases, the overriding aim has been to disrupt as little as possible the existing operating model post-Brexit.

Across the transfers there are two main ways that reinsurance has been used to achieve this post-transfer: reinsurance back to Group or reinsurance back to the UK company. These are both internal reinsurance arrangements with a simple difference:

  • Reinsurance back to Group is when the transferring business is reinsured by an entity of the Group which is not the UK company. The Group entity then remains the reinsurer post-transfer, typically with no or limited changes to the underlying reinsurance terms;
  • Reinsurance back to the UK company is when the transferring business is reinsured by the UK company that is transferring the business. Therefore, new reinsurance is introduced as part of the transfer, from the insurer receiving the transferring business, back to the UK. This new reinsurance typically covers a very high proportion of the business.

We have seen that around 40% of insurers have chosen to reinsure back to Group and 20% have reinsured back to the UK Company. Quota shares have been the favoured method of reinsurance, with 80% of transfers having a quota share arrangement in place for the transferring business.

Capital coverage ratios

The Independent Expert is required to comment on the capitalisation of the entities involved in a transfer. This is to ensure that the transferring policyholders are not materially adversely affected by the transfer from a capital perspective.

A key measure of capital strength considered by Independent Experts is the SCR coverage ratio – the available capital in excess of provisions, divided by the Solvency II SCR. Whilst this ratio doesn’t capture all aspects of policyholder protection, it provides a helpful initial measure of capital strength, with a higher ratio indicating there is more capital available per £ or € of capital required.

Typical descriptions for SCR coverage ratios are “Very well capitalised” for when the coverage ratio is above 200%, “Well capitalised” for coverage ratios between 150% and 200%, “Sufficiently capitalised” for coverage ratios between 100% and 150% and “Insufficiently capitalised” for coverage ratios below 100%.

In the table below we summarise the proportions of each level of capitalisation for transferring policyholders on a pre- and post-transfer basis.

How have SCR coverage ratios changed for transferring policyholders pre- and post-transfer?

Pre-transfer Post-transfer
Very well capitalised 24% 22%
Well capitalised 38% 33%
Sufficiently capitalised 38% 45%
Insufficiently capitalised 0% 0%

We have seen that the capital coverage for transferring policyholders in most cases is similar on a pre- and post-transfer basis, but with a slight reduction in overall coverage, eg with around 7% of transferring policyholders moving from a well capitalised to a sufficiently capitalised insurer.

In cases where coverage ratios have decreased as a result of the transfer, reasons such as planned capital injections, Group support and the benefits of being part of a larger and more diverse insurer have been used to justify that this will not materially adversely impact the transferring policyholders.

FSCS and FOS arrangements

In all cases, losing access to the UK’s Financial Services Compensation Scheme and Financial Ombudsman Service was not considered a material impact by the Independent Experts.

The three key reasons that were cited for this were:

  • Brexit would potentially have had a greater impact on policyholders than the loss of access to these rights.
  • The financial strength of the entities involved made the likelihood of policyholders having to use these schemes very low.
  • In some cases, there was some form of equivalent scheme(s) in the country that the transferring business was being transferred to.

Now that Brexit has happened, the argument that the impact of Brexit would be greater than the impact of losing access to FSCS and FOS arrangements is no longer directly relevant. It will therefore be interesting to see how Independent Experts treat the materiality of this issue going forward.

What next?

After the spike in the number of Part VII transfers in response to Brexit, there are some key questions remaining about the landscape for transfers for the coming year and beyond:

  • Will firms look to bed in their new operating models or is there a backlog of transfers that will proceed, now that the dust is settling on Brexit?
  • How will sentiment on the potential loss of FSCS and FOS change now that Brexit is not an external (and for many insurers an unwanted) driver for the transfers?
  • How will the legacy run-off proceed for insurers that have decided not to undertake a Part VII transfer?
  • How will continued uncertainty around the EU’s position on UK Solvency II equivalence impact transfers?

Even with this level of uncertainty, one thing is for sure: earlier consideration of these and other key issues, and appropriate engagement with the regulators, will remain key.

Please get in touch if you would like to discuss these themes, and how we are helping our clients successfully deliver on their Part VII transfers.

Ed Gaughan
Ed Gaughan