Steven Mendel asks what the ripple effects of the EU referendum are likely to be
Is this reasonable? As pretty much everything else is up in the air, why should the insurance industry be any different, you might ask? But there is one big difference. The insurance industry is based, at its core, on individuals being able to make economic and financial predictions about the future, based on past events and data. So what predictions can we make about the likely effect of Brexit on the insurance industry?
I am going to take a deliberately consumer-centric view of this question and try to understand how consumers might experience the referendum result and the expected political and economic consequences.
1. Of one change, I am certain - premiums will increase in the short to medium term owing to a number of factors. I have a few hypotheses as to why this will happen and a few strong assertions. I set these out below to encourage debate and thought on this important subject. For the avoidance of doubt, it is likely that few industry players or consumers would see any of these as a positive:
- Reduced returns Markets hate uncertainty and we have plenty of that right now. Uncertainty dampens demand, which in turn reduces returns. Plus the base rate is likely to be reduced further to close to, or even, zero. Lower returns mean that insurers will earn less on their assets that back insurance premiums and hence they will have to increase premiums to compensate. Of course if bonds are held to maturity, as is often the case, then the impact of this will be reduced.
- Onshoring Many providers of discounted insurance today (think offers you see in the newspapers and trains for very cheap travel insurance) have been able to support their low-cost operations by being domiciled and (importantly) regulated overseas - for example, in Malta. They rely on the EU's so called 'passporting' rules that allow them to operate anywhere inside the EU as a function of being regulated in another of the EU states. The Financial Conduct Authority (FCA) has not made any mention of its intention to end this practice, but I am sure that such a decision will be reviewed in the coming months. Note that a weaker sterling may go some way to offset this impact.
- Fewer players While a number of continental EU insurers have already reaffirmed their commitment to the UK market, it can surely only be a matter of time before some of the offerings that are only marginally profitable are withdrawn. Fewer offerings mean less competition. Less competition means higher prices.
- Scrapping of EHIC/ E111 One of the reasons that European travel insurance is low cost is because there is the presumption that should a policyholder fall ill while overseas, they will be treated in a local hospital on the reciprocal healthcare arrangement that exists across the EU and therefore not require expensive repatriation.
- If this reciprocal arrangement falls away, then policyholders are likely to make larger claims and so premiums will have to increase to compensate.
- Ongoing relevance of Solvency II Ok, perhaps not a driver of increased premiums, but I don't believe that the vote outcome will have much direct impact on Solvency II - it will remain (somebody had to!) a core part of UK regulatory requirements. Yes, it is having a negative effect on long-term investment and on efficiency of the sector. Accepted, it is far from perfect and perhaps in the fullness of time it might be refined and perhaps even redefined. But as a concept it is here to stay, not least because we'll have to adhere to it to continue to provide insurance solutions into the EU. Helpfully, the Prudential Regulation Authority (PRA) has brought in rules to ease short-term compliance with Solvency II since the vote, to reduce the immediate pressure on insurance companies to sell assets at a time when values are reduced.
- Staffing costs While I very much doubt that we will end up with a solution for exit that limits the free movement of employment across the EU - this being a condition of a free trade agreement - I strongly believe that the UK just became a less desirable place to work. Consequently, the cost of employment will rise, with fewer available applicants for each role. As over 300,000 people are employed by the insurance industry in the UK (according to the Association of British Insurers), the impact of a rise in these costs will be passed onto consumers in the form of higher premiums.
- Credit ratings The impact of the cut in the UK's credit rating from AAA to AA has, in turn, led to the downgrading of the credit rating of some UK insurers and, by association, to increased costs, which will be passed onto consumers.
2. Rising redundancy cover sales
With increasing uncertainty over job security, it is possible that more consumers might seek to protect themselves from losing their employment by buying unemployment cover, separate from anything that they might already have tied to their mortgage.
3. Reintroduction of gender-specific rates
One of the less-justifiable EU laws was that of abolishing gender-specific insurance rates. Under rules that came into force at the end of December 2012, insurers were not permitted to charge differential rates to men and women. So motor insurance premiums for 17-year-olds are set equally for male and female drivers, despite the well-known fact that teenage boys have a worse driving record than teenage girls.
Consequently, girls pay higher premiums than they would have done before the rule change. The same principle applies, but in the other direction, when it comes to annuity rates - male and female rates have to be set equal, despite the fact that women live longer than men. It means men end up paying more for an annuity than they did before the change. Most experts believe that this rule is bonkers, and it is possible that the UK might push to repeal this law.
As a corollary to this thought, it is possible that the reintroduction of gender-specific rates might bring down premiums overall.
A number of insurers built into their gender-neutral rates a load to take account of the extra risk that they were carrying in not knowing precisely how to combine gender-specific rates. This loading would, presumably, fall away under this scenario and in doing so provide a small glimmer of consumer upside!
4. Changing corporate structures/brands
Much was made in the remain campaign of the 500 million potential customers in the EU, and it is obvious that UK insurers will not wish to miss out on these.
So, insurers based in the UK may need to set up a subsidiary inside the European Economic Area, and insurers based outside the UK may wish to set up a subsidiary inside (or close to) the UK to retain access to Europe's largest insurance market. Many larger cross-European insurers have authorised carriers in Dublin (as Ireland is always likely to have favoured nation status for the UK, while remaining inside the EU). I suspect that this will not lead to new brands, just to new instances of existing brands, but it could cause confusion to consumers and drive them to rebroke/ review at the time of renewal.
Perhaps of less importance to consumers, but worthy of note, is the effect of a weakening pound (likely to drive up the cost of overseas claims and reduce the value of sterling-denominated investments), plus, my own favourite, the lack of preparedness.
A pre-referendum survey of insurers by law firm Kennedys found (while highlighting that up to 48,000 jobs in the insurance sector would be put 'at risk' on exit - more than double the size of the UK steel industry) - that "most firms said it was too early to undertake detailed contingency planning until the outcome of the vote was known" and that "to do otherwise risked incurring unnecessary cost"!
How much of the above will become a reality, I clearly have no idea, but one thing is certain: the insurance industry is about to enter a period of significant change, and with change comes opportunity.
Steven Mendel is chief executive and co-founder at Bought by Many