It is still early days, but the recent Brexit vote presents us with uncertain times ahead. Below I have set out some practical ideas for insurers to consider while the dust settles.
1. Impact of FX movements on business plans, balance sheets and internal models.
Whenever there is a significant FX swing, particularly between Sterling and the Dollar, some firms get caught out. The appreciation of the US Dollar should help London firms with significant dollar premium volumes backed by a Sterling denominated balance sheet. Underwriters may find Sterling-denominated premium volume targets easier to meet, and this could relieve some of this year’s underwriting pressure. However, firms who hold capital in Sterling but have peak exposures in other currencies may find themselves exposed. The question is whether Solvency II has pushed firms to be overweight in Sterling.
2. Was the Brexit vote a trigger event?
Marcuson Consulting consider that the Brexit vote should be treated as an internal model and ORSA trigger event. This requires firms to review all or part of their internal models. Key elements to review and, where needed to revise, are:
- Back-testing performance of ESG considering aspects such as – how have asset prices, yield curves, inflation and FX behaved relative to the internal model? The limitations of single-currency models should come under scrutiny.
- Whether credit market behaviour are adequately captured in scenarios considered. Were movements correlated as expected?
- How well have asset models anticipated the behavior of complex assets, particularly holdings in hedge funds?
- Whether the Brexit scenario in the operational risk component proved sufficient or now needs expansion.
- Whether insurance risk should be increased for recessionary classes. An interesting outcome of this exercise may be that business contingency plans and scenario modelling are not well enough reflected in internal models and ORSAs. If processes are shown to be disconnected, stronger links between them will be needed.
3. Impact on insurance classes.
Economic shocks tend to give rise to a spike in professional indemnity, D&O and other liability lines. How will these be affected? Similarly, political risk, contingency and credit-related classes could see losses emerge. Insurance firms also need to consider whether FX and recessionary effects, including any future changes to cross-border trade will impact claim settlement costs. Will portfolios normally affected by economic events be affected by a combination of soft market wordings and new types of Brexit-related losses? That could prove painful.
4. Insurance – safe haven or capital flight?
Will investors put their money into insurance and reinsurance at this time? Or put another way, will this increase or decrease the pressure on the rating environment? While the financial services sector seems tarnished, perhaps London and other insurance and reinsurance stocks will emerge over time as a safer haven for investors. The logic for this comes from the international nature of their exposures and the continued certainty that hurricanes, earthquakes and other catastrophes will continue to happen and demand for protection will remain. So will capital continue to see this sector as a good place to seek yield?
5. Time to redomicile?
We think this needs a little care. A lot of discussion we have seen focusses on the various models of relationship that the UK might end up with post-Brexit. All well and good, however consider the Brexit referendum from a global perspective. The continent, and indeed the world, is a murky place. If the majority of voters in Britain can vote (however narrowly) in support of the idea of leaving the EU, what is the sentiment elsewhere? If a large part of the UK’s vote is seen as a cry by many against the changing shape of the modern globalized world, then its implications for the politics of other developed economies around the world should not be ignored. Relocation is an expensive and time-consuming exercise; yet a degree of preparation and flexibility of approach will be needed in the months and years ahead.