Where do we stand now and how are things likely to progress from here?
On 23 June, the people of the United Kingdom voted to leave the European Union. Where do we stand now and how are things likely to progress from here? Three questions and answers by Michael Menhart, Chief Economist at Munich Re, and Carsten Prussog, Chief Executive for United Kingdom at Munich Re.
Four months have passed since the referendum, the official exit process has yet to start, and the economy so far seems to be dealing fairly well with the uncertainty. What is your assessment of the situation?
Michael Menhart: Political uncertainty remains high, but the financial markets have stabilised after the initial shock. The UK economy has also stayed fairly robust, and fears about an immediate recession appear to be exaggerated. But this is a current snapshot that camouflages the challenges of the coming months. In particular, the looming reticence by UK companies to invest should have a noticeable impact on the economy in 2017. The economic effects of the vote have also been very limited in the rest of the EU, but a dampening effect on growth as a result of Brexit may become apparent next year.
At a political level, the announcement by Prime Minister Theresa May that the exit process will begin in the spring of 2017 as well as its objectives has given a little more clarity after months of speculation. But uncertainty about the future relations between the EU and the UK will continue even after exit negotiations begin – and this will have negative economic consequences.
What consequences does the Brexit vote so far have on the insurance industry – and on Munich Re's business?
Carsten Prussog: The immediate impact after the Brexit vote was that the market cap of some of our clients, especially those with significant life portfolios, fell significantly. Meanwhile, with capital markets having stabilised and the economy still holding up, the situation is less dramatic.
Further on, we observe challenges for clients in several areas, prominent among them are exchange rate effects and concerns about passporting rights. With the GBP significantly weaker against both EUR and USD, the FX effects may impact the P&Ls for those clients who operate internationally. Secondly, those clients that today leverage passporting from the UK to the EU have started discussing implications of the fundamental change in EU-UK relations, e.g. the potential need to capitalise branches or to extend branches to full subsidiaries. In both areas we as Munich Re are more than happy to offer our advice.
As regards Munich Re, the impact of the Brexit vote in some areas, especially Property business is manageable, since we collect premiums, put up reserves and pay claims in GBP. However, the lower yield curves impact our Casualty book and we need to be sensitive about a potential increase in claims frequency in Financial Lines business due to the growing economic uncertainty.
Will there be a compromise between the EU and the UK, what might this look like, and what will happen if the two sides fail to reach a compromise?
Menhart: Even if there is now some degree of certainty about the timing of the UK's exit from the EU – the spring of 2019 as it currently stands – the details of Brexit will still be the subject of much discussion. One extremely conflicting issue is the UK's wish for greater national sovereignty – particularly with regard to immigration controls – and continued access to the single market. The UK government has given clear priority to regaining sovereignty, and will only seek continued access to the single market in this context. But free movement of persons is a core principle of the EU, and it is also mandatory for participation in the single market by non-EU countries such as Norway and Switzerland. The EU will not wish to allow the UK to cherry-pick which aspects of the EU it will adopt and which it will abandon, as such an approach could encourage exit movements in other countries.
It is also unclear whether two years will be sufficient time to complete the exit negotiations. This seems unlikely, as the issues to be negotiated are so complex. We should expect that many issues will remain unresolved even after the UK has left the EU, and the uncertainty about the outcome and consequences of Brexit for the UK and the EU will continue for a considerably longer period.
Even if the current positions taken by the UK and the EU appear to be intransigent, a compromise that gives the UK greater control over immigration whilst allowing companies mutual market access appears to me to be conceivable. If the UK were to pull out entirely, the price would be too high in economic terms (not least for the UK itself), but also in political terms, particularly for the rest of the EU. Nonetheless, I am somewhat concerned that the hard-line advocates will prevail in the end, and that the UK and the EU will have to completely renegotiate all of their trading rules. In view of the difficulties of concluding such treaties – as clearly illustrated by the current negotiations over CETA and TTIP – the economic consequences of such an approach could be extremely disadvantageous especially for the UK.
Prussog: Our clients, foremost those with EU exposure, are closely following the political debate and will have to prepare for upcoming changes. Some clients are already engaging to lobby to keep the regulatory duplication and administration as low as possible.
Ultimately from an EU perspective it will be a subtle balancing act between “drawing a clear line” (to avoid “domino effects”) and “keeping a very important trading partner engaged”. The importance of the UK insurance market globally, potential regulatory arbitrages, e.g. with regards to Solvency II, and additional administrative/regulatory burdens/costs – and thus the overall impact on our business - will depend on the negotiations in the upcoming years.