What does EIOPA’s Supervisory Statement on the use of third country branches mean for the Lloyd’s and London Market?

March 2023

EIOPA confirmed its expectations in a Supervisory Statement (SS) on the use of third country branches by EU registered insurers and intermediaries (firms) on 3 February 2023. EIOPA members have long been concerned that EU firms disproportionately rely on third country branches to serve EU policyholders. It initially identified this issue in the context of the risks arising from the UK’s withdrawal from the EU. Nonetheless, EIOPA confirms the SS applies to any third country, and not just the UK.

For firms in the UK, EIOPA’s SS is a strong reminder that the EU does not expect firms to continue as if Brexit had not occurred. The UK is no longer part of the EU, and so it should be treated as such. EU firms should not set up branches in third countries, such as the UK, with the sole purpose of serving EU policyholders. EIOPA clarifies its stance in the SS that where third country branches are established by EU firms, the primary purpose of this should be to serve the market in which the branch is situated. Therefore as a minimum, firms should review their business operations now to better understand their geographical spread. In this article, we explore the actions we consider firms should be taking now.

A matter of govenance, resource and expertise in the EU

EIOPA considers EU firms should maintain an appropriate level of corporate substance in the EU. EIOPA reiterates that by corporate substance it means:

board members
key functions holders, and
staff.

The level of corporate substance should be proportionate to the nature, scale and complexity of a business. As a Lloyd’s underwriter or delegated underwriter, your business will naturally be complex. This means that depending on the specific risks you underwrite, the expectation for sufficient governance, resource, and expertise to be based in the EU may be greater for you than for non-Lloyd’s underwriters.

Effective decision-making, risk management and proper supervision

EIOPA states appropriate corporate substance within the EU will allow for effective decision-making and risk management. This in turn will reduce financial, operational and reputational risk, ultimately providing better policyholder protection. Furthermore, EIOPA expects that the way in which the business is structured does not limit the capacity of National Competent Authorities (NCAs) to properly supervise the business.

The harms EIOPA is looking to address above are clear and unsurprising. It expects a firm’s ‘mind and management’ to be based in the same place as the policyholders it seeks to serve.

Reverse branches and the delegated underwriter

EIOPA is clearly concerned by the ‘reverse branch’ model that transpired post-Brexit. Several UK intermediaries (and insurers) will have sought authorisation from a Member State in the lead up to Brexit, and then continued business as usual in the UK as a third country branch, with minimal changes to its operational and governance arrangements in the post-Brexit world.

EIOPA’s SS specifically calls out intermediaries (which includes managing general agents) and recognises that intermediaries may carry out underwriting / place risk. Referring to the Insurance Distribution Directive, EIOPA states this does not provide unfettered direct access for third country intermediaries to EU markets. Therefore, EU firms should not be disproportionately dependent on a third country branch to carry out distribution activities and / or delegated underwriting for EU policyholders.

If you are placing risk under delegated authority, you will want to take stock of where your specialist staff are based and assess whether the EU firm has staff with the right level of knowledge, expertise and capability to carry out their duties effectively. See the ‘What should I be doing?’ section below where we continue our discussion on steps you might want to take following EIOPA’s SS.

EIOPA shares further expectations in the SS

EIOPA provides some further expectations in the SS when compared to its earlier consultation. Where there are concerns about technical expertise or specialist risk coverage in the EU, NCAs should act to promote:

relocation or secondment of staff from the third country branch to the EU firm, and / or

reduction of insurance risk by way of reinsurance.

EIOPA has been more prescriptive here. It chose to suggest practical solutions to NCAs on how they might want to address the issue of a lack of expertise in the EU. While the SS specifically states that NCAs ‘are encouraged’ to promote the above solutions, it remains to be seen how consistently this is implemented across the market.

What should I be doing?

Review your business operations

The first thing that a firm’s management should do is act now to fully analyse and understand how its business operations are spread and run across various entities located in different jurisdictions. You will know where your board is situated, but can you say the same for all your key function holders and other staff?

Once you understand your geographical spread and where certain functions sit in detail, you will then be able to answer the exam question of whether you disproportionately rely on your third country branch to serve your EU customers. To help you answer the question, EIOPA shares an example of disproportionate dependence; where a firm is unable to demonstrate to the NCA that it can continue operating normally and without undermining policyholder protection where there is sudden loss of access to the third country branch. As such, firms will want to think about their operational resilience, and carry out activities such as mapping dependencies, setting impact tolerances and scenario testing. This will be in addition to contingency planning.

Engagement and transparent conversations

Concerned? You’ll be pleased to hear that it is for NCAs to decide, on a case-by-case basis, whether an EU firm disproportionately relies on a third country branch. Therefore, once you have analysed and assessed how your arrangements are split between the EU firm and the third country branch, you will want to engage with the NCA of the Member State in which your EU firm is authorised. A transparent conversation upfront will help you understand how the NCA plans to interpret and implement EIOPA’s SS. This will either give you a peace of mind, and confirmation that you can broadly continue as per your current arrangements, or alternatively help give you the focus that will be needed to transform your business operations.

Time for transformation

If your conversations with NCAs lead to you taking a decision to transform your business, you will want to ask yourself the following questions:

Board and other governance committees – will board members need to move to the EU firm, if so, how many? Where will other key governance committees sit?
Target operating model - you might wish to assess your current operating model: remote, in office, or hybrid? A fully remote or hybrid model is likely to provide the greatest flexibility and potentially cause the least disruption to current arrangements.
Staff – a key and sensitive topic. Staff may not be willing to relocate, which will be particularly problematic where you are unable to find the same skill-set in the EU Member State. You might want to think about training and upskilling in this instance. Whatever the outcome of staff moves, one thing that you can be sure of is impact to your firm’s culture. You’ll want to monitor this closely.
Risk management and controls - will these be fit for purpose in the new world? Or if there is little change, are current controls sufficient to demonstrate that the EU firm can conduct effective decision-making? For example, firms will want to consider how the EU firm exercises oversight over the third country branch’s operations.

Transformation of a business is no small feat, and can take many months of strategic planning, followed by careful execution, and then various cycles of assurance. If you make use of a third country branch, and you don’t know your contingency plans in case of loss of access to the branch, your time to act is now.