EIOPA members had 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 confirmed 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, by now firms should have as a minimum reviewed their business operations to better understand their geographical spread.
A matter of governance, resource and expertise in the EU
EIOPA emphasises the importance for EU firms to uphold an adequate level of corporate substance within the EU. EIOPA defines "corporate substance" as:
- board members
- key functions holders, and
- staff.
The level of corporate substance should be proportionate to the nature, scale and complexity of a business. Depending on the structure of the specific business model, the expectation for sufficient governance, resource, and expertise to be based in the EU will be much greater. Where a firm underwrites a varied product range and has several methods to reach its target audience, it is likely that its business will be inherently complex.
Effective decision-making, risk management and expertise in the EU
EIOPA asserts that maintaining an appropriate level of corporate substance within the EU is crucial for enabling effective decision-making and risk management. This, in turn, helps to mitigate financial, operational, and reputational risks, ultimately ensuring enhanced protection for policyholders. Additionally, EIOPA expects that the structure of the business should not impede the ability of NCAs to adequately supervise the operations.
The concerns addressed by EIOPA are evident and unsurprising, as it emphasises the importance of aligning a firm's "mind and management" with the location of the policyholders it aims to serve.
The rise of the reverse branch
EIOPA is clearly concerned by the ‘reverse branch’ model that transpired post-Brexit. Several UK firms 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.
How have NCAs reacted?
It is the responsibility of NCAs to determine, on a case-by-case basis, whether an EU firm is excessively dependent on a third country branch. Following EIOPA’s SS, some firms may have analysed and evaluated the distribution of their operations between their EU firm and third country branch, and possibly proactively contacted the NCA of the Member State where their EU firm is authorised. These transparent upfront conversations would have helped firms understand how the NCA plans to interpret and implement EIOPA’s SS. This will either have given firms a peace of mind, and confirmation that they can broadly continue as per their current arrangements, or alternatively help give firms the focus that was needed to transform their business operations.
In cases where firms did not take proactive measures, it is likely that some NCAs will begin including such considerations in their BAU supervisory processes. For example, NCAs have begun asking firms about their operation split, asking firms in some instances to make changes to their operations to increase corporate substance within the EU firm, which includes staff with technical expertise. Another NCA performs annual onsite inspections of insurers with third country branches; this enables the NCA to collect meaningful data to better understand the operational split of EU versus third country activity. Other NCAs are at the discovery phase of their supervision, and have requested information from firms in order to understand how they are complying with EIOPA’s SS.
Additionally, NCAs are making references to the expectations set out in EIOPA’s SS with respect to firms’ outsourcing arrangements. This doesn’t come as a surprise, as EIOPA makes clear that while outsourcing is not the same as using a third country branch for insurance functions, outsourcing raises similar risks, such as the financial, operational and reputational risks discussed above. Therefore the SS becomes relevant for NCAs where they are considering the supervisory actions to take where they identify similar outsourcing risks. For example, where an NCA is concerned about a lack of technical expertise at the EU firm, they should consider, where possible, promoting secondment of staff from the outsourced entity to the EU firm.
What should firms be doing?
Reviewing business operations
Where firm management teams haven’t already, they should act now to fully analyse and understand how its business operations are spread and run across various entities located in different jurisdictions. Firms should know where all their key function holders and other staff are situated.
After this, firms will need to consider the key question of whether they disproportionately rely on their third country branch (or service company) to serve their EU customers. To help firms answer this 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.
Transformation
If engagement with NCAs leads to decisions regarding business transformation, firms will want to consider the following questions:
- Board and governance committees: Will board meetings need to be conducted in the EU, and will board members need to relocate to the EU firm? If so, how many? Where will other key governance committees be located?
- Target operating model: Firms will want to evaluate their current operating model, whether it is remote, in-office, or hybrid. Firms will need to carefully consider how they adapt their current work practices to create an operating model that benefits both the EU firm and its branch.
- Staff: This is a crucial and sensitive topic. Some staff may be unwilling to relocate, which can be problematic if the same skill set is not readily available in the EU Member State. Consideration should be given to training and upskilling in such cases.
- Risk management and controls: Will these be suitable for the new environment? If there are minimal changes, are the current controls sufficient to demonstrate effective decision-making by the EU firm? For instance, firms should assess how the EU firm oversees the operations of the third country branch.
Transforming a business is a significant undertaking that requires months of strategic planning, careful execution, and multiple cycles of assurance. We are aware EIOPA continues to treat the use of third country branches as a priority, additionally we are seeing NCAs increase their scrutiny in this area, for example by committing to carry out a review in this area this year. Some NCAs are carefully considering the size of an insurer's business, and how it is split across the EU and a third country branch before taking pragmatic decisions. Other NCAs have requested information from some firms to better understand how these firms are complying with EIOPA’s SS. Therefore, if your firm relies on a third country branch, and in particular lacks contingency plans in the event of losing access to the branch, it is crucial for you to act now.
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