A focus on the implications of Scottish independence: Insurance
As we approach September 18 the position of insurance services in Scotland remains uncertain. We take a look at the potential implications for insurers if there is a Yes vote.
A closer look at insurance
As we approach September 18 2014 – the date of the Scottish Independence referendum – the position of insurance services within Scotland remains uncertain.
If there is a Yes vote, an independent Scotland will need to elect a new government; there is no way of knowing which party, if any, will gain a majority, and thus we can’t be sure which party will be in a position to decide future policy affecting the insurance sector.
In the light of this uncertainty, we have identified a number of questions and issues to be aware of. Because we work extensively both with and within Scotland, these questions are at the forefront of our minds; clients can be reassured that we are ready to help and advise without political bias, offering them solutions that anticipate and respond to the changing situation.
If a different currency is adopted, what will be the implications for the insurance industry?
The Scottish government has confirmed that keeping the pound within a ‘sterling zone’ would be the best option for an independent Scotland, stating that a currency union would help preserve the integrity of the single union, particularly for financial services. Many of those who support independence suggest that a currency union would be in the best interests of businesses both north and south of the border, as it would ensure the continuation of cross-border investment and trade.
However, the UK Government has rejected the idea of an independent Scotland retaining the pound. In February 2014, George Osborne, the UK Chancellor, indicated that: “If Scotland walks away from the UK, it walks away from the UK pound.”
If an independent Scotland has to establish a different currency from the rest of the UK, significant changes would have to be made to existing insurance policies which would have to be converted into the new currency. The situation would be further complicated by the fact that sterling would continue to exist, and issues may arise over whether the relevant terms of a particular contract should be converted into the new currency or remain in sterling as originally drafted.
It has been suggested that the use of a different currency in Scotland could create a barrier to trade, with the prospect that businesses in Scotland, especially those in the financial services sector, might face problems due to complications such as transactions costs, and the exchange-rate risks of using a different currency.
Membership of the EU
How would an independent Scotland ensure membership of the EU so that insurance companies currently operating both north and south of the border can continue to do effective business?
There is a great deal of EU regulation affecting the financial services sector, particularly in some areas such as insurance, and this is set to continue. As a result, Scotland’s position in Europe in the event of independence is highly significant to the operation of this sector in Scotland.
One of the most hotly debated issues has been whether an independent Scotland would become a member of the EU, and if so, on what basis. The Scottish government has indicated that one of the main benefits of independence would be that Scotland will be able to take its place as an independent member state within the EU. This would allow the Scottish government to influence EU policy directly in order to safeguard the interests of Scotland, rather than leaving it to the UK government to do so. If an independent Scotland wanted to join the EU, it would have to apply and negotiate membership terms. The Scottish government has expressed confidence that membership could be agreed in the 18 months after the referendum in time for independence in 2016.
In the event that an independent Scotland joins the EU, there would be several immediate consequences for the financial services sector; for example, a separate Scottish financial regulator is likely to be a requirement, and this would be likely to add to compliance costs and complexity for Scottish financial institutions with large cross-border businesses. The Scottish government has suggested that a Scottish regulator could work closely with the existing UK regulators to maintain an integrated approach, and this could mitigate the negative impact of an independent regulator in Scotland.
However, if an independent Scotland was outside the EU, then doing business with other member states, including the rest of the UK, would become more complicated. Having said that, it would appear that the prospect of Scotland remaining outside the EU is increasingly unlikely. A report by the European Policy Centre think tank published in May 2014 suggested that it would not be in the interests of any of the existing EU member states to have an independent Scotland outside the EU; this would mean losing the benefits of Scotland’s membership, including its contributions to the budget.
Legal, tax and regulatory frameworks
Insurance is an important part of the financial services sector in Scotland. It could be argued that Scotland is a popular location for financial services business, including insurance companies, because it is part of the UK where there is an established tax and regulatory system. Many insurance products, such as motor insurance, are designed to fit into the UK systems so insurance products can be sold across the UK. If independence occurs, will there be separate legal/tax/regulatory frameworks here?
According to a UK government research paper, financial services activities contributed £8.8bn to Scotland’s economy in 2010 – accounting for more than 8% of the country’s onshore activity. As part of the UK, Scotland’s financial services industry is subject to the UK-wide regulatory framework. Businesses operating in Scotland are bound to be considering the impact that Scottish independence might have on tax, legal requirements and regulation. Concerns have been raised that costs would increase for UK firms operating in the Scottish market, and vice versa, if faced with separate regulatory and tax systems.
Those who are against Scottish independence argue that if Scotland becomes a separate regulatory jurisdiction, this would disrupt the operation of the UK-wide market. Differing regulatory standards would mean that businesses would be faced with the increased cost of complying with the requirements of two regulatory systems instead of one. A recent Ernst and Young survey of 29 financial services leaders, including insurers, found 86% of respondents assessed the impact of Scotland having its own regulator, or having to work with regulators in both the UK and Scotland, as being “adverse”. Just over half of the companies said it would be “very adverse”.
According to the Scottish government, however, regulation in an independent Scotland would be on a consistent and harmonised basis with the rest of the UK in order to minimise the impact on financial services industries.
The Scottish government has indicated that an independent Scotland would provide a financial services compensation system equivalent to the existing provision in the UK. However, Danny Alexander, the Treasury chief secretary and former Scotland secretary, recently told the Financial Times: “The idea that an independent Scotland would have sufficiently deep pockets to support a financial services sector of that scale when risks arise seems to me to be utterly implausible. One thing people could expect if Scotland does go independent would be for the financial services sector to shrink considerably.”
At present, insurance products are designed to fit with and supplement the legal and regulatory systems. At the moment, these systems are mostly UK-wide, which means that the same insurance products can be offered throughout the whole of the UK. However, in the event of Scottish independence, where differences may emerge in legal and regulatory requirements, the necessity for different products could arise, leading to additional costs.
Scotland’s legal system already differs from that in England and Wales, and this has not presented a significant obstacle to businesses setting up here. Contracts entered into in Scotland are often made the subject of English law, and there seems no reason why this practice could not continue in the event of independence if required.
The tax regime is also a significant area in relation to insurance products. If Scotland became independent, there could be differences in this area. In the case of Insurance Premium Tax and VAT for instance, businesses would need to consider what they would need to pay and what they would need to do in order to deal with any changes to tax regimes.
Effect on financial services
What effect would independence have if Scotland is no longer part of a unified, fully integrated single market for financial services across the UK?
The United Kingdom forms a single market of over 60 million people; Scotland's economy and that of the rest of the UK are closely integrated. The UK insurance industry is the largest in Europe and the third largest in the world, accounting for seven per cent of worldwide premium income. According to evidence given to the House of Lords
Economic Affairs Committee into the economic implications for the UK of Scottish independence, trade with the rest of the UK is currently worth over two-thirds of Scotland's output. 94% of Scottish insurance industry products were sold to the rest of the UK and only 6% in Scotland.
The UK Government maintains that the UK's single market brings economic benefits to Scotland and the rest of the UK, and that if two smaller markets are created after Scottish independence, Scotland's smaller economy would be disproportionately affected.
Those in favour of Scotland remaining in the UK argue that the single market will be weakened by differences in currencies, regulation and taxation. Mr John Cridland, Director General of the CBI, indicated: "The single market is a key UK asset and the certainty and level playing field of rules on tax, law and regulation adds to economic growth… we feel inevitably that if there were two independent countries… in this one island, there would be a fragmentation of the single market."
The Scottish government’s position is that if Scotland votes yes to independence, businesses will continue to provide products and services to consumers across Scotland and the rest of the UK irrespective of where they are based. The Scottish government has suggested that the market for financial services, including insurance, across Scotland and UK is likely to remain highly integrated in the event of independence, and this will be consistent with the European single market in financial services.
While fears have been expressed that, in the event of independence, Scotland would become a less attractive place to do business, resulting in a less robust financial services sector in Scotland, the severity of the threat to the UK single market would depend to a large extent on the decisions of the governments of both an independent Scotland and of the rest of the UK.
Businesses based in Scotland
Although most of the large UK insurers are based down south, there are still some with a significant Scottish presence including RSA. Will these businesses still want to be based in Scotland in the event of independence?
The United Kingdom has a well-developed and regulated insurance industry which is the third largest in the world, and in Scotland, the insurance industry plays a major role in the country’s economy. In the Scottish government’s publication ‘Scotland’s Future: Your Guide to an Independent Scotland’, published in November 2013, the Scottish government indicated that: “Membership of the EU and the increasingly integrated single market for financial services will be central in Scotland’s continuing success as a leading financial centre”.
The Scottish government has asserted that an independent Scotland would not replicate the economic structure of the UK, but instead would create opportunities for businesses to work “more efficiently and effectively”. It has pointed out that in the interconnected global economy, many businesses work across a number of different countries without difficulty, and the Scottish government has confirmed its commitment to making independent Scotland an attractive and competitive place to do business, with tax rates designed to boost economic activity. For example, the Scottish government has confirmed its intention to introduce a “competitive” corporation tax for Scottish businesses which will be up to 3% lower than the prevailing UK rate.
However, in a UK government publication in May 2013 – ‘Scotland Analysis: Financial Services and Banking’ – it was claimed that: “the exceptionally large and highly-concentrated financial sector of an independent Scotland would be likely to increase the risks, to markets, firms and consumers, of financial services firms operating in an independent Scotland”; the UK government goes on to claim that one consequence of this may be that if large businesses are faced with a greater concentration or risk, they may look to restructure, perhaps moving their headquarters out of Scotland. It is suggested that, if this were to happen, it could undermine Scotland’s current status as an important financial centre. However, it has been argued that the size and concentration of a financial system is not a problem in itself, provided it is well regulated.
The Institute and Faculty of Actuaries (IFoA) has stated that Scotland becoming an independent country would have a “significant impact” on financial services, including the insurance industry. According to a paper published by the IFoA in October last year, the result of the September 2014 independence referendum will have an effect on regulation of the financial services sector and its future growth.
Standard Life, which has had its headquarters in Scotland for nearly 200 years, announced in February this year that, in the event of a vote in favour of Scottish independence, it would relocate its operations outside Scotland, citing uncertainties over issues such as currency. The following month, RBS announced its intention to move its headquarters out of Scotland in the event of independence, having noted in its annual report that the uncertainties post-independence, particularly in relation to the fiscal, monetary, legal and regulatory landscape, “could significantly impact the group's costs and would have a material adverse effect on the group's business, financial condition, results of operations and prospects.”
However, as there are so many unknowns regarding what might happen if Scotland votes yes to independence, many businesses appear to be adopting a “wait and see” approach and are unlikely to make any firm decisions until the outcome of the referendum in September has been confirmed.
This information is intended as a general discussion surrounding the topics covered and is for guidance purposes only. It does not constitute legal advice and should not be regarded as a substitute for taking legal advice. DWF is not responsible for any activity undertaken based on this information.