The Bank of England’s Prudential Regulation Authority (PRA) has warned life insurers that it will consider “explicit” regulatory restrictions on the amount and structure of FundedRe to prevent “rapid build-up of risks in the sector”.
In recent years there has been a growing appetite for the use of funded reinsurance arrangements in the UK life insurance market to support the writing of bulk purchase annuity (BPA) business which has seen some record-breaking transaction levels over recent years.
It has been reported that there were circa £50bn in deals in 2023, and 2024 is expected to surpass that, with some expecting transactions to reach as high as £80bn.
There is also a growing trend of private equity giants acquiring life insurance and bulk annuity books, and establishing themselves on the island of Bermuda, where most of the long-term insurance gets reinsured.
In a ‘Dear CEO’ letter published on Friday, the regulator said that while there was some improvement in risk management practices for funded reinsurance transactions, further improvements were still needed to meet the PRA’s expectations.
Gareth Truran, executive director of insurance supervision at PRA expressed concern over the growing number of funded reinsurance transactions, which he said could “if not properly controlled, lead to a rapid build-up of risks in the sector”.
PRA said it would monitor market practices and assess the risks to its objectives from this market over the coming months, taking into account the growth of funded reinsurance in individual firms and markets as a whole.
In particular, it said, it will monitor closely the volume of funded reinsurance transactions by firms, any change in quality of the collateral and the nature of funded reinsurance counterparties active in the market, and the progress firms make in implementing risk management and control arrangements in line with its supervisory statement.
PRA warned that it will consider action including “explicit regulatory restrictions on the amount and structure of [funded reinsurance], or measures to address any underestimation of risk, or regulatory arbitrage, inherent in these transactions”.
Life Insurance Stress Test
PRA is planning a Life Insurance Stress Test for next year on failure in insurers’ funded reinsurance arrangements.
It said the test will incorporate a funded reinsurance recapture event, and information gathered through this exercise will also help inform the regulator’s views on market developments.
Michael Abramson, partner and risk transfer specialist at Hymans Robertson, said the PRA’s stress test for insurers has only ever been published at industry level, whereas the core parts of the 2025 stress test will be published individually for the larger insurers.
He added that the new stress test also covers two new areas – asset concentration and funded reinsurance.
Although these will only be published at an industry level, he said that individual insurer disclosures should be seen as helpful for pension schemes that are considering a buy-in or a buyout.
Abramson said: “The disclosures will help to assess the security of such an insurance policy, in addition to the solvency position sensitivities already disclosed by some insurers.”
Matthew de Ferrars, partner at Pinsent Masons, said that when selecting a bulk-annuity insurer to partner with, pension scheme trustees and their advisers are “increasingly looking to compare insurers’ capital, funding and liability management arrangements”.
He said: “This can be a challenge as it takes trustees into a complex and specialist area which can sometimes be unfamiliar territory for them.
“The PRA’s shift to financial resilience reporting on an individual firm level is a welcome development that will enable these comparisons to be made more easily.”
Chris Riach, legal director at Pinsent Masons, added that the PRA’s proposals for the 2025 life insurance stress test take into account the new powers it is being afforded under the Solvency UK regime which will replace Solvency II.
He said: “A key shift this time is that the PRA intends to report the results of the exercise at an individual firm level.
“This means schemes and their advisers will have access to consistent, risk-based comparisons of the financial resilience of the largest insurers active in the UK bulk annuity market and be able to take this into account in their decision-making,” he continued.
Riach said: “It will also likely be of real interest to providers of capital to those insurers. Insurers with the most robust financial positions could therefore stand to benefit, with the PRA expecting firms that perform less well to make changes to improve their prospects in this accelerating market.”
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