The UK’s Prudential Regulation Authority (PRA) will continue its focus on funded reinsurance in 2025 amid concerns that rapid growth of funded reinsurance transactions could lead to a “rapid build-up” of risks in the bulk purchase annuity (BPA) market if not controlled properly.
In a ‘Dear CEO’ letter sent to life insurers on 9 January and signed by Garetg Truran, executive director of insurance supervision at PRA, the regulator said it continues to see a “rapid” growth in the BPA market across the UK life sector, given a continued high demand for corporate defined pension scheme risk transfer solutions.
While UK insurers have not yet published final figures for 2024, the BPA market is expected to have reached £40-50bn last year.
The PRA said it expects the UK life firms to “proactively manage in a prudent manner” their capacity to support growth in this business, and to ensure that high levels of competition for BPA business do not weaken firms’ pricing discipline and incentivise weaker risk management standards.
The regulator highlighted that the structure and complexity of BPA transactions are also evolving to meet demand, with features such as long price locks, trustee termination options and in specie premiums. These features, it said, can bring additional sensitivities to a firm’s balance sheet, and they may require firms to implement new risk management approaches or limit their exposure to such features.
The Authority said it expects firms to ensure that their risk management and control frameworks keep pace with changes in business practice and with evolving transaction features.
Supervisory statement
In July 2024, the regulator published a supervisory statement setting its expectations on UK firms’ use of funded reinsurance. It said that the firms’ self-assessments show that they are not yet fully meeting the PRA’s supervisory expectations and, while remediation plans are in place in many cases, the regulator expects that further work is likely to be required.
It added that firms’ single name exposure limits also do not currently appear to align with its expectation that single counterparty exposures should not threaten firms’ ability to meet their solvency risk appetite upon recapture.
The PRA said it expects relevant firms to make rapid progress in addressing gaps identified against its expectations, and this will be a priority for the regulator’s supervisory engagement this year.
It added that a funded reinsurance recapture scenario will also be included in the 2025 Life Insurance Stress Test.
The regulator warned that if it finds that firms are not achieving the risk management practices – including prudent limits – needed to mitigate the risks funded reinsurance poses to its objectives, it will consider the further use of its powers to address those risks.
James Silber, partner and co-lead of the insurer financial risk team at LCP, said the regulator seeks to strike a balance between the need for increased capacity to meet high demand without compromising risk management in a way that weakens the protection for current and future policyholders.
He said: “In particular, the PRA notes its continued focus on BPA insurers’ use of funded reinsurance where it believes the current growth has the potential to lead to systemic risks if not properly controlled.”
Silber noted that it is to be “expected” that it will take time for the BPA insurers to meet PRA expectations in full. He said: “We are reassured that the PRA anticipates rapid progress will be made this year to address remaining gaps.”
He said that a funded reinsurance stress test which will be included in the 2025 Life Insurance Stress Test exercise will help the regulator assess and compare exposures across the market.
However, he pointed out that the funded reinsurance aspects will not be disclosed publicly at a firm level, meaning it won’t provide visibility of funded reinsurance exposures and sensitivities for individual BPA insurers.
He said: “We have been calling for greater disclosure of [funded reinsurance] exposures for some time and are hopeful that the insurers will voluntarily disclose greater detail in their year-end results that will be published in March.”
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