The Prudential Regulatory Authority (PRA) is to further scrutinise insurers’ use of “funded reinsurance”, in a move one consultant says could affect capacity and pricing for larger bulk annuity transactions.
Last week, the PRA’s director for prudential policy Vicky White gave a speech outlining the regulator’s ongoing work on the funded reinsurance sector.
In particular, she indicated that the PRA was studying the way in which funded reinsurance bundles together investment and longevity risk, and whether this may give rise to “regulatory arbitrage” or “underestimation of risk”.
Gavin Smith, principal at LCP, said the regulator’s reference to regulatory arbitrage “is a phrase they are unlikely to have used lightly and could signal new rules imposing limits on the structures used or requiring insurers to hold more capital”.
For defined benefit (DB) pension schemes exploring a bulk annuity transaction, Smith said the regulator’s work was unlikely to affect pricing or capacity in the short term as the PRA had said it was “forward-looking” in its approach.
He added: “Lower usage of funded reinsurance has the potential to increase pricing and/or reduce capacity for some insurers who have been using it…
“Competitive dynamics remain firmly tilted in favour of schemes, and insurer appetite is strong, so we think it is unlikely to have much impact other than for the largest transactions.”
Smith praised the aim of providing more transparency on how bulk annuity transactions are priced and structured, as the current market’s complexity and lack of disclosure “means it is difficult for trustees and sponsors to independently assess the implications for insurer security”.
PRA to ‘act now’ on future funded reinsurance rules
White also stated that the PRA would consider whether the existing UK regulatory framework for insurers and reinsurers “provides the right treatment for these innovative transactions”.
She emphasised that the regulator was cognisant of one of its roles, to promote competition and innovation among the firms it supervises, but added that it still needed to ensure risks being taken were appropriate.
White said: “Whenever something grows very fast, particularly where it involves complex interactions between regulatory regimes, it should prompt all of us – regulators and regulated alike – to stop and consider whether the incentives driving that growth are misaligned compared to alternatives with a similar economic risk profile.”
The PRA was seeking to “act now to get the treatment right for the future, so that unmitigated risks do not rise to a level where they could put the resilience of the sector and its policyholders in peril”, White added.
She said the PRA was still formulating its views and intended to consult with the insurance sector through roundtable discussions later in the year “to get to a common understanding of the issue and decide if the right course of action is to change the rules to ensure a consistent treatment across economically similar structures”.
At the start of this year, the PRA warned of “systemic risk” building up in the bulk annuity sector due to the concentration of risk among a few providers of funded reinsurance. These are reinsurance companies that take on longevity and investment risk from a bulk annuity insurer.
The PRA will soon carry out a stress test exercise for UK insurers, including a test of their use of funded reinsurance arrangements.
