The UK Prudential Regulation Authority's new requirements for use of funded reinsurance is unlikely to inhibit growth in the UK pension risk transfer market.

The regulator, which first put funded reinsurance in its crosshairs in 2022, issued new requirements for its use on July 26 this year over concerns about "a rapid build-up of risks" at UK life insurers if growth in usage was left unchecked. Insurers had been using more funded reinsurance to help meet a surge in demand for pension risk transfer (PRT) deals.

The new requirements will make using funded reinsurance more costly and time-consuming and may curtail its use in the short term, but should not dent the prospects of the UK pensions risk transfer market, according to specialists.

"As long as pricing stays within a reasonable range, then there will be no impact on volumes," Charlie Finch, partner at consultancy Lane Clark & Peacock LLP said in an interview. "The volumes will continue to be driven almost entirely by the level of demand. And most of that demand is driven by funding levels within pension schemes."

Mounting concerns

Funded reinsurance, also known as asset-intensive reinsurance, is a form of collateralized quota-share cover for annuity business, which is used globally. The insurer transfers both liabilities and assets associated with annuity business to the reinsurer.

The most common use in the UK market is to support PRT deals, known in the UK market as bulk purchase annuity (BPA) transactions, where defined benefit pension scheme liabilities are insured. BPA writers use funded reinsurance for two key reasons: increasing their capacity to do deals and accessing assets they would otherwise be unable to.

Business volumes in the UK BPA market have surged in recent years as higher interest rates boosted funding levels of defined benefit pension schemes, making more of them eligible for insurance. Deal volumes hit a new record of £49.1 billion in 2023, beating the previous record of £43.6 billion set in 2019, according to a report by pensions consultancy Hymans Robertson LLP. The firm expects volumes of at least £50 billion a year for the remainder of the decade.

The growth in the market has led to increased levels of funded reinsurance usage overall. Usage varies widely across the nine active UK BPA writers. One of the biggest writers, Legal & General Group PLC, increased funded reinsurance cessions to 23.2% of gross new business premium from its global PRT activities in 2023 from 10% in 2022. Rothesay Life PLC, another top BPA writer, uses no funded reinsurance.

Anecdotally, 10% to 20% of UK BPA business on average could be supported by funded reinsurance, Lara Desay, partner and risk transfer specialist at Hymans Robertson, said in an interview. "I do think that has marked up quite dramatically over the past four, five years or so," she said.

As funded reinsurance usage has grown, so has the concern of the Prudential Regulation Authority (PRA), culminating in the new requirements. Many of the requirements focus on insurers' understanding of counterparty risk and ability to recapture the liabilities and the collateral assets if a reinsurer fails. The regulator is worried about insurers recapturing assets because many funded reinsurance providers are based in offshore financial centers such as Bermuda, so they can invest in a wider array of assets without attracting additional capital charges. UK-based insurers may face challenges when taking these assets onto their own books.

Among other things, the PRA now expects insurers to set internal investment limits for counterparties, establish a collateral policy and recapture plan, and factor funded reinsurance-related risks when calculating solvency capital requirements.

In an accompanying letter to insurer CEOs, the regulator warned that if insurers did not meet its expectations, it would consider further action, including explicit restrictions on the amount and structure of funded reinsurance used.

The PRA is not the only regulator keeping tabs on funded reinsurance. Petra Hielkema, CEO of the European Insurance and Occupational Pensions Authority (EIOPA), said at a conference in Bermuda in September that a third of Europe's national insurance supervisors have encountered funded reinsurance in their markets, "a development that EIOPA is closely monitoring."

New funded reinsurance legislation is pending in the Netherlands, law firm Hogan Lovells said in a report Oct. 3. In the US, the National Association of Insurance Commissioners' Life Actuarial Task Force is proposing asset adequacy testing for ceded reinsurance, including asset-intensive reinsurance.

Some prominent BPA writers have played down the effects of the PRA's new requirements on their business.

The new requirements are "broadly sensible risk management," but their introduction "doesn't impact our plans and the levels we're using," Jeff Davies, Legal & General's CFO, said on an earnings call. Aviva PLC CFO Charlotte Jones said on an earnings call there would be "no impact" on her company's funded reinsurance program because it is "incredibly modest," accounting for about 5% of the portfolio of matching adjustment assets related to Aviva's BPA business.

Short-term disruption

But the market will face some disruption because of the new requirements. Insurers have already had to meet a tight Oct. 31 deadline for submitting a range of information about their funded reinsurance programs to the PRA. This included an assessment of current risk management practices against those now required, limits of funded reinsurance with individual counterparties and in aggregate, and a summary of taken and planned actions to get into line with the new requirements.

The Oct. 31 deadline means companies had a lot to prepare in a relatively short time, according to Monty Iliev, director of retirement and decumulation at Willis Towers Watson PLC's insurance consulting and technology division. "I think some firms may have planned to carry out some of this work running into 2025, so this really narrows down their timelines," Iliev said.

Funded reinsurance may also get more expensive. As one of the PRA's concerns is the compliance of collateral assets in case these assets are recaptured, insurers may want to narrow the types of assets used as collateral, Hymans Robertson's Desay said. "There is a direct correlation between those collateral assets and the pricing that the reinsurer can offer."

The new requirements could also make accessing the UK BPA market tougher for insurers and reinsurers alike. Wei Hou, head of UK and Ireland life and asset intensive for Europe at reinsurance broker Gallagher Re, said in an interview that he had not yet seen a material reduction in funded reinsurance use because incumbent companies had already considered the requirements when negotiating deals. The PRA's new expectations largely align with those outlined by the regulator in a consultation in November 2023. But he added: "It could mean a higher barrier for new entrants, for example — both for insurers and reinsurers — who [are] yet to get through the preparations of the work for the funded re transactions."

Greater clarity

Despite the challenges, some expect the effects on the UK BPA and funded reinsurance markets to be limited and short-lived. The changes could prompt insurers to use less funded reinsurance than they would have otherwise done, which could have a knock-on effect on pricing and capacity, Finch at Lane Clark & Peacock said, "but we expect it to be small."

Work on the new requirements "may delay the usage of funded [reinsurance] in the very short term," Iliev said. "But I would expect the usage of funded [reinsurance] to broadly remain at the levels that were observed in 2023 going into this year and next year."

A further positive is that the companies involved are in little doubt about the regulator's position on funded reinsurance. The requirements provide "very clear guidance" on how the PRA expects companies to deal with funded reinsurance, Hou said, "which looks to me very positive."

The PRA's expectations may also help assuage any concerns that pension scheme sponsors have about insurers' use of funded reinsurance. The PRA's proactivity on risk management "gives our clients comfort that this is an area which is being monitored and therefore, insurers will likely be taking sensible approaches on," Finch said.

The industry will learn more about the effects of the new requirements if and when the PRA responds to its findings from the Oct. 31 information request and the upcoming life insurance stress test, taking place in 2025, which includes a funded reinsurance recapture scenario.

As it stands, the insurers' and PRA's messaging seems at odds, with insurers saying they are meeting requirements and the regulator remaining concerned, Desay said, making it unclear whether or not insurers are in line with the PRA's new expectations. She added: "We should get further clarity on that towards the end of the year or early next year, I would have thought, following that info request piece."