The UK’s Prudential Regulation Authority (PRA) will introduce stress testing for insurers’ exposure to funded reinsurance (funded re) transactions for the first time in 2025. The UK regulator first signaled its concerns over the use of this type of reinsurance treaty in June 2023 when it warned this structure could leave carriers exposed in stressed markets.
Speaking at an industry conference in April, Lisa Leaman, Head of Insurance Supervision at the PRA, said that the 2025 Life Insurance Stress Test (LIST), due to be published in June, would outline the proposed funded re stress tests.
Funded re is the transfer of all the material risks of a bulk purchase annuity (BPA) transaction – both investment and insurance – to counterparties, which are sometimes based outside the UK.
An example of this type of transaction is when a book of in-force annuities moved from an unnamed UK insurer to Bermuda-based Resolution Re in February 2024 in a deal worth £2.5bn.
While German authorities quashed a deal between Zurich and life backbook specialist Viridium in January, UK regulators have not publicly stopped any similar deals despite a backdrop of the significant increase in funded re-linked BPA activity in recent years.
Leaman, however, made clear that the UK prudential regulator was watching the sector closely.
“One motivation for these transactions is to invest in a wider range of assets, which may not be eligible for MA [Matching Adjustment}. This creates potential risks and capital strain on recapture if the collateral is not eligible for the MA,” she said.
Leaman said that this strain was increasing. Citing a 2018 PRA speech titled: ‘An annuity is a very serious business’, given by the regulator’s then Executive Director of Insurance Supervision David Rule, she said transactions in the UK BPA market have increased from roughly £10bn a year in 2018 to over £50bn in 2023 and she predicted activity would double in size over the next decade.
This increase in BPA activity, and the increased use of funded re, has prompted an evolution in regulator’s perception of the main risks facing BPA insurers.
Rule’s 2018 speech cited data due diligence, longevity, and asset selection as the three biggest risks facing the sector. Six years later, in Leaman’s talk to the same audience, she spoke about ‘recapture risk’ – that is, when insurers are left holding a pool of non-MA eligible assets in the event of taking back a book of business if a counterparty defaults – but the regulator also has other concerns.
“Our stress test will assess the ability of firms to measure the risks associated with the recapture of a Funded Re arrangement in stressed conditions,” says Leaman
There is also additional risk if reinsurers in these transactions have large, concentrated exposures similar to those of the insurer ceding the risk.
This in turn has led to what Leaman termed an ‘emerging risk’ from the increased use of Funded Re by UK insurers.
Leaman stressed that the regulator is currently in the exploratory stage of understanding the industry’s exposure to funded re; the conclusions of the stress tests will only be published at the sector, not company, level.
“We will continue to monitor the volume and the increase in complexity of Funded Re arrangements, as the product develops. This will inform our views on the publication of individual firm-level results of the Funded Re stress in future LIST exercises,” says Leaman.
Another topic of relevance to the life insurance industry that Leaman mentioned at the conference is that of Solvency UK – the local iteration of the EU standard. The PRA will outline the next steps this month and Leaman said that the revised MA is the most relevant change for BPA players.
The MA gives an uplift to the risk-free rate when insurers match long term liabilities with similarly dated assets and is intended to reduce capital volatility for long term, buy and hold investors.
Leaman said there were a number of misconceptions circulating in the market around the potential changes to the MA regime and she made it clear that the PRA will not require firms to reapply for permission to apply MA status to an asset portfolio if it already has this under the existing Solvency II regime.
She also said that reform of the MA was intended to broaden the pool of available assets and not exclude ones already permitted for MA calculation.
“Finally, we understand that the implementation date of 30 June 2024 for the MA reforms may pose practical challenges to firms in some areas. The PRA will communicate, as part of the policy statement, the date(s) on which new requirements will take effect, and whether early adoption will be possible on a voluntary basis,” she says.
Leaman also said that the PRA is considering introducing MA ‘sandboxes’ – that is experimental environments to develop MA eligible assets which can then be granted regulatory approval.
She said that the regulator’s immediate priority was to implement the current proposed set of reforms but that MA sandboxes could be included in the future.
“We are open to new ideas, and we agree that it is important to think about how we could bridge any gap that might emerge in future between what is allowed by the form of prudential regulation, and those financing needs of the UK economy that can best be met from the life insurance sector,” says Leaman.
Leaman said that UK life insurers currently hold around £250bn in assets to back their long-term liabilities and by broadening the pool of assets that can be MA eligible would have major benefits for the UK economy.
Leaman also said that the government intended to review the impact of Solvency UK in five years’ time to assess their impact, but she was bullish about the potential positive impact of the changes.
“What will the BPA sector look like in five years’ time? I anticipate several positive developments. A far larger sector with insurers providing sound, efficient and effective management of defined benefit liabilities as they run off.
“More transparency, as market discipline will be enhanced by the disclosures from our Life Insurance Stress Tests. Enhanced accountability, with firms taking greater responsibility for the prudence of the MA through the new attestations that they will make,” she says.
