The Bank of England’s regulator has proposed a change in the capital treatment of life insurers’ use of funded reinsurance, a capital management strategy that helps offset longevity and investment exposures acquired in bulk purchase annuity (BPA) deals.
Insurers use funded reinsurance to shift off their books some of the liabilities they assume when selling BPAs to defined benefit pension schemes. This improves their solvency ratios, freeing up capital to then bid for more or bigger deals.
Concerned that current capital requirements may not fully capture the underlying risks of funded reinsurance, the Prudential Regulation Authority (PRA) has proposed a recalibration intended to align the treatment of these deals with similar direct investments.
In CP8/26 – Funded reinsurance, a consultation paper published at the end of last month, the PRA proposes to increase the capital buffers that insurers must put aside to cover any losses if funded reinsurance deals go sour. The proposal would shift the value from an average of 2%-4% to 10%.
The PRA said that it was acting out of concern that the capital treatment of funded reinsurance deals had given rise to “misaligned incentives” and “underestimated risks”.
“This can lead insurers to build up concentrated exposures in complex reinsurance structures, including indirect exposures to illiquid and private credit-related assets, as opposed to direct investments in better-understood assets. The PRA considers that this also leads to competitive distortions in the BPA market and may be driving a wider misallocation of capital,” the Consultation Paper stated.
This proposal represents the PRA’s most significant policy intervention following a multi-year period of heightened supervisory focus on the funded reinsurance market, which saw £6.5bn of premiums written last year and more than £9bn in 2023. The PRA estimates total exposure to the instruments is about £40bn, although funded reinsurance is thought to have supported less than 30% of all BPA deals since 2024, according to Fitch Ratings.
In a speech given at the 23rd Westminster and City Annual Bulk Annuities Conference, PRA Executive Director of Insurance Supervision Gareth Truran said the regulator felt emboldened to act.
“We have concluded the current UK regulatory framework does not properly reflect the risks involved, and that left unchecked, this would become a bigger issue for the resilience of the sector over time,” he said.
“We want to act now to correct this imbalance before it grows to pose more material risks across the sector.”
While the framework remains subject to consultation, industry observers largely expect it to be adopted in full. The proposal introduces a standardised methodology for capital allocation, requiring insurers to calibrate their reserves based on the reinsurer’s credit quality and the underlying collateral. Central to this is a refined Counterparty Default Adjustment (CDA), which ensures the value of the reinsurance asset accurately reflects potential losses in a default scenario.
The practical impact of these measures will become clearer following the proposed implementation date of 30th September 2026. Primarily, this concerns whether the new capital constraints will affect transaction volumes or an insurer’s capacity to deal.
Given the PRA’s lengthy period of engagement on the topic, however, some industry experts believe the sector is well-positioned to adapt.
“I don’t think it will constrain them, mainly because I think the amounts of capital that they have available will be more than sufficient, even if the business becomes a bit more capital intensive,” said Michael Abramson, Partner and Risk Transfer Specialist at Hymans Robertson.
Abramson further suggests that any shift in market activity will be gradual, rather than an immediate reaction to the new rules coming into force.
“It won’t just be a cliff edge from October. It’s not so straightforward to enter into a funded reinsurance arrangement at exactly the same time as you do the actual BPA, so in general we will see any impact coming through a bit sooner,” he said.
While insurers may have plenty of capacity, a second potential impact lies in pricing. It could be argued that a more capital-intensive framework might theoretically suggest a rise in premiums for pension schemes, but the highly competitive nature of the current landscape suggests a more nuanced outcome.
“It is worth also saying that you do see some insurers winning business where we know they are not using funded reinsurance. So, it is not the only driver of competitive pricing,” Abramson added.
In its Consultation Paper, the PRA also highlighted the difficulty of overseeing the reinsurers and the opportunity cost of funded reinsurance deals.
Some of the capital provided for funded reinsurance transactions comes from overseas reinsurers – some of which are owned by alternative investment firms or have investment partnerships with them – that do not fall under the purview of the PRA.
Not only is the regulator concerned that offshore reinsurers might not meet its solvency requirements, but the Consultation Paper also makes reference to one of the British government’s priorities for insurance industry investment.
The recent reforms to the Solvency regulatory regime allow for other investments, such as infrastructure investments, to qualify for the matching adjustment portfolio.
“The proposals are expected to remove the uneconomic incentive to employ funded reinsurance and therefore lead to lower use of funded reinsurance and an increase of direct investments. Compared to the counterfactual, this is expected to lead to an increase in UK productive investments as those are more likely to arise from direct investments by UK insurance firms,” says the PRA.
Slaughter and May lawyers, however, questioned the likelihood of that happening.
“This may be an oversimplification, as it is difficult to say with any certainty the investments which insurers would have made absent the availability of funded reinsurance,” the firm wrote in a report.
The new rules are set to come into force on 1st July next year but are being back-dated for funded reinsurance transactions where risk is fully transferred after 30th September (there is a savings provision that any deals completed before this date should be considered business as usual).
Unless something unexpected happens between now and the end of the consultation period, which ends on 31st July, funded re deals will incur a 10% capital charge from 1st October. Until the end of July, however, there is still plenty of analysis that can be done.
“Firms may want to use this time to evaluate the impact of the changes to different transaction structures (e.g., funds withheld, funds transferred or hybrid structures), counterparty insurance financial ratings and credit spread environments. Firms could also use the consultation as a chance to test with the PRA how much weight it would give to certain structures, contractual terms or credit protections not specifically referred to in the consultation,” said Mayer Brown in a recent article.
