By Charlie Finch, Partner at LCP
These regulatory reforms could have a big impact on the dynamics in the bulk market over the next year – particularly for larger transactions. We summarise below three of the key ongoing developments and comment on what they mean for schemes considering a buy-in or buy-out.
PRA 'thematic review' of bulk annuities
The PRA announced in January that it would undertake a thematic review of the bulk annuity market to “seek assurance that… risk management disciplines are keeping pace with any [bulk annuity] growth ambitions”. All eight of the insurers in the market are seeking to significantly grow their volumes of bulk annuities and the PRA is keen to see this being done in a controlled way.
LCP comment:
Our analysis shows that up to £300bn of assets and liabilities could transfer from DB pension schemes to insurers by the end of 2026 – this would double the volume of annuities on insurer balance sheets and represents a massive macro-economic shift for the UK economy.
It is reassuring that the PRA is considering the implications of this rapid growth and is focussing on suitable controls being in place to ensure that the insurance regime continues to provide a safe long-term home for peoples’ pensions.
At this stage, we don’t know what changes may emerge from the thematic review or the timeline for its conclusions. Could the PRA seek to slow the pace of transfers to insurers?
PRA review of 'funded reinsurance'
A key area that has fallen under scrutiny by the PRA is the use of 'funded reinsurance'. This is where insurers reinsure not just the longevity risk associated with a buy-in but transfer the asset risk as well. Effectively the insurer is doing a further buy-in with the reinsurer and passing across a proportion of the liabilities. This has been increasingly used by some insurers to allow them to increase their capacity to write larger transactions (giving access to the reinsurer’s asset sourcing capabilities) and reduce the capital impact of transactions on the insurer. There has also been a huge growth in reinsurers offering funded reinsurance – with some of them being relatively recently set up specialist reinsurers based in Bermuda.
In the preliminary feedback from its review, the PRA stated that it sees limited risks with the use of funded reinsurance within a diversified asset strategy – moving away from the language used last September when the review was announced, which mooted “limits on acceptable structures or on volumes of transactions”. However, the PRA stressed that funded reinsurance should not be used simply to expand capacity to meet the accelerating demand noting this could create “a systemic vulnerability in the form of a concentrated exposure to correlated, credit-focussed reinsurers”. The PRA also highlighted a number of “areas of concern” in the collateral structures insurers have used to protect against counterparty default in the reinsurance arrangements. Stronger collateral arrangements will help further mitigate counterparty risk but will potentially dilute the economic benefits of funded reinsurance to the insurers. The PRA made it clear that it expects to be notified of any individually material funded reinsurance transactions in the future.
LCP comment:
Funded reinsurance represents a potential systemic risk to the insurance market so we welcome the steps being taken by the PRA to ensure it is being used in a controlled way.
The PRA has sought to balance suitable controls against not overly limiting a key mechanism that insurers can use to increase capacity to write bulk annuities – particularly to undertake larger £5bn+ transactions.
In our view the disclosures in insurer financial statements on reinsurance provide limited insight into the extent the insurers are relying on these arrangements to manage capital and risk. As part of our involvement in industry forums, we have been lobbying the
PRA to improve the information available to pension schemes including the scale of insurers’ exposure to reinsurance counterparties.
Solvency UK – clarity finally emerging
The Solvency II reforms – to be called Solvency UK in future – have been in train since 2020 and there still remains uncertainty over their impact. However, we are expecting clarity to emerge over the next 12 months with a raft of consultations now underway.
At the end of June, the PRA published its latest consultation paper which confirmed timescales for implementation:
The 65% reduction in the 'risk margin' element of capital requirements will be implemented for 2023 year ends; and
The wider asset eligibility rules will be in place in H2 2024 along with a new 'attestation' regime for senior management at the insurers to justify the investment default assumptions they have adopted.
LCP comment:
Our current expectation is there will be a modest reduction in insurers’ capital requirements as a result of Solvency II reform, albeit materially less than the 10-15% initially indicated by the Government. This benefit is already reflected in insurer pricing and has been helping to support attractive pricing over the past year.
We will be reading with interest the consultation due in September on the widening of asset eligibility requirements. This change could be beneficial for insurers in terms of being able to source a wider range of attractive assets – helping to support pricing, both for increased market volumes and also for some of the very large bulk annuity transactions.
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