The Bank of England regulates and supervises insurers through the PRA. Credit: iStock
Funded reinsurance transactions involving UK life insurers will face enhanced regulatory requirements under new proposals unveiled by the Prudential Regulation Authority (PRA).
The plans – set out in a consultation published today (29 April) – would see funded reinsurance being treated more like other investments that UK life insurers hold, ending what the watchdog said was "a regulatory inconsistency".
The PRA said that, as a result of the new rules, UK life insurers using funded reinsurance will hold capital which better reflects the risks from the default of their reinsurance counterparty, particularly where the reinsurer has a lower credit rating or where they hold riskier collateral.
It said that, for the average funded reinsurance, firms currently hold capital worth 2-4% of the value of the annuity liabilities, compared to 11-15% for similar investments.
The PRA estimated that, under the latest proposals, the capital held for the average funded reinsurance transaction would shift to around 10% - a move it said would "materially address the inconsistency" while recognising there are some differences.
Bank of England deputy governor for prudential regulation and PRA chief executive Sam Woods said: "Funded reinsurance is growing rapidly and has the potential to undermine the resilience of insurers if not managed properly.
"Today's proposals aim to iron out the discrepancy in the regulatory treatment for these deals, to protect pensioners and improve insurers' incentives to invest directly in the UK economy."
In recent years, UK insurers have sold bulk purchase annuities (BPA) to defined benefit pension schemes. Under these transactions the insurer takes over full responsibility for paying members' regular pensions for as long as needed.
The PRA said many UK life insurers in the BPA market are now increasingly using funded reinsurance, in which the UK life insurer pays a large up-front premium to an offshore reinsurance counterparty, who invests this in assets to fund future payments to the insurer. These assets do not need to be compatible with UK standards, while the offshore reinsurer still benefits from access to the UK insurance market.
The PRA estimates that current funded reinsurance exposure of UK firms is around £40bn, but this number is rising quickly, reflecting both BPA market growth and how the current treatment unduly favours funded reinsurance over other similar risks.
The PRA's 2025 life insurance stress test showed this risk could in future have a meaningful impact on life insurers' solvency positions if the use of funded reinsurance continues to grow.
The PRA said the proposals should reduce incentives for firms to choose funded reinsurance over other sources of capital, supporting future resilience and also driving more direct investment in its place, including investment in the UK economy.
It said the proposals would not apply to business already executed or completing shortly, but would apply to any business from 1 October onwards.
Market impact
LCP said it the PRA was proactively focussing on an area it sees as a potential source of risk to insurer resilience, particularly against systemic risks.
Partner James Silber said: "We expect the proposals to lead to a moderation in the use of funded reinsurance from October given the greater capital insurers will need to hold. Funded reinsurance is likely to remain a key part of the toolkit, potentially with changes to the structures and counterparties, but we also expect to see insurers diversify into alternative asset strategies to optimise pricing.
Partner Charlie Finch added: "Last year we projected that over £350bn of assets will be transferred from pensions schemes to insurers over the next decade. Funded reinsurance has been a key tool used by insurers to support growth so these proposals have the potential to impact overall market capacity and pricing. However, it is a highly competitive market and the insurers have shown a consistent ability to re-optimise their strategies as circumstances change. Trustees are likely to want to scrutinise these changes when entering into buy-ins."
