Bank of England issues warning to life insurers

The Bank of England will consider intervening to restrict the flow of assets being channelled overseas through life reinsurance deals if they do not adequately tighten controls protecting pension savers, the Financial Times has reported.   

The warning is contained in a letter to life insurance chief executives on Friday which said firms had not done enough to improve their risk management of so-called funded reinsurance deals. 

These are where UK life insurers pass a chunk of their pension liabilities, and the assets backing them, to overseas reinsurers, in jurisdictions such as Bermuda, the FT said. 

Gareth Truran, executive director for insurance supervision at the BoE’s Prudential Regulation Authority, said the BoE was concerned that the growth in funded reinsurance transactions “could, if not properly controlled, lead to a rapid build-up of risks in the sector”. 

He added that UK insurers were using funded reinsurance “in a way that is not consistent with prudent risk management”. The regulator said it would consider action including “explicit regulatory restrictions on the amount and structure of [funded reinsurance], or measures to address any underestimation of risk, or regulatory arbitrage, inherent in these transactions”. 

These complex transactions are being increasingly used by life and annuity insurers active in the booming market for corporate pensions deals. Companies offload their pension liabilities, paid for with the assets backing them, to insurers, who then pass on a chunk of those obligations to overseas reinsurers. The Bermuda market has seen rapid growth in this area.   

Regulators in the UK, Europe and the US are increasingly concerned that the retirement savings of ordinary people are being put at greater risk through their life insurers’ deals with reinsurance firms in territories that have more flexible investment rules. 

In the US, the National Association of Insurance Commissioners held a meeting on Thursday to discuss proposals for extra testing by life insurers of their reinsurance contracts, touching on transparency.  

Frederick Andersen, the NAIC’s chief life actuary, told the meeting that in some deals US regulators can “lose insight” into whether reserves are adequate to back policyholder promises.  “That and the increased use of reinsurance in recent years has led to an identified concern by regulators and has led to the discussion over the past several months,” he told attendees, the FT reported. 

These concerns have been fuelled by the crisis surrounding 777 Re, a Bermuda reinsurer that ran into trouble after building up exposure in a mix of illiquid investments from football clubs to budget airlines that were linked to its private equity parent. 

The BoE is planning a stress test next year on a failure in insurers’ funded reinsurance arrangements. 

Effective immediately, the regulator is demanding that firms set limits on the degree of reinsurance they do with individual reinsurers, but also on the aggregate business they do across a group of similar reinsurers that could get into problems in a credit market downturn.

 Among the other requirements, the PRA is demanding that insurers have clear policies over the collateral backing these reinsurance arrangements, and to demonstrate that taking collateral back in a period of market stress would not put them in breach of UK rules over where they can invest. 

The PRA said the work it had already done with firms revealed the “particularly high level of uncertainty in the probability and potential size of losses” insurers were exposed to through funded reinsurance deals, due to the “absence of adequate public, historic or forward-looking data” on counterparty risks. 

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