Regulator to stress test UK life insurers on reinsurance exposures
The Prudential Regulation Authority plans to stress test insurers on their exposure to reinsurers through a range of funded reinsurance deal, the Financial Times has reported.
The FT story said the stress testing, which will take place in 2025 come as a result of concern about the risk posed by offshore arrangements, including with Bermuda-based re/insurers, to UK retirement savers.
The Bank of England’s PRA warned last year that the systematic use of so-called funded reinsurance deals posed “significant potential risks” to UK pension providers.
UK businesses are offloading about £50 billion a year in pension liabilities to insurers, after rising interest rates improved pension scheme funding levels and fuelled activity in this market.
Insurers are entering into transactions to pass on a slice of their liabilities — and the assets that back them — to reinsurers, which are often located offshore in places such as Bermuda.
“The growing trend for these deals has prompted concern that they might be creating a vulnerability through what the PRA has called a ‘concentrated exposure to correlated, credit-focused reinsurers’.” The FT said. “Pension trustees have also said they are worried about the potential threat from such arrangements.
“The PRA has now told executives that, in next year’s stress test, it plans to include an ‘exploratory scenario’, modelling the impact on insurers of a failure in their funded reinsurance arrangements, people familiar with the matter told the Financial Times.”
The scenario would probably include the collapse of a significant funded reinsurer being used by the life insurer, meaning that the risks are “recaptured” by the primary insurer, sources told the FT. In such a situation, the insurer would be put back on the hook for the pension risks, but potentially without the assets that had been set aside.
In a typical funded reinsurance deal, the insurer passes on to the reinsurer key risks associated with the pension scheme being taken over, such as asset risk or longevity risk.
It also cedes to the reinsurer certain assets to back those risks, which are held as collateral, under an agreed set of investment guidelines. Government bonds might be swapped out for other private credit assets as the reinsurer attempts to generate yield, for example.
Global policymakers have in recent years increased scrutiny of these agreements, particularly where some of the collateral is moving offshore and beyond the oversight of a national regulator.
One area of concern previously highlighted by the PRA was whether assets put in these collateral pools might become difficult to trade in a stressed market, and might not be able to match the relevant liabilities.
The PRA has separately proposed, as part of a consultation process that runs until this week, that firms set limits on the funded reinsurance deals they do with individual counterparties. The regulator has also demanded that insurers notify it of any significant funded reinsurance transactions.
Insurers, meanwhile, defend the use of funded reinsurance as one of a number of risk management tools that provide security to their customers’ benefits.
The Bermuda Monetary Authority and the Bermuda International Long Term Insurers and Reinsurers (BILTIR) have not responded directly to the stories, but the BMA referred Bermuda:Re+ILS to its research papers on long-term insurance.
The BMA is carrying out a review of its supervision of long-term insurance and has said it will carry out scenario-based testing. IT and BILTIR members have also noted that the BMA must be notified of all block transaction and as part of its approval process, consults with the regulator of the country where the transaction from, which would include the PRA.
