The UK’s latest call for a general election has put the highly supported Bank of England’s (BoE) efforts to scrutinise the use of funded reinsurance by life insurers in the bulk purchase annuity (BPA) market on hold.

The Bank consulted in November on setting out its expectation for life insurers’ use of reinsurance that would lead to a supervisory statement covering its expectations on:

  • the ongoing risk management of funded reinsurance arrangements;
  • the modelling of the solvency capital requirement associated with funded reinsurance arrangements; and
  • how firms should consider the structuring of funded reinsurance arrangements.

According to S&P Global Ratings, last year some BPA insurers reinsured as much as 30% of their BPA premium, adding that the regulator is right to scrutinise this market.

In a new report by the firm – Funded reinsurance deserves the heightened regulatory scrutiny – S&P Global Ratings pointed out that if a BPA writer has to recapture the ceded exposure, the reversion of asset and liability risks to the insurer could increase the strain on its capital.

Specifically, the report said the BPA writer’s regulatory solvency position could come under pressure if the recaptured assets did not qualify for certain regulatory benefits in the UK, such as eligibility for a “matching adjustment”.

It added that without this benefit, some players could see a material drop in their solvency ratio; some could even have a negative ratio.

Ali Karakuyu, director and lead insurance analyst at S&P Global Ratings, said: “The heightened regulatory scrutiny for Funded Re transactions is well warranted. Many insurers are increasingly using Funded Re as a tool to mitigate risk. However, should an insurer’s BPA asset and liability exposures need recapturing, their regulatory solvency position could come under pressure.”

It seems, though, that the regulatory intervention has been put on hold during the election process. The response to the consultation that closed in February was initially expected to be published by the BoE in the first half of the year. However, the bank said it is following the Cabinet Office’s election guidance, which includes limiting communications and activities until after the general election.

It said that it will reconsider publication dates after this period.

Material adjustments

The bank’s Prudential Regulation Authority (PRA) has, however, published its policy statement on the Review of Solvency II: reform of the matching adjustment, which pertains to all UK Solvency II firms and insurance and reinsurance undertakings that have a UK branch.

One key aspect of the proposed matching adjustment reform is the expansion of asset eligibility to allow insurers to match a portion of their liabilities with assets with “highly predictable” cash flows instead of only “fixed and certain” cash flows.

The highly predictable contribution is capped at 10% of the total matching adjustment.

Another part of the reform is the removal of a cap on sub-investment-grade assets and the introduction of notching to reflect differences in credit quality.

Other aspects of the matching adjustment changes are the introduction of an annual matching adjustment appropriateness attestation, and the inclusion of a streamlined application process.

Michael Abramson, partner and risk transfer specialist at Hymans Robertson, said the regulation “slightly expands the universe of suitable assets” that insurers can use to back buy-ins and buyouts.

In particular, he said that the regulations provide some flexibility in respect of the matching adjustment, which encourages insurers to invest in assets with cashflows that match their liabilities.

He said: “This may provide a modest boost to insurer capacity as well as helping some pension schemes by making it easier for insurers to take on their existing assets as part of a buy-in or buyout.”

Abramson warned, however, that pension schemes should manage their expectations, as many illiquid assets held by schemes will still fall outside of the new insurer regulations.

“The publication of these regulations means that the first phase of the new Solvency UK framework is now largely complete, with any remaining details focused on more operational aspects,” he noted.

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