Funded reinsurance transactions involving UK life insurers will face enhanced regulatory requirements under new proposals revealed by the UK’s watchdog, the Prudential Regulation Authority (PRA), in a consultation paper.
Under plans in a consultation published recently, funded reinsurance – or funded re, which involves UK life insurers paying a large up-front premium to a reinsurer in return for future payments – would be treated more like other investments that UK life insurers hold, ending a regulatory inconsistency, said the PRA.
As a result, 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.
"The fact that the PRA has moved back from applying a new construct is a big positive."
For the average funded reinsurance, an insurance company can currently hold capital equal to 2-4% of the value of annuity liabilities, compared with 11-15% for similar investments, said the PRA. Under the new proposals, the PRA said it estimated that the capital held for the average funded reinsurance transaction would shift to around 10%, which materially addresses the inconsistency but recognises that there are some differences.
“The fact that the PRA has moved back from applying a new construct, the so-called unbundling approach, and are looking to implement the regulation through traditional means, is a big positive,” said Bob Tyley, Head of Insurance Investment & ALM, at Howden IAL. “It is operationally simpler. It means adjusting the processes and approaches that are already in place and not creating a brand new construct for funded re.”
Tyley said the industry has made it clear, both at the roundtables and externally, that operationally, the unbundling approach was a step too far in terms of how to address the challenge and that there is not enough capital held against funded re.
10% - can it be negotiated?
The industry has given lukewarm feedback so far. At a Fitch Ratings event last week on life market consolidation, the topic was raised with panellists saying 10% might see some pushback, with hopes of lowering it.
"At the end of the day, the quantum is excessive as far as the industry is concerned."
“Without being specific about the numbers, the genuine feel from the industry is that the number is too high,” said Tyley. “Although it is appreciated that the current framework may not provide as much sufficient capital as would be necessary, but that would be helpful with regard to covering something that one could regard as a systemic risk. That’s the way the PRA is looking at funded Re.
“But at the end of the day, the quantum is excessive as far as the industry is concerned,” he said.
The PRA estimates that the current funded reinsurance exposure of UK firms is around £40 billion, but this number is rising quickly.
“Funded reinsurance is growing rapidly and has the potential to undermine the resilience of insurers if not managed properly,” Sam Woods, Deputy Governor for Prudential Regulation and Chief Executive Officer of the PRA, said. “[The] 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.”
Unintended consequences?
The consultation paper intends to try and sort out any issues that the funded re question has raised, but Tyley was less convinced it was an issue that needed such a strong hand at all.
Tyley said the consultation paper may appease some and annoy others.
“Anybody has the right to respond to the consultation paper,” he said. “I would expect the vast majority of the industry who use funded re will be responding on the basis that the intended approach is better than what was previously suggested, but the calibration is too high.”
The reason for the consultation paper has been for more scrutiny of funded re. The PRA says that many UK life insurers in the Bulk Purchase Annuities market are now increasingly using funded reinsurance.
"Whether firms are still in the process of improving their processes or have already completed them, the amount of governance over the top of their funded re exposures is significant."
In this, the UK life insurer pays a large up-front premium to an offshore reinsurance counterparty, which 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 changes, Tyley sees as largely unnecessary. Whilst concerns around the systemic risk aspect are prescient, they are not as pressing as some may believe.
“Whether firms are still in the process of improving their processes or have already completed them, the amount of governance over the top of their funded re exposures is very significant,” he said.
“I am not concerned about the industry taking excessive risk to funded re under the current framework.”
- Life Insurance
- Bob Tyley
- Sam Woods
- Howden IAL
- Prudential Regulation Authority (PRA)
- Bulk Purchase Annuity
- funded re
- regulation
