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The Bank of England plans to stress test insurers on their exposure to reinsurers through a flurry of corporate pension deals, according to people familiar with the matter, as concerns mount about the risk posed by offshore arrangements to UK retirement savers.
The BoE’s Prudential Regulation Authority, which supervises insurers, 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 £50bn a year in pension liabilities to insurers, after rising interest rates improved pension scheme funding levels and fuelled activity in this market.
As insurers race to free up capital to do more deals, they are entering into transactions to pass on a slice of those 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”. 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, the people said. 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.
In a statement, the PRA said it would “continue to monitor how market practice evolves in relation to funded reinsurance and will keep under review whether further measures are required”.
The Financial Conduct Authority, which also oversees the sector, said it would “always carefully consider concerns raised about particular markets.
“Fellow regulators will, as appropriate, consider the financial implications of any such deals falling under their remit,” the FCA added.
Mick McAteer, co-founder of the Financial Inclusion Centre think-tank and a former FCA board member, said the stress-test plan was “very welcome”. “The role of reinsurance, particularly offshore reinsurance, is making [it] even harder to regulate an already opaque life insurance sector,” he added.
