The regulator for insurers and banks has warned of “systemic risk” within the bulk annuity market as insurers compete for DB pension schemes’ business.
Specifically, the regulator for insurance companies and banks highlighted the concentration of risk among a few providers of “funded reinsurance”. These are reinsurance companies that take on longevity and investment risk from a bulk annuity insurer.
Both the PRA and the Financial Policy Committee have expressed concerns about the growth in the use of funded reinsurance, warning that “if not properly controlled” it could lead to “a rapid buildup of risks in the sector and have the potential to pose systemic risks”.
“If we consider that firms are not achieving the risk management practices needed to mitigate the risks funded reinsurance poses to our objectives, we will consider the further use of our powers to address those risks.”
Prudential Regulatory Authority
Self-assessments by insurance companies have shown that they are “not yet fully meeting” the PRA’s expectations in this regard, the regulator said in an insurance outlook document published last week.
“In many cases remediation plans are in place, but we judge that further work is likely to be required,” the PRA said.
“For example, firms’ current internal investment limits for aggregate exposures appear insufficient to prevent a build-up of systemic risk in view of current activity trends.
“Firms’ single name exposure limits also do not currently appear to align with our expectation that single counterparty exposures should not threaten firms’ ability to meet their solvency risk appetite upon recapture.”
The PRA expects insurers to make “rapid progress” to address these concerns in 2025, ahead of a stress test later this year.
Failure to do so could result in regulatory interventions, the regulator said.
“If we consider that firms are not achieving the risk management practices – including prudent limits – needed to mitigate the risks funded reinsurance poses to our objectives, we will consider the further use of our powers to address those risks,” the PRA said.
James Silber, partner at LCP and co-lead for the consultancy's insurer financial risk team, said: “It is perhaps to be expected that it will take time for the bulk annuity insurers to meet PRA expectations in full, and we are reassured that the PRA anticipates rapid progress will be made this year to address remaining gaps.”
He said the stress test – the results of which will be published at the end of this year – will help the regulator “assess and compare exposures across the market”.
“However, [these] aspects will not be disclosed publicly at a firm level, meaning it won’t provide visibility of funded reinsurance exposures and sensitivities for individual bulk annuity insurers,” Silber added. “We have been calling for greater disclosure of funded reinsurance exposures for some time and are hopeful that the insurers will voluntarily disclose greater detail in their year-end results that will be published in March.”
A growing bulk annuity market
Almost £50bn worth of new bulk annuity business was written by insurers in 2023, and the figure for 2024 is expected to be a similar level.
Consultancy group LCP has already predicted £40bn to £50bn of new business in 2025, and has forecast annual volumes to remain at this level over the next decade as DB schemes seek to lock in strong funding positions.
The PRA said it expected insurers to “proactively manage in a prudent manner their capacity to support growth in this business, and to ensure that high levels of competition... do not weaken firms’ pricing discipline and incentivise weaker risk management standards”.
The regulator also acknowledged innovations from bulk annuity providers such as deferred premiums, which involve part of the insurance premium being delayed to allow the sale of illiquid assets.
The PRA highlighted that such services “can bring additional sensitivities to a firm’s balance sheet”, requiring additional risk management approaches.
“We expect firms to ensure that their risk management and control frameworks keep pace with changes in business practice and with evolving transaction features,” the regulator said.
