With funded reinsurance becoming more popular over the past few years, is it worthy of the regulatory scrutiny it is receiving?

Standard & Poor’s reports that excess positions recorded in defined benefit pension schemes have created opportunities for companies to reduce exposure to pension risk. Trustees can now negotiate insurance solutions from a stronger position.

In the UK alone, the annual premium for bulk purchase annuities (BPA) will reach around £50 billion in 2023, attracting new entrants to the market. To harness this growth potential, some insurers are ceding the longevity and risk of assets through Funded Re (Funded Re) transactions.

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Funded Re has gained attention in recent years but still represents a small portion of the total reserves ceded to reinsurers in the UK BPA market. In 2023, some players have waived up to 30% of their BPA premiums via Funded Re, while others have yet to adopt this approach.

It is more common for insurance companies to transfer their longevity risk only to their reinsurers. However, UK and Bermuda regulators have introduced new measures covering Funded Re, which S&P Global Ratings believes will enhance insurers’ resilience by enhancing risk management practices for Funded Re transactions.

Reducing risks for the UK BPA market

The rapid growth of the UK BPA market is driven by pension scheme trustees seeking to reduce risk. Rising interest rates have reduced the value of pension scheme liabilities, causing many schemes to move from deficit to surplus positions.

According to the Pension Protection Fund Index 7800, as of April 2024, the total surplus of the 5,050 defined benefit corporate pension schemes in the UK was £458.3 billion. Total liabilities amounted to £939.7 billion, against assets of £1,398 billion, indicating a funding level of 148.8%, compared to 99.6% in April 2019.

The improved funding situation has made pension risk transfer deals more attractive. Standard & Poor’s expects the annual premium for UK BPA transactions to remain close to £50 billion over the next three years, attracting new entrants to the market. New participants include Royal London Mutual Insurance Society Ltd. And M&G PLC. Established players have expanded their expertise to handle larger deals.

New reinsurers are also entering the market, while existing companies are becoming more active in life reinsurance. Despite ample reinsurance capacity from existing reinsurers, most only cover longevity risks.

Insurers that write BPA policies manage investment and longevity risks by ceding some to reinsurers. Investment risk includes interest rate risk, while longevity risk involves the risk that annuity holders will live longer than expected. Many insurance companies cede a significant portion of their longevity risk to reinsurers.

Read more: The Bank of England is exploring tighter oversight of life reinsurance abroad

Over the past three years, a greater number of BPA writers have transferred longevity and investment risk via Funded Re transactions, often with reinsurers based outside the UK. Some BPA providers are waiving up to 30% of their annual premiums through Funded Re, paying annual reinsurance premiums of up to £3bn-£4bn. Others avoid Funded Re because of insufficient benefits in asset creation, asset valuation, or capital management.

The primary benefits of Funded Re for BPA authors include access to the asset creation capabilities of reinsurers and the ability to free up greater capital than transferring longevity risk alone. This strategy helps insurance companies improve their competitive position and improve their BPA market share.

Major global reinsurers providing longevity risk solutions include American Reinsurance Group, Swiss Re Group, SCOR SE, Hannover Re, Munich Re and PartnerRe. Primary insurance companies in the United States, such as Prudential Financial Company, MetLife Company, Pacific Life Insurance Company, and Massachusetts Mutual Life Insurance Company, also offer longevity risk reinsurance services. Refinancing is primarily provided by reinsurers with significant asset management experience, and is often owned by private equity firms.

According to Standard & Poor’s Global Ratings, counterparty credit risk is the key risk in any reinsurance transaction, including Funded Re. Transactions are typically conducted on a blocking or transfer of funds basis, with collateral allocated to mitigate credit risk. If a BPA writer were to recover the ceded exposure, he or she faces quality and management risks of the collateral, which could result in increased capital pressure.

UK regulatory reforms are expected to expand the range of assets eligible for MA from June 2024, which could reduce the need for reinsurance. However, S&P does not expect significant changes in the number or volume of refinancing transactions due to these reforms.

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