The Prudential Regulation Authority is consulting on tougher capital requirements in funded reinsurance deals, used by some buyout providers, which could apply to deals from 1 October. The PRA estimates UK firms currently have a roughly £40bn exposure to funded reinsurance but believes this number is going up rapidly. 

In a funded reinsurance transaction, UK life insurers can currently pay a reinsurer an up-front premium for taking on both asset and longevity risk, freeing up capital for further deals and replacing the asset and longevity risk of a pension fund with the counterparty risk the reinsurer poses.  

On average, they currently hold collateral of 2% to 4% of liabilities. Under the PRA’s proposals published on Wednesday, this would rise to about 10%, making the practice less attractive, although still more attractive than holding 11% to 15% of capital for similar investments. The change would support future resilience while driving more direct investment, including in the UK economy, the regulator argued.  

“Funded reinsurance is growing rapidly and has the potential to undermine the resilience of insurers if not managed properly. Today’s 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,” said Sam Woods, deputy governor for prudential regulation and chief executive of the PRA. 

The growth of funded reinsurance reflects both bulk purchase annuity market growth and “how the current treatment unduly favours funded reinsurance over other similar risks”. 

The PRA has been watching longevity and funded reinsurance since at least 2022, at the time citing complex and concentrated risk in this space. 

The PRA’s concerns stem from the fact that firms offering funded reinsurance tend to operate under offshore regimes with lower capital requirements, while still being able to access UK longevity risk. Last year, the regulator’s director of insurance and cross-sectoral policy, Vicky White, spoke of “potential regulatory arbitrage”.  

The regulator previously pointed to the growing use of illiquid assets as collateral and the emergence of reinsurers with high exposure to credit markets, potentially leading to positive correlation in a crisis. In 2023, it also found “material shortcomings” in dealing with recapture risk, the possibility that risk lands back on an insurer’s balance sheet if a reinsurer goes under.  

Last year, a life insurance stress test found that funded reinsurance could in future have a meaningful impact on life insurers’ solvency positions.  

The consultation closes on 31 July. Responses can be sent by email to: CP8_26@bankofengland.co.uk.