David Rule, Executive Director of Insurance Supervision at the UK’s Bank of England, said this morning that interest rate sensitivity has helped to drive an uptick in longevity reinsurance usage.
Speaking at an Association of British Insurers event today, Rule discussed Solvency II as a regime, with a particular focus on life insurers and recapping how the regulations were supposed to work.
It’s an interesting speech, worth reading the transcript, and one fact in particular stood out.
Rule said that an uptick in reinsurance of longevity risk has been seen to be a reaction among UK life and annuities insurers to interest rate sensitivity.
Rule explained that the fall in UK sterling interest rates between January and September 2016 resulted in an increased overall risk margin for major UK life insurers of nearly £44bn, up from £30bn.
Rule explained why this matters; “Solvency II requires insurers to assume that an acquirer would be able to hedge the market risks but not the insurance risks – such as longevity – on the book. The interest rate sensitivity arises because lower interest rates both reduce the discount rate applied to the future capital requirements and lead to higher future capital requirements.”
This interest rate sensitivity has the potential to introduce procyclicality into Solvency II, Rule said, which could incentivise insurers to reduce risk as interest rates decline and take on more risk as interest rates rise, as they seek to maintain a stable solvency capital ratio (SCR).
Rule went on to explain that the effects of this have been seen in longevity risk markets; “We saw some evidence of this behaviour in 2016, primarily through a sharp increase in reinsurance of longevity risk on new annuity business.”
This perhaps goes some way to explain also the reduction in longevity reinsurance activity at the January 2017 renewals and since, as there may be an expectation (or hope) among UK life insurers that interest rate rises could be ahead.
This example shows that no matter how well planned a solvency regime is there will likely always be some linkage to other factors in capital markets, which could result in cyclicality and even correlation emerging, as seen between interest rates and life insurers tendency to offload longevity risk to reinsurers.
