In a recent analysis, Fitch Ratings forecasts that the UK life sector will maintain its cautious approach towards funded reinsurance (Funded Re) for bulk annuity transactions, keeping its usage below 30% of premiums from 2024 to 2026.
This strategic restraint, combined with proposed stringent regulations and insurers’ preference for diverse panels of highly rated reinsurers, is anticipated to mitigate risks amid the burgeoning bulk annuity market.
The resurgence of higher interest rates has facilitated corporates in offloading pension liabilities to insurers, propelling a surge in pension risk transfers, including bulk annuity transactions.
Funded Re, also referred to as asset-intensive reinsurance, has been a favoured mechanism among insurers to alleviate capital requirements by sharing longevity and investment risks with reinsurers.
Under this arrangement, insurers pay an upfront premium to reinsurers, who subsequently assume a portion of annuity payments and collateralize the business with a dedicated portfolio of assets.
While acknowledging the potential benefits of funded re, the Prudential Regulation Authority (PRA) has consistently cautioned against associated risks.
These risks primarily revolve around the peril of overreliance on a limited number of credit-focused reinsurers, potentially exposing insurers to vulnerabilities in case of reinsurer failure, especially during credit market stress.
Despite these warnings, Fitch Ratings asserts that the current approach to funded re in the UK life sector does not pose substantial risks.
Insurers, typically rated entities, prudently manage their counterparty risk exposure through diversified panels of highly rated reinsurers, with funded re applicable to less than 30% of bulk annuity business. Additionally, the industry hedges over 80% of longevity risk, further enhancing risk management practices.
As the bulk annuity market expands, funded reinsurance is expected to gain prominence, albeit at a controlled pace.
Most established insurers possess considerable excess capital and are likely to resort to funded re only for their largest transactions to alleviate capital strains, with tactical usage for other deals.
Furthermore, adherence to stated risk appetites, including counterparty risk, is expected to prevail, reinforced by tighter controls proposed by the PRA in November 2023.
Potential newcomers to the bulk annuity market, while possibly exhibiting higher risk appetites or a greater reliance on funded re, are anticipated to face heightened scrutiny from the PRA in alignment with its cautionary stance.
