The review will also assess how firms monitor and meet liquidity demands arising from derivative instruments used in their asset and liability management for bulk annuity portfolios. The PRA’s focus on these areas reflects its earlier identification of funded reinsurance arrangements used extensively by UK annuity providers as a potential source of systemic risk.
Funded reinsurance and capital effects
Funded reinsurance involves transferring both asset and investment risk and longevity risk to a reinsurer, covering all material risks of a bulk purchase annuity transaction.
During its previous thematic work, the PRA identified four key areas of risk in funded reinsurance arrangements, which it set out to firms as part of its supervisory messaging.
The PRA also noted that many bulk annuity transactions using funded reinsurance generated an upfront positive economic capital benefit for insurers, driven by premium differentials between the direct annuity contract and the reinsurance.
Counterparty and systemic risk concerns
In its June 2023 letter, the PRA highlighted that life insurers may be underestimating counterparty risks arising from funded reinsurance structures.
The PRA has identified that increasing exposures to a limited number of longevity reinsurance providers through these arrangements create potential systemic risk in the bulk annuity market.
The thematic review on risk management will therefore place particular emphasis on how firms assess and mitigate concentration risk to reinsurance counterparties within their bulk annuity books. Supervisory communications and speeches
The PRA reiterated its concerns about the UK bulk purchase annuity market in a speech delivered on 27 April 2023, which set out supervisory priorities for the sector.
Charlotte Gerken delivered a further speech on bulk annuities at the end of April 2023, in which she addressed PRA priorities and acknowledged the potential benefits of funded reinsurance when used prudently.
These communications followed the PRA’s thematic review in 2022-2023 and framed the June 2023 letter to chief risk officers that drew attention to counterparty risk underestimation.
Market growth and balance sheet trends
Record premium volumes were written in the UK bulk annuity market in 2023, with market expectations that elevated transaction activity will continue in future years.
Industry estimates suggest the UK life insurance industry could onboard more than £500 billion of pension liabilities and associated assets over the coming decade through bulk annuity and related transactions.
Other estimates place potential volumes even higher, indicating that life insurers could take on more than £600 billion of pension liabilities and assets over the same period.
Several UK bulk purchase annuity insurers released longevity provisions in 2023, reflecting excess mortality experience from the pandemic and amendments to their longevity bases.
Bulk annuity writers continue to allocate a substantial proportion of their balance sheets to illiquid assets as part of their investment strategies for backing long-dated liabilities.
Link to funded reinsurance policy development
On 16 November, the PRA released draft measures aimed at addressing perceived risks in the market for funded reinsurance used in bulk annuity structures.
Those draft measures built on the findings of the 2022-2023 thematic review of funded reinsurance and the June 2023 letter that set out concerns about counterparty risk management by life insurers. The new thematic review on risk management in bulk annuity markets will sit alongside these draft measures as part of the PRA’s broader supervisory response to rapid growth in the sector and increasing use of complex risk-transfer structures.
