PRA funded-re proposal narrows capital arbitrage between reinsurance and direct assets

Funded reinsurance usually involves a collateralised reinsurance contract that transfers both asset and liability risks from a portfolio of annuities to a reinsurer, often based offshore. UK insurers' exposures have grown significantly alongside the bulk purchase annuity market, and in recent years about 15% of new BPA business written by UK insurers has been ceded this way.

The PRA would define funded reinsurance as arrangements that back either annuity or capital redemption liabilities, and would change the counterparty default adjustment calculation for recoverables to better reflect both the risk of a reinsurer defaulting and the downgrade risk of the assets held as collateral. It estimates the capital held against funded reinsurance would rise to around 10%.

Its case rests on more than principle. The 2025 Life Insurance Stress Test showed that recapturing arrangements from a single counterparty could materially damage firms' capital positions, even with the relatively small exposures on the books at year-end 2024. The IAIS and the IMF have identified the same risks, and insurance regulators in the Netherlands and the US have recently acted on similar arrangements.

The changes would not apply where all the risks covered are fully transferred to the reinsurer on or before 30 September 2026.

Aligning the treatment with economically similar direct assets is aimed at the capital advantage that made funded reinsurance attractive in bulk annuities. The September cut-off leaves fully completed arrangements outside the draft rules, while the calculation change itself starts in 2027.

Sources: bankofengland.co.uk · slaughterandmay.com