With funded reinsurance becoming more prevalent over the past few years, is the brewing regulatory scrutiny around it deserved?
S&P reports that record surplus positions at defined benefit pension schemes have created opportunities for companies to reduce pension risk exposure. Trustees can now negotiate for insurance solutions from a stronger position.
In the UK alone, the annual premium for bulk purchase annuities (BPA) was approximately £50 billion in 2023, attracting new market entrants. To harness this growth potential, some insurers are ceding both longevity and asset risk through funded reinsurance (Funded Re) transactions.
Funded Re has gained attention in recent years but remains a small portion of the total reserves ceded to reinsurers in the UK BPA market. In 2023, some players ceded up to 30% of their BPA premium via Funded Re, while others have yet to adopt this approach.
It is more common for insurers to transfer only longevity risk to reinsurers. However, UK and Bermudian regulators have introduced new measures covering Funded Re, which S&P Global Ratings believes will enhance the resilience of insurers by strengthening risk management practices for Funded Re transactions.
The UK BPA market's rapid growth is driven by pension scheme trustees seeking to reduce risk. Higher interest rates have decreased the value of pension scheme liabilities, resulting in many schemes moving from deficit to surplus positions.
According to the Pension Protection Fund's 7800 Index, as of April 2024, the aggregate surplus of the 5,050 corporate pension schemes offering a defined benefit in the UK stood at £458.3 billion. Total liabilities were £939.7 billion, against assets of £1,398 billion, indicating a funding level of 148.8%, compared with 99.6% in April 2019.
The improved funding position has made pension risk transfer deals more attractive. S&P predicts that the annual premium for UK BPA transactions could remain near £50 billion for the next three years, drawing new entrants to the market. Recent entrants include Royal London Mutual Insurance Society Ltd. and M&G PLC. Established players have scaled up their expertise to handle larger deals.
New reinsurers are also entering the market, while existing ones are becoming more active in life reinsurance. Despite ample reinsurance capacity from established reinsurers, most of it covers only longevity risk.
Insurers writing BPA policies manage investment and longevity risks by ceding some to reinsurers. Investment risk includes interest rate risk, while longevity risk involves the risk of annuity holders living longer than expected. Many insurers cede a significant portion of their longevity risk to reinsurers.
Over the past three years, more BPA writers have transferred both longevity and investment risk via Funded Re transactions, often with reinsurers based outside the UK. Some BPA providers cede as much as 30% of their annual premium through Funded Re, paying annual reinsurance premiums of up to £3 billion to £4 billion. Others avoid Funded Re due to insufficient benefits in asset origination, asset valuation, or capital management.
The primary benefits of Funded Re for BPA writers include access to reinsurers' asset origination capabilities and the ability to free up more capital than by transferring longevity risk alone. This strategy helps insurers improve their competitive position and optimize their BPA market share.
Major global reinsurers providing longevity risk solutions include Reinsurance Group of America, Swiss Re Group, SCOR SE, Hannover Re, Munich Re, and PartnerRe. US primary insurers like Prudential Financial Inc., MetLife Inc., Pacific Life Insurance Co., and Massachusetts Mutual Life Insurance Co. also offer longevity risk reinsurance. Funded Re is mainly provided by (re)insurers with significant asset management expertise, often owned by private equity firms.
According to S&P Global Ratings, counterparty credit risk is the key risk in any reinsurance transaction, including Funded Re. Transactions typically operate on a funds-withheld or funds-transfer basis, with collateral set aside to mitigate credit risk. If a BPA writer must recapture ceded exposure, it faces the quality and management risk of the collateral, potentially increasing capital strain.
Regulatory reforms in the UK are expected to expand the scope of MA-eligible assets from June 2024, possibly reducing the need for reinsurance. However, S&P does not anticipate significant changes in the number or size of Funded Re transactions due to these reforms.
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