In Europe and the U.S, the rapid increase in bulk annuity and similar pension de-risking transactions, whereby corporate pension scheme liabilities are transferred to a life insurer, has in turn led to a rapid increase in the use of funded reinsurance, under which both investment/market risk and longevity risk are passed on to a reinsurer.  Whilst regulators acknowledge the benefits of life insurers making use of reinsurance arrangements as a strategic tool for managing risk and capital and the pricing benefits for the end customer, in recent years the significant increase in the volume of business ceded by life insurers to, typically, offshore reinsurers (such as Bermuda) has raised regulatory alarm bells.

Of particular concern to insurance regulators is the potential for concentrated offshore counterparty risk, potential correlations in risks given the increasingly credit-focussed business models of many reinsurers (particularly new entrants), and the challenges which illiquid assets can present, particularly in a recapture scenario. With these types of transactions being mainly offshore, the regulators are also concerned about the lack of transparency around the structure of transactions and their inability to exercise direct regulatory oversight of the relevant reinsurance counterparties.

In a number of jurisdictions regulators have either already reviewed, or are in the process of reviewing, the adequacy of existing regulation to assess whether it is sufficient to deal with the potential new risks arising from these types of reinsurance arrangements. In doing so, the regulators are having to find a balance between supporting the market’s desire for investment flexibility and innovation but also ensuring policyholder security.

In the UK, the Prudential Regulation Authority (the PRA) has already published new guidance on its expectations of life insurers entering into, or currently holding, funded reinsurance arrangements as cedants. In the U.S., at the August 2024 meeting of the National Association of Insurance Commissioners (the NAIC),  the Life Actuarial Task Force published for comment its revised proposals for a guideline which will require asset adequacy testing using a cash flow testing methodology for ceded reinsurance transactions. The International Association of Insurance Supervisors is continuing to monitor structural shifts in the life insurance sector, including increased use of cross-border asset intensive reinsurance and plans to publish an Issues Paper in 2025. In the European Union, following the publication of its Supervisory Statement on Supervision of Reinsurance Concluded with Third Country  Insurance and Reinsurance Undertakings in April 2024, EIOPA is due to provide guidelines on the use of innovative reinsurance techniques during 2024.  In a recent speech delivered by Petra Hielkema, Chair of EIOPA, she noted that one-third of European national supervisors have encountered asset-intensive reinsurance in their markets and it remains a development they are closely monitoring. New legislation in relation to funded reinsurance is also due to come into force in the Netherlands in 2025. This area is a high priority for regulators and going forward all parties to funded reinsurance arrangements should be prepared for increased regulatory scrutiny and expect to provide more information about transaction structures and details of their exposure under those transactions.

Position in the UK

In early 2023, the Prudential Regulation Authority (the PRA) conducted a thematic review of firms’ practices in structuring funded reinsurance transactions (‘Funded Re’), risk frameworks and capital requirements. It concluded that new, specific policy was needed to supplement existing expectations and requirements and in July 2024, following a consultation period, the PRA published a Policy Statement (PS13/24) containing final policy and feedback on its consultation, a new Supervisory Statement (SS5/24) and Dear CEO Letter.

The Supervisory Statement, which came into effect on 26 July 2024, sets out the PRA’s expectations for life insurers entering into, or already party to, Funded Re arrangements as cedants. Recognising the role of Funded Re as part of a diversified asset strategy, the principles underpinning the Supervisory Statement all build on the requirements of the Prudent Person Principle. However, the Supervisory Statement requires firms to pay particular attention to certain key risks inherent in Funded Re arrangements, for example those associated with any potential future need to recapture one or more treaties, potential correlation issues between different reinsurance counterparties, and the approach to illiquid types of collateral (particularly as regards valuation and Matching Adjustment eligibility). The PRA’s comments about certain categories of contractual protection (e.g. the use of haircuts and over collateralisation) and their role in helping to manage risk will also undoubtedly influence market terms going forward.

In addition, the PRA has asked firms to provide to their PRA supervisor by 31 October 2024:

A self-assessment analysis of the firm’s current risk management practices against all the expectations set out in the Supervisory Statement.

A summary table of the firm’s board approved Funded Re limits for individual counterparties, for correlated counterparties and the firm’s aggregate limit.

A summary, including a timeline, of the activities the firm has conducted and intends to conduct to meet the expectations in the Supervisory Statement.

• An overview of the perceived level of confidence in the modelling at a transaction level and how this has been used to shape Funded Re investment limits.
• An overview of the steps taken by the board to limit its risk appetite for the amount and complexity of Funded Re transactions.

The PRA will continue to monitor the use of Funded Re by firms and the market as a whole and consider whether more supervisory measures are necessary. In addition, the next life insurance stress test due to be conducted by the PRA in 2025 will include an exploratory scenario on a Funded Re recapture stress, which will enable the PRA to assess a firms ability to safely recapture transferred risks under stressed conditions. As it is an exploratory scenario, the results will only be published at sector level. However, in future, the biennial life insurance stress tests will include a specific Funded Re stress, the results of which will be reported upon at individual firm level.

Position in the U.S.

While no regulations or guidelines specifically focussed on Funded Re have yet come into effect in the U.S., this is set to change in the near future. Following a significant increase in the amount of Funded Re ceded by U.S. life insurers to Bermuda-based reinsurers, the American Academy of Actuaries published in February 2024 an Issue Brief (Asset Intensive Reinsurance Ceded Offshore from U.S. Life Insurers (with Focus on Bermuda)) which reviewed the market, common practices, procedures and guidance.  This was considered by the Life Actuarial Task Force (LATF) of the National Association of Insurance Commissioners (NAIC) at the NAIC Spring Meeting in March 2024, leading to a proposal being put forward for comment under which life insurers would be required to carry out asset adequacy testing for ceded reinsurance transactions using a cash flow testing methodology.  At the NAIC Summer Meeting (held in August), the LATF considered the feedback to the initial proposal and published an initial draft Actuarial Guideline on asset adequacy testing for reinsurance for further consideration and discussion.  Areas for consideration include scope (should it only apply to treaties of certain size and impact), frequency and rigour of analysis, aggregation and – perhaps most controversially – whether the guideline would have retroactive application to treaties effective from a specific date e.g. 1 January 2021 (or perhaps even earlier).  The target date for implementation of the guideline is year-end 2025, with public comments on the draft requested.

Authored by Jonathan Russell, Bob Juelke, Edward Steward, and Kirsten Barber.