Enhancing oversight of Funded Reinsurance in the UK

The Prudential Regulation Authority (PRA) has published its Policy statement (PS13/24 – Funded reinsurance) and Supervisory Statement (SS5/24]) following its Consultation Paper on Funded Reinsurance (Funded Re). 

Funded Re involves UK life insurers transferring significant pension liabilities and corresponding assets to reinsurers, primarily to manage risk and reduce capital requirements. As these transactions become more prevalent within the corporate pensions market, the PRA has introduced new measures, effective from 26 July, 2024, to ensure these practices do not compromise the pensions of UK individuals. 

In this article we summarise the purpose of these measures, outline the reinsurance in scope, detail the high-level changes, and suggest next steps for firms engaged in Funded Re.

At a glance

While anticipated, the treatment of intra-group reinsurance has not been updated in the supervisory statement, in fact the PRA made it explicitly clear in the “Dear CFO” letter that intra-group reinsurance is within the scope of the regulations. There have been updates in relation to aspects such as diversification between funded reinsurance counter parties and managing uncertainties from internal model outputs for funded reinsurance.

It is outlined in the “Dear CFO” letter that by October 31 2024, UK life insurers using or considering Funded Re must provide their PRA supervisor with:

1. Self-assessment analysis: An evaluation of current risk management practices against SS5/24 expectations, including justifications for any deviations.
2. Limits: A summary of board approved Funded Re limits for individual and correlated counterparties, as well as the aggregate limit.
3. Remediation activities: A summary and timeline of actions taken and planned to meet SS5/24 expectations.
4. Confidence in modelling: An overview of confidence in internal model outputs and how this has influenced Funded Re investment limits.
5. Risk Appetite: An overview of steps taken to manage risk appetite for Funded Re transactions, addressing any gaps in meeting SS5/24 expectations.

Purpose and scope of the Funded Re regulations

The PRA’s regulations aim to protect UK pensioners by ensuring that the capital held against transferred pension liabilities is adequate, even when these liabilities are reinsured overseas in jurisdictions with different regulatory landscapes, such as Bermuda. The regulations explicitly include the oversight of intra-group transactions, maintaining the existing terminology in the regulatory framework to ensure that it continues to encompass such arrangements. The PRA’s focus remains on managing the risks associated with counterparty reliability and the adequacy of capital, which are critical given the divergence  in regulatory standards across jurisdictions.

Changes to regulatory requirements

Based on the feedback received, the PRA will implement the following changes compared with the wording in the Consultation Paper:

• Inclusion of a clarifying statement confirming that firms may consider diversification between Funded Re reinsurance counterparties and associated risks.
• Clarifications on the expectations for firms in setting internal investment limits, particularly concerning limits for recapture from a single counterparty.
• Adjustments to the expectations regarding collateral policies, including considerations of the nature of collateral assets and documentation requirements.
• Revisions to expectations concerning Board involvement in recapture plans. This states that while high-level principles and inherent uncertainties in recapture plans should be set, explicit board approval for each individual plan is not required.
• Guidance on managing uncertainties in internal model outputs for Funded Re arrangements stressing that firms must incorporate identified uncertainties into their risk management, potentially through stricter investment limits or reduced risk-taking in contracts and collateral.
• Clarity on the PRA’s considerations regarding collateral mismatch risk, particularly the removal of the wording for infrequent rebalancing, the PRA expects firms to justify rebalancing frequency by assessing the risk of large shortfalls at recapture and to factor these potential shortfalls into their capital and limits.

Amendments to the PRA’s expectations regarding the application of collateral haircuts 

The PRA states that firms should use risk-based collateral haircuts or over-collateralisation linked to the risk being addressed, and guidance has been revised to ensure haircuts and over-collateralisation account for the expected volatility of key risk factors affecting collateral value and the amount due from the reinsurer under stressed conditions. The PRA has decided not to differentiate between types of reinsurers, and inter-group type of reinsurance arrangements, treating all counterparties with consistent scrutiny.

Recommended actions for insurers

Insurers should take the following steps to enhance their risk management practices and remain compliant:

1. Strengthen governance frameworks to ensure comprehensive oversight of Funded Re arrangements.
2. Revise internal models to incorporate the new regulatory expectations and to better capture the specifics of collateral assets.
3. Enhance modelling of collateral assets – advanced look through modelling will support both the requirements for collateral management and recovery modelling. Consider partnering with external experts such as 4most, for the latest advances in modelling complex assets. This will help in assessing and managing the risks more effectively.
4. Respond to the PRA by the deadline of October 31, 2024. 

Conclusion

As the market for Funded Re continues to evolve, the PRA will keep a close watch on its impact on the financial stability of the UK and adjust its supervisory approaches as necessary. Insurers must now align their practices with these updated requirements to safeguard the interests of UK pensioners effectively.

Get in touch if you are interested in learning more about how 4most can support your organisation navigate the evolving regulatory landscape – info@4-most.co.uk.