Navigating Regulatory Reforms in Funded Reinsurance

With significant regulatory transformations on the horizon for 2024, it’s crucial not to overlook the new regulations around Funded Reinsurance set out in CP24/23. These arrangements, involving ceding portions of annuity premiums to reinsurers (sometimes part of the same group) to mitigate asset and longevity risks, are experiencing a surge in popularity in the UK for their ability to reduce capital requirements on insurers’ balance sheets. However, the PRA has expressed concerns about the appropriate management and recognition of underlying risks in the Solvency Capital Requirement (SCR).

There’s a lot to be done for insurers, as the new regulations will necessitate enhancements to the risk management of these arrangements, improvements to the SCR modelling, changes to the way these arrangements are reflected in the base balance sheet and look-through modelling of the collateral.

Enhancing Ongoing Risk Management Processes:

The PRA’s consultation paper outlines expectations for insurers, necessitating a shift towards a quantitative risk assessment framework. This transition includes adopting new metrics such as the “immediate recapture” metric and the maximum acceptable loss, alongside managing the business using internal investment limits. Additionally, insurers are required to develop robust recapture plans and articulate explicit collateral policies.

Impact on Solvency Capital Requirement (SCR) Modelling: 

The revised SCR modelling will incorporate enhanced Probability of Default (PD) calculations under both base and stress scenarios, accompanied by additional requirements for Loss Given Default (LGD) and downgrade assumptions. Standard formula firms are also affected, as the risks around funded reinsurance will need to be incorporated into the ORSA.

Furthermore, there are stringent rules around modelling the collateral assets on a look-through basis and around the modelling of management actions, including what re-collateralisation under stress looks like.  

Recapture within Matching Adjustment Portfolios (MAP):

Models will need to assume that in the event of recapture, the assets do not form part of the MAP unless insurers can clearly demonstrate that these assets meet the eligibility criteria for inclusion in the MAP. This creates an additional requirement on the modelling of underlying assets that is previously not mandated. Insurers will need to think carefully about how they might source the data and develop the models needed to demonstrate this eligibility.

Entering and structuring Funded reinsurance arrangements

Insurers will need to adopt a significantly more quantitative approach for new arrangements, utilising quantitative internal investment limits, a quantitative risk assessment process and taking account of the maximum acceptable loss. This sets a much higher regulatory bar than currently in place, necessitating additional analysis for most insurers.
  

Next Steps

With the implementation deadline slated for Q2 2024, the time to act is now to ensure compliance with the new regulations when they come into effect.

• Implement quantitative ongoing risk management for existing arrangements.
• Modelling of collateral assets to enhance PD calculations and the ability to re-collateralise under stress.
• Review and enhance SCR modelling for Funded reinsurance arrangements.
• Adapt current processes to assume recapture outside the MAP or conduct the necessary analysis to demonstrate that assets would be MA eligible under the firm’s existing permissions.
• Develop quantitative assessment methods for new arrangements.

With extensive experience in asset modelling and a wealth of actuarial technical expertise both in the UK and overseas, 4most stands ready to support you in navigating these regulatory changes. 

Want to learn more about how we can support your organisation? Contact us – info@4-most.co.uk.