Funded reinsurance has been the subject of increased regulatory scrutiny in the UK and US over the last 18 months, but experts believe it will remain part of insurers' risk and capital management toolkit. Ronan McCaughey writes

Risk transfer experts have explained why there are plentiful drivers for funded reinsurance, how insurers can best manage the risks from funded reinsurance and the implications of growing regulatory scrutiny.

Speaking in an InsuranceERM webinar last month, the panellists said there has been a growing appetite in recent years for the use of funded reinsurance, which is also known as asset-intensive reinsurance, as a source of capital for insurers writing bulk purchase annuity (BPA) business.

Reinsurers also see funded reinsurance as an attractive method of deploying capital and investment capabilities to access new business opportunities in bulk annuity markets.

In a nutshell, funded reinsurance involves the transfer of both longevity and investment risks and has expanded along with the strong growth of the BPA market internationally.

Hamish Wilson, global head of individual & flow, savings & retirement at reinsurer Pacific Life Re, was among the expert panel speaking in the webinar.

He said by providing a source of capital funded reinsurance allows bulk annuity insurers to continue writing volumes of business they are looking to achieve.

He explained funded reinsurance is also used for capital optimisation as it means reinsurers can potentially offer higher returns than those that can be achieved by insurers themselves. In addition, he noted it brings additional diversification benefits and the reduction of asset risks.

As the individual retirement income market grows globally, Wilson said "there is potential for the demand for funded reinsurance to increase even further".

He also stressed "there is absolutely room for all in this market" as traditional longevity protection reinsurers compete for funded reinsurance business with newer entrants that are backed by either private equity or asset management firms.

Regulatory spotlight

Given the expected rapid growth in insurer balance sheets as more and more defined benefit pension schemes seek to pass them their liabilities, the UK's Prudential Regulation Authority (PRA) has stepped up its oversight of funded reinsurance.

In late July, the PRA published a Dear CEO letter alongside a policy statement PS13/24 and supervisory statement SS5/24 setting out the PRA's expectations on the approach for ceding insurers using funded reinsurance as a means of risk management. Insurers are required to submit a self-assessment of their current practices against the expectations, by 31 October.

A note published last month by an Institute and Faculty of Actuaries (IFoA) working group said the PRA has three broad areas of concern about funded reinsurance:

• Counterparty limits: The robustness of insurance firms' controls on the extent of the use of funded reinsurance

• Collateral policy and counterparty SCR calculations: The quality and quantity of the collateral provided by the reinsurer to the insurer as security against the liabilities reinsured, alongside the quantum of the capital held by ceding firms against the risk of the reinsurer defaulting

• Recapture plan: The robustness and governance around ceding firms' recapture plans, which set out the proposed actions if one or more of their reinsurance counterparties were to default

Nick Reilly, head of business development for the UK and Northern Europe at actuarial software vendor and consultancy RNA Analytics, spoke during the webinar about the potential for counterparty default risk from funded reinsurance.

Reilly said if insurers pass assets to reinsurers they want to ensure those assets are ring-fenced and there are a range of ways to do that such as using collateral, custodians and loan notes.

He commented: "Another point to include is [the need] to reduce any kind of delays, not only the delay in bringing the assets in-house, but also some of the assets in their current form may be unsuitable for you to bring onto to your balance sheet immediately. The more controls and oversight you put in, the more you reduce residual risk."

Structuring a deal

Fellow webinar panellist Jamie Logie, chief underwriting officer at reinsurer Resolution Re, explained there are several structuring points that go into a funded reinsurance contract.

Logie said: "Before you even go into discussions you need to think about what is the counterparty quality, what is the credit rating and what is the solvency ratio track record? All of these things need to be considered before you get to the technical stage of how you protect yourself in a worst-case scenario."

He added: "Generally, across the mature life insurance markets we look at, most insurers fully collateralise the premium and, in many cases, over-collateralise by a small percentage. This has costs. The more collateral you need to post, ultimately the more costly it is for a reinsurer, so that will ultimately lead to a less attractive price, and it is about getting that balance right."

Logie also stressed the importance for re/insurers involved in funded insurance deals to have clear investment guidelines. He said: "There are rightful concerns that assets coming back on recapture won't be fit for matching adjustment rules. Clearly, the more flexibility you have on investment guidelines the more attractive the premiums will be."

While the PRA has increased its focus on funded reinsurance over the last 18 months, James Mullins, a partner and head of risk transfer solutions at consultancy Hymans Robertson, told the webinar audience he expects more regulatory scrutiny to come.

For example, he noted the PRA has provided further details of the stress tests the country's leading bulk annuity providers will have to perform in 2025.

Among the exploratory scenarios to best tested, this will involve showing the impact of recapturing, under stress, all funded reinsurance arrangements with their most material counterparty.

US concerns

Logie added the National Association of Insurance Commissioners (NAIC) and US state regulators have similar concerns to the UK's PRA around funded reinsurance.

Going offshore for asset-intensive reinsurance has created some concerns for the NAIC and state regulators in the US.

In April, Tricia Matson, chairperson of the Asset Adequacy and Reinsurance Issues Task Force at the American Academy of Actuaries, told InsuranceERM of the regulatory arbitrage around reserving and capital for life liabilities that had opened up offshore asset-intensive reinsurance, much of which is being ceded to Bermuda.

Logie said in the US there is a preference for an enhanced disclosure regime where an appointed actuary, as part of giving an actuarial opinion, will be a key part of the governance around funded reinsurance and particularly offshore funded reinsurance, "and that will increase transparency and consistency".

Looking ahead

Looking ahead, the experts were asked if funded reinsurance will play a major role in the life insurance, annuities, and pension risk transfer markets in the future?

Reilly answered unequivocally yes, while Mullins said funded reinsurance will be part of the re/insurers' toolkit with moderate usage. Wilson concurred and said funded reinsurance "will be there to support the industry".

The regulatory actions and press headlines about funded reinsurance risks has caused some stakeholders to pause. Mullins noted Hymans Robertson has seen a lot of concerns from trustees about funded reinsurance over the past year. But he added: "I would say most trustees go from being sceptical to taking comfort, and they also take comfort from the steps the PRA is taking."

Mullins wrapped up the discussion neatly by concluding: "Modest percentages of funded reinsurance will remain in the UK market. I think the steps the PRA has taken so far, and any future steps, will reduce the use of funded reinsurance compared to what otherwise would have been the case. It will definitely be part of the toolkit for many years to come."

Originally published by InsuranceERM  ‘The future for funded reinsurance remains bright’