The Bank of England warned on Thursday that depending on reinsurers for help in meeting a surge of demand for corporate pensions deals could create a “systemic vulnerabilities” for the industry and restrain domestic investment.
The rise in interest rates has sparked a boom in the bulk annuity industry, whereby companies sell their pension liabilities and assets that back them to insurers. was the UK’s largest transaction of this type, announced in February. Analysts expect that up to £60bn worth of benefits will transfer to insurers during this year. This would be a record.
Some insurers use “funded reinsurance”, also known as “funded reinsurance”, to increase their ability to make deals. It involves transferring a portion of pension promises and the assets that support them to reinsurance companies, usually in foreign jurisdictions like Bermuda.
Charlotte Gerken warned executives of the dangers of these structures in a letter sent to them on Thursday. She is the executive director for insurance supervision of the BoE’s Prudential Regulating Authority.
There was the possibility that pension providers would have to pay benefits without any assets backing them, and the failure of a reinsurer. Also, if the credit markets were to be shook by a sudden shock, insurers might not be able to react.
Gerken warned of “significant risks” for the industry if funded reinsurance arrangements are used to satisfy the demand for bulk deals.
She wrote: “The effect could be an acceleration of these transfers, but at the cost of creating systemic vulnerabilities in the form a concentrated exposure of credit-focused correlated reinsurers.”
She said that the use of these transactions had an “opportunity costs” in that assets ceded by reinsurers cannot be reinvested in long-term UK investment, which is one of the key goals for government.
The regulator identified collateral used in funded insurance deals such as illiquid assets and privately owned assets that could be difficult to sell in a market under stress, as well those that did no adequately reflect the pension liabilities that they were meant to back.
The regulator stated that it was evaluating whether “further measures” were required to protect the sector’s soundness. Gerken requested that all insurance companies notify the regulator immediately of any funded reinsurance transactions they enter into.
Funded reinsurance has been used by bulk annuity providers such as Aviva and Just Group to support their transactions. Just Group said in its annual report for 2022 that the setup “enabled [us] to optimize our capital use with our ambition to increase sales”.