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The Bank of England on Thursday warned insurance groups that relying on reinsurers to help meet a surge in demand for corporate pension deals risked creating a “systemic vulnerability” for the sector and restraining domestic investment.
Rising interest rates have lit a fire under the so-called bulk annuity market, where companies offload their pension liabilities, and the assets backing them, to insurers. The UK’s biggest transaction of this kind was announced in February and analysts expect as much as £60bn of benefits will be transferred to insurers this year, which would mark a new record.
Some insurers are making use of what is known as “funded reinsurance” to increase their capacity to do deals. This involves passing on a chunk of pension promises, and the assets behind them, to reinsurers, often in foreign jurisdictions such as Bermuda.
In a letter to executives on Thursday, Charlotte Gerken, executive director of insurance supervision at the BoE’s Prudential Regulation Authority, which supervises insurers, warned of the risks embedded in these structures.
These included the risk that reinsurers could fail, leaving pension providers to pay the benefits but without the assets to back them — and that a shock in the credit markets could make it difficult for insurers to respond.
Gerken warned that the systematic use of funded reinsurance arrangements to meet the demand for bulk annuity deals posed “significant potential risks” to the sector.
“The effect might be to accelerate these transfers in the short run, but it would come at a cost of creating a systemic vulnerability in the form of a concentrated exposure to correlated, credit-focused reinsurers,” she wrote.
The use of such transactions also had an “opportunity cost”, she said, in that assets ceded to reinsurers are not available for reinvestment in long-term UK investments, which is a key goal for the government.
The regulator had identified collateral being used in funded reinsurance deals, such as illiquid and privately held assets, that might be difficult to trade in a stressed market, as well as those that did not sufficiently mirror the pension liabilities they were intended to back.
The regulator said it was considering whether “further steps” were needed to protect the soundness of the sector. Gerken asked that insurance groups notify the regulator promptly of individual funded reinsurance transactions entered into from this point on.
Bulk annuity providers including Aviva and Just Group have made use of funded reinsurance to support their deals. In its 2022 annual report, Just said the set-up “enabled us to optimise our use of capital with our ambition to grow sales”.
Aviva and Just did not immediately comment.
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