Bank of England gearing up to stress test insurers on exposure to reinsurers

The Bank of England (BoE) is gearing up to conduct stress tests on insurers to evaluate their vulnerability due to their connections with reinsurers, particularly through a surge in corporate pension transactions.

The move comes amid rising concerns about the potential risks offshore reinsurance arrangements pose to the retirement savings of UK citizens.

According to sources reported by the Financial Times, the BoE’s Prudential Regulation Authority (PRA), which oversees the insurance industry, highlighted last year the significant risks associated with the widespread use of funded reinsurance deals by UK pension providers.

The trend of UK companies transferring around £50 billion annually in pension liabilities to insurance companies has accelerated. This shift has been driven by increased pension funding levels, thanks to higher interest rates, sparking more activity in the pension liability insurance market.

To manage more transactions and liberate capital, insurers are increasingly engaging in deals that transfer a portion of these liabilities and the corresponding assets to reinsurers. These reinsurers are frequently based offshore, in locations like Bermuda, raising concerns about the creation of vulnerabilities due to what the PRA describes as “concentrated exposure to correlated, credit-focused reinsurers.” Pension trustees have also expressed apprehension about the dangers these deals may pose.

In response, the PRA plans to include an “exploratory scenario” in its upcoming stress test for insurers, specifically examining the impact of a failure in their funded reinsurance arrangements. This scenario is expected to simulate the collapse of a major funded reinsurer involved with the life insurer, which would result in the primary insurer reassuming the pension risks, possibly without the previously allocated assets.

The PRA has proposed setting limits on the amount of funded reinsurance deals insurers can conduct with any single counterparty, as part of a consultation process concluding this week. It has also requested insurers report any significant funded reinsurance transactions.

While insurers defend funded reinsurance as a crucial risk management tool that ensures customer benefit security, the PRA has stated it will continue to observe market practices related to funded reinsurance and assess the need for further regulatory measures.

The Financial Conduct Authority (FCA), also regulating the sector, has pledged to consider any concerns about these markets seriously.

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