Increased regulatory scrutiny
The increasing use of innovative and complex “funded” or “asset-intensive” reinsurance structures by life insurance companies, fuelled in particular by the unabated growth in the pension de-risking market, has caused the insurance regulatory spotlight to focus on this area.
In Europe and the U.S., the rapid increase in bulk annuity and similar pension de-risking transactions, whereby corporate pension scheme liabilities are transferred to a life insurer, has in turn led to a rapid increase in the use of funded reinsurance, under which both investment/market risk and longevity risk are passed on to a reinsurer. Whilst regulators acknowledge the benefits of life insurers making use of reinsurance arrangements as a strategic tool for managing risk and capital and the pricing benefits for the end customer, in recent years the significant increase in the volume of business ceded by life insurers to, typically, offshore reinsurers (such as Bermuda) has raised regulatory alarm bells.
Of particular concern to insurance regulators is the potential for concentrated offshore counterparty risk, potential correlations in risks given the increasingly credit-focussed business models of many reinsurers (particularly new entrants), and the challenges which illiquid assets can present, particularly in a recapture scenario. With these types of transactions being mainly offshore, the regulators are also concerned about the lack of transparency around the structure of transactions and their inability to exercise direct regulatory oversight of the relevant reinsurance counterparties.
In a number of jurisdictions regulators have either already reviewed, or are in the process of reviewing, the adequacy of existing regulation to assess whether it is sufficient to deal with the potential new risks arising from these types of reinsurance arrangements. In doing so, the regulators are having to find a balance between supporting the market's desire for investment flexibility and innovation but also ensuring policyholder security.
In the UK, the Prudential Regulation Authority (the PRA) has already published new guidance on its expectations of life insurers entering into, or currently holding, funded reinsurance arrangements as cedants. In the U.S., at the August 2024 meeting of the National Association of Insurance Commissioners (the NAIC), the Life Actuarial Task Force published for comment its revised proposals for a guideline which will require asset adequacy testing using a cash flow testing methodology for ceded reinsurance transactions. The International Association of Insurance Supervisors is continuing to monitor structural shifts in the life insurance sector, including increased use of cross-border asset intensive reinsurance and plans to publish an Issues Paper in 2025. In the European Union, following the publication of its Supervisory Statement on Supervision of Reinsurance Concluded with Third Country Insurance and Reinsurance Undertakings in April 2024, EIOPA is due to provide guidelines on the use of innovative reinsurance techniques during 2024. In a recent speech delivered by Petra Hielkema, Chair of EIOPA, she noted that one-third of European national supervisors have encountered asset-intensive reinsurance in their markets and it remains a development they are closely monitoring. New legislation in relation to funded reinsurance is also due to come into force in the Netherlands in 2025.
This area is a high priority for regulators and going forward all parties to funded reinsurance arrangements should be prepared for increased regulatory scrutiny and expect to provide more information about transaction structures and details of their exposure under those transactions.
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