Bank of England (BofE) executive director for insurance supervision, Charlotte Gerken, has warned insurers against over-indulging in new business in the short run amid a period of accelerated growth in the bulk purchase annuity (BPA) market.

Speaking at the 20th BPA Conference, Gerken noted that “a lot is happening” in the BPA market, with the UK insurance industry preparing itself for record levels of BPA transfers, while pension scheme funding levels have greatly benefited from the rise in interest rates.

Gerken explained that this structural shift in the provision of retirement income has also given insurers an increasingly important role as long-term investors in the UK real economy, emphasising the need to exercise moderation in the face of “considerable temptation”.

“Insurers need to balance the short term financial and reputational incentives to grow rapidly, with long term and enduring financial strength, to meet the long term needs of policyholders and the economy,” she stated.

Gerken also highlighted three key areas where a trend for insurers to stretch their supply capacities in the short term was already being seen in practice, including an expansion of BPA insurer risk appetites, an increased reliance on third party capacity, and greater interconnectivity with the wider financial system.

In particular, Gerken said that the BofE’s supervisory work found that there is an increased appetite to insure deferred pension scheme members: the younger, not yet retired individuals.

However, she warned that this can bring several additional risks for insurers, including much greater uncertainty in longevity risk, as assumptions have to be made over a much longer period of time, together with risks stemming from policyholder options, such as cash commutation, flexibility on retirement age and transfers.

Gerken also pointed out that the disruption in the UK gilt market last autumn resulted in some pension schemes being overweight in illiquid assets as gilt values fell significantly, and schemes sought to reduce their leverage under liability driven investment strategies.

According to Gerken, insurers have since been increasingly developing solutions to accept illiquid assets as part of the BPA premium, suggesting that pension schemes may be reluctant to dispose of these assets in the open market, potentially at a large discount.

“This requires significant due diligence, and we are seeing insurers seeking more advice from third party specialists such as property valuation experts both for illiquid asset valuation and to calibrate adequate market value haircuts,” she continued.

“Alternatively, we have seen deferrals of premiums incorporated in deals giving pension schemes time to dispose of such assets in an orderly fashion. These premium arrangements can be complex and potentially capital intensive due to the increased uncertainty they can create.”

However, Gerken clarified that while the Prudential Regulation Authority (PRA) welcomes innovations in the market as insurers seek to better support their clients, insurers are expected to understand the additional risks and uncertainties when accepting premium that includes such assets.

“Even if firms use external expertise to price or manage these deals, boards remain accountable for the decisions taken,” Gerken stated.

“They need to understand the basis for advice from third parties and to challenge the advice robustly.”

Focus on the BPA market has been on the rise, with industry experts predicting a surge in the scheme buyouts, after recent funding improvements resulted in a “strong finish” to 2022, with recent analysis revealing that buy-in and buyout volumes reached £15.8bn in H2 2022.

Indeed, The Pensions Regulator also recently revealed that around a quarter of schemes are thought to have sufficient funds for buyout, urging pension scheme trustees to ensure that their long-term targets remain appropriate.

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