The heightened regulatory scrutiny for funded reinsurance (funded re) transactions is “well warranted”, according to S&P Global Ratings, with new measures from UK and Bermudian regulators expected to help improve risk management on funded re transactions.

In its report on funded reinsurance, S&P Global Ratings noted that record surplus positions at defined benefit (DB) pension schemes have given many companies an opportunity to reduce their pension risk exposure, with trustees able to negotiate for an insurance solution from a position of relative strength.

It also pointed out that, in order to harness the market's growth potential, some insurers are choosing to cede both the longevity and asset risk obtained via these bulk annuity purchase (BPA) deals to reinsurers through funded reinsurance transactions.

Whilst funded re comprises “only a small portion” of the total outstanding reserves ceded to reinsurers for the UK BPA market, S&P noted that funded re has garnered more regulatory attention as it has become more prevalent over the past few years, with differing attitudes amongst key BPA players.

Indeed, S&P noted that while some players ceded as much as 30 per cent of their BPA premium via funded re in 2023, indicating an increasing appetite for this type of transaction, others have yet to cede any of their premium via funded re.

The report suggested that there are some important potential benefits of using funded re for BPA writers, such as the opportunity to benefit from reinsurers' asset origination capabilities, and the opportunity to free up more capital than can be achieved by transferring longevity risk.

In addition to this, it said that both the insurer and the reinsurer could benefit from improved risk/return optimization, noting that some insurers use funded re as part of their pricing and growth strategy, to improve their competitive position and optimize their BPA market share.

However, it warned that If a BPA writer has to recapture the ceded exposure, it will be exposed to the quality of the collateral and the risk of managing it, and the reversion of asset and liability risks to the insurer could increase the strain on its capital.

"Specifically, the BPA writer's regulatory solvency position could come under pressure if the recaptured assets do not qualify for certain regulatory benefits in the U.K., such as eligibility for a 'matching adjustment' (MA)," it stated.

"MA-eligible assets get preferential treatment in the solvency ratio calculation,” the report stated.

“If an insurer has to recapture assets, it may face the operational cost of optimizing the assets to ensure eligibility for the MA.”

Whilst it is still far more common for insurers to transfer only longevity risk to reinsurers, the U.K. and Bermudian regulators have already introduced new measures covering funded re.

However, S&P Global Ratings suggested that that these measures will enhance the resilience of insurers, and will help contribute to stronger and more-consistent risk management relating to funded re transactions.

S&P Global Ratings lead insurance analysis, director, Ali Karakuyu, said: “The heightened regulatory scrutiny for funded re transactions is well warranted. Many insurers are increasingly using funded re as a tool to mitigate risk.

“However, should an insurer’s BPA asset and liability exposures need recapturing, their regulatory solvency position could come under pressure.”

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