The Prudential Regulatory Authority has outlined new policy expectations on funded reinsurance (Funded Re), following concerns that the current growth in Funded Re transactions could, if not properly controlled, lead to a rapid build-up of risks in the sector.

The PRA previously confirmed that UK bulk purchase annuity (BPA) firms would be stress tested on the use of funded reinsurance, with industry experts highlighting the heightened regulatory scrutiny for funded reinsurance as being “well warranted".

The PRA has now also written to the CEO's of a number of life insurance firms, to draw attention to its new final policy statement, which outlines its expectations in respect of insurers entering into or holding funded reinsurance arrangements as cedants.

In particular, the statement outlined expectations on the ongoing risk management of funded reinsurance arrangements; the modelling of the solvency capital requirement associated with funded reinsurance arrangements; and how firms should consider the structuring of funded reinsurance arrangements.

The letter explained that whilst the PRA has seen some evidence of firms developing and improving their risk management practices for these transactions, further improvements are still needed by UK insurers to meet the regulator's policies and expectations.

It stated: "The PRA will continue to monitor market practice and assess the risks to its objectives from this market over the coming months, taking into account growth of FundedRe in individual firms and the market as a whole.

"In particular, we will monitor closely the volume of FundedRe transacted by firms, any change in the quality of the collateral and the nature of FundedRe counterparties active in the market, and the progress firms make in implementing risk management and control arrangements in line with SS5/24."

In addition to this, the PRA warned that, if firms are not meeting expectations on the risk management practices needed to mitigate the risks FundedRe poses, it will consider whether it is appropriate to take further action.

This could include making use of any of the PRA's powers under the Financial Services and Markets Act (FSMA) 2000 to address those risks, including supervisory powers under section 55M and rule-making powers.

This could include, for example, consideration of explicit regulatory restrictions on the amount and structure of FundedRe, or measures to address any underestimation of risk, or regulatory arbitrage, inherent in these transactions.

The PRA's new expectations are expected to prove helpful, as S&P Global Ratings said that the new measures will help mitigate the associated risks of FundedRe, if implemented properly.

S&P Global Ratings analyst, Ali Karakuyu, also clarified that, despite the warning over Funded Re use, the UK's BPA market is not expected to be negatively affected, due to the pipeline of demand for pension risk transfer to insurers and the BPA sector's good profitability.

In addition to this, he pointed out that the recent UK solvency changes have resulted in a more favourable treatment of BPA business in terms of capital requirements, particularly in relation to matching adjustment eligible assets.

"We therefore continue to forecast that the annual BPA premium will remain about £50bn over 2024-2026," he added.

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