Whilst the initial results of the Prudential Regulation Authority's (PRA) life insurance stress test (LIST 2025) have revealed a "reassuring picture of resilience" across bulk annuity insurers, concerns around funded reinsurance (FundedRe) remain.

The stress test, which marked the third time that the PRA has asked UK life insurers to participate in a stress testing exercise and the first under the new Solvency UK regulatory regime, focused on sector-level findings, although the PRA will also publish insurer-level findings for the core scenario shortly.

The test covered 11 of the largest UK life insurers active in the bulk purchase annuity (BPA) space, accounting for more than 90 per cent of annuity liabilities.

This revealed that the sector is resilient to a severe financial market stress scenario that impacts insurers’ investment portfolios through a decline in risk-free interest rates, falls in equity and property prices, along with widening spreads and subsequent defaults and downgrades.

In particular, the test's core financial market stress scenario - designed to be severe but plausible – saw firms experience an aggregate £8.6bn reduction in capital surplus above regulatory requirements, with £12.9bn of assets downgraded to below sub-investment grade. 

However, participating firms maintained sufficient capital resources, with the aggregate solvency capital requirement (SCR) coverage ratio falling from a strong starting point of 185 per cent to 154 per cent post-stress.

In addition to this, the PRA confirmed that all firms would continue to meet their regulatory capital requirements, underscoring the sector’s robust starting position and ability to absorb significant shocks of the kind tested in the exercise.

LCP partner, James Silber, said that the initial findings paint a "reassuring picture of resilience across the bulk annuity insurers, even under severe financial stress".

"That should give trustees and sponsors confidence in the sector’s overall financial strength and additional comfort over the security of insured member benefits," he continued.
 
This was echoed by LCP partner, Charlie Finch, who argued that the test was a "really important exercise", particularly with a "staggering" £350bn to £550bn of assets set to be transferred from defined benefit pension schemes to insurers over the next decade. 

"For schemes that plan to enter into a buy-in now or in the future, LIST 2025 provides an opportunity to better understand the robustness of the insurance regime and the differing risk profiles between insurers," he added.

Aon Risk Settlement Group head of insurer due diligence, Sam Matto-Willey, agreed, highlighting the findings as a "valuable step forward for transparency in the UK bulk annuity market".

The anticipated firm-level findings are also expected to provide even more insight and, according to Matt-Willey, will form "another key part of the toolkit to support insurer selection decisions and enhance financial strength due diligence ahead of an annuity purchase".

However, he clarified that the results, which necessarily involve simplifications and limitations at a single point in time, "do not provide a ‘one stop shop’ for financial strength information".

"Considered, holistic analysis of insurers, across financial strength, member experience, environmental, social and governance (ESG) and cyber risk management, remains vital for ensuring appropriate decision-making and monitoring," he stated.

“We expect that these stress test results will be of most interest to schemes considering insurance - but for schemes that aren't, they provide some insight into the level of resilience needed to offer benefit security comparable to that achieved by insurance.”

This was echoed by Aon head of life consulting, Michelle Lister, who warned that while trustees and sponsors will surely be eager to see firm-level disclosures on 24 November, context will be key in analysing these results.

"Given the simplifications and nuance of the exercise, we would warn against drawing quick conclusions that could lead to misinterpretation," she stated.

Pinsent Masons partner, Matthew de Ferrars, agreed, suggesting that while the insurer-level results could shift focus onto a more in-depth comparison between insurers, given that the scenario used for the LIST 2025 was only a single scenario and very sensitive to the variety of ways different insurers invest, "there is a danger of overly simplistic comparisons between insurers being drawn".

“Trustees should continue to focus on the strength of the regime as a whole and the industry-wide level results of the LIST 2025, which have shown that the sector as a whole is resilient to the severe financial market stress scenario it has been tested against," he said.

And broader market-level concerns remain, even where firms were able to absorb the impact of some stressor.

In particular, the PRA said that the findings on FundedRe showed that recapturing reinsured liabilities under stress can significantly affect life insurers’ solvency, albeit that firms could absorb these impacts as at 31 December 2024. 

This is in line with previous concerns raised by the PRA, as it recently confirmed that it would be working with the BPA market on FundedRe concerns after identifying several risks around the growing use of FundedRe.

This included concerns that FundedRe arrangements could be receiving preferential treatment, as well as the idea that FundedRe may be encouraging investment away from UK productive assets and towards offshore reinsurers, distorting investment incentives and competition within the BPA market.

The PRA also raised some concerns over the second exploratory scenario in its LIST 2025, asset concentrations, as whilst the results of this scenario showed that the sector remains resilient to the additional stress specified in the exercise, the PRA acknowledged that there were some limitations to this, which it will consider in future exercises.

More broadly, the PRA also clarified that while the results of LIST 2025 show the life insurance sector is resilient to the type of scenario tested in this exercise, regulatory exercises such as this are designed to supplement and not replace firms’ own solvency and risk management assessments.

Given this, it emphasised that all firms are still expected to maintain robust risk management capabilities, including use of their own stress and scenario testing, to test their resilience to a range of downside scenarios and to inform their capital planning.

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