The UK life insurance regime is about to undergo “potentially significant change” that could have a “far-reaching” impact on defined benefit (DB) pension scheme endgame strategies and members, according to Cardano.

In its quarterly covenant update, Cardano stated that the UK pension risk transfer market is arriving at a "unique juncture", driven by evolving supply and demand factors, regulatory change, and macroeconomic and capital market volatility.

Cardano associate director, Michael Luo, pointed out that while insurers in the market have underlined their confidence in being able to meet increasing demand, some market commentators have questioned whether insurer capacity/supply will be sufficient.

“Against this backdrop, the UK life insurance regime is about to undergo potentially significant change,” he continued, pointing out that the UK government's review of Solvency II remains ongoing.

"Whilst there is market consensus over many of the proposed changes, uncertainty remains over what is arguably the most important component – the Solvency II Matching Adjustment – which, in effect, allows insurers to provide cheaper insurance by taking advance credit for at-risk returns," he explained.

“This, and the resultant overall changes to UK insurance regulation that follow, could have significant ramifications for UK life insurers and DB scheme members.”

In addition to this, Luo noted that life insurers are also navigating a macroeconomic climate that has not been experienced in over 40 years, warning that insurers could see the quality of their investments deteriorate through increased credit downgrades and defaults.

Furthermore, according to Luo, any insurers looking to raise hybrid debt capital in the near-future may experience higher borrowing costs than in recent years, whilst any increase in volatility in interest rates and credit markets could create pressure on liquidity management.

In light of the current circumstance, Luo argued that trustees and sponsors will need to put more focus on understanding insurers’ financial strength, risk management and capital resilience when undergoing an insurer-led risk transfer exercise, to ensure the most appropriate insurer is selected to deliver benefits to their scheme members.

“For schemes already holding buy-in policies, proportionate monitoring of their insurer counterparty should form an important part of the scheme’s wider integrated risk management framework,” he said.

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