By Craig Turnbull, Partner and Head of Regulatory Advisory and Rosie Fantom, Head of Bulk Annuities and Risk Transfer Partner at Barnett Waddingham
The regulatory impact
The first hurdle for trustees to navigate is the evolving regulatory landscape, in the wake of Brexit untethering UK insurance regulations from EU rules.
The UK insurance regulator – the Prudential Regulation Authority (PRA) - is currently consulting on reforms to the UK’s insurance regulatory regime, with many of the proposed reforms specifically focused on the regulatory rules for bulk purchase annuity (BPA) business, affecting both BPA insurers and their clients.
The Solvency UK reform programme aims to:
Increase the extent to which the UK insurance sector invests in UK ‘productive finance’ (broadly, UK infrastructure and long-term corporate debt);
Improve the competitiveness of the UK insurance sector (for example, by reducing the burden of regulatory compliance costs), and; maintain policyholder security at existing levels.
These new regulations are likely to marginally reduce insurers’ annuity reserving requirements, meaning the amount of assets they need to hold, relative to the annuities they are paying out, will fall. The new regulations also provide further investment flexibility, broadening the investible universe for BPA firms, although use of these newly eligible asset types will be subject to stringent regulatory limits, suggesting evolution rather than revolution in insurance firms’ annuity investment strategies.
Overall, the new regulations are not expected to have a material impact on how insurers manage their business or on BPA pricing, but implementation of the reforms is likely to demand significant attention from BPA firms’ senior management over the next year.
The role of funded reinsurance
In some of the largest transactions in H1 2023, insurers are understood to have used significant volumes of ‘funded reinsurance’ - where a portion of the transaction is effectively passed through to a reinsurer, typically domiciled in Bermuda. BPA insurers have been using reinsurance for a long time – the reinsurance market is active and mature, but the use of funded reinsurance is relatively new.
Funded reinsurance allows insurers to write more business and manage capital capacity constraints. However, the step-up in funded reinsurance volumes has prompted the PRA to question whether firms are adequately managing the associated risks, leading to the PRA announcing a new consultation on insurers’ use of funded reinsurance in November 2023.
The consultation does not propose new regulatory rules but would strengthen the PRA’s supervisory expectations about how firms manage the risks of funded reinsurance, which might lead to some insurance firms going further in terms of their counterparty credit risk capital modelling or setting reinsurance exposure limits. We do not expect the use of funded reinsurance in new BPA transactions to cease, but the consultation may limit the extent to which it is used in future.
As with all transactions, we recommend that trustees evaluate their proposed insurer, focusing on its business model, the inherent risks, and the way those risks are managed before transacting.
The capital challenge
Capital is one form of capacity constraint for the BPA insurers. Another is the size and depth of the asset classes in which firms invest, which in turn feeds into how they price new transactions coming to market. The Solvency UK reforms’ widening of the investible universe could lead to improved pricing, but the changes are expected to be incremental rather than material.
The projected appetite for new business will encourage new forms of capital and investment supply into the BPA market; the only question is how?
With some potential ‘mega deals’ (multi-billion-pound transactions) already rumoured to be receiving pricing indications from BPA insurers, and new insurers entering the BPA market, some answers are likely to emerge very soon.
Access to sufficiently attractive illiquid assets is a key variable in BPA pricing. Insurers could be forced to use less favourable options as demand outstrips the volumes of illiquid assets that insurers can readily originate. Insurers may also look to increase profit margins in response to higher demand.
As things stand however, we continue to see our clients get attractive pricing, with competition high among insurers as the final transactions of 2023 closed.
Shifting sands for schemes to navigate
The outlook for the UK BPA market over the next twelve months is very strong. But there are challenges for both trustees and sponsors:
In November, the Chancellor used his Autumn Statement to propose further changes to pensions. In particular, the potential for greater flexibility regarding scheme surpluses along with possible changes in tax treatment could cause trustees and sponsors to re-evaluate their long-term strategy for DB liabilities.
November also saw the announcement of the pension industry’s first superfund transaction, highlighting another option for trustees and sponsors to consider in their evaluation of their long-term strategy.
Meanwhile, the key Solvency UK reforms are expected to take effect at the end of June 2024, against a backdrop of PRA concerns about funded reinsurance. The attractiveness of the future use of funded reinsurance may also be impacted by the regulatory changes that are underway in Bermuda, where the majority of UK funded reinsurance has been transacted.
Much of the projected future BPA market demand comes from larger pension schemes that imply unprecedented transaction sizes. Impending mega deals in the market are likely to require innovations in how insurers structure and arrange transactions. A £10bn+ transaction is not business as usual for the BPA market. Such transactions could make use of multiple BPA firms and/or introduce new mechanisms that allow third-party capital to be used to support these transactions.
The UK BPA market itself is in flux, with potential mergers and acquisitions, along with some new entrants joining the fray.
For those who hoped for a year of taking stock after a busy 2023 in the world of UK bulk annuities, 2024 may well prove to be a disappointment.
|
