Another PRA call to action for Insurance Firms – Funded Reinsurance

At the end of July, the Prudential Regulatory Authority (“PRA”) issued a Supervisory Statement, SS5/24, covering Funded Reinsurance. 

This set out the PRA’s expectations in respect of UK Solvency II firms that are life insurers entering into or holding Funded Reinsurance arrangements as Cedants. Funded Reinsurance is a form of collateralised quota share reinsurance contract which transfers part or all of the asset and liability risks associated with a portfolio of annuities to a counterparty.

While the PRA recognises that such reinsurance contracts can be an important part of risk management, in the context of Funded Reinsurance, the PRA has identified concerns around counterparty risks being underestimated as a result of the risk profile of the counterparties, the complexities of the arrangements, and the uncertainty around the effectiveness of management actions where there is a stress scenario occurring.

The PRA understands that proper risk assessment around the counterparties and the collateral exposures may enable some diversification benefits to be achieved, that can result in lower solvency capital requirements or make higher investment limits appropriate, but there is the potential that these transactions may also generate increased risks and a heightened level of uncertainty of those risks in a stress scenario, which may for example impact the collateral quality, the liability valuation, the risk of contract recapture, and the risk of multiple counterparty failures within the arrangements of a firm's portfolio. The PRA expects firms to be prudent when recognising benefits and taking account of the level of uncertainty in the probability and potential size of the losses associated with Funded Reinsurance arrangements.

The PRA have stated that they will be seeking assurance in respect of firms’ practices, focusing on the exposures that in its view present the greatest risk. The PRA might consider this as a topic when meeting with firms in their normal meetings, or they may instruct a Skilled Persons’ review to look at this area.  

The PRA are focusing on the following key areas:

1. Risk Management, including counterparty internal investment limits, collateral policy, and recapture plans
2. Solvency Capital Requirements, including probability of default, loss given default of downgrade, collateral, and recapture within Matching Adjustment portfolio
3. Entering Into and Structuring the Arrangement, including basis risk, collateral mismatch risks, time horizon, and contractual mitigations.  

There is a lot of technical detail in the supervisory statement with some clear actions for firms to take as a matter of urgency. At Brighter Consultancy we have a breadth and depth of risk management and actuarial skills and capability available to help you as you navigate this additional challenge, given that this is now a more urgent topic for 2024.

 The PRA in their accompanying Dear CEO Letter, stated that to allow PRA to assess firms’ current positions against their expectations, they expect the boards of UK life insurers using, or considering using, Funded Reinsurance to consider the implications of SS5/24 and to provide their PRA supervisor, by 31 October 2024, with the following:

1. Self-Assessment analysis: An assessment of the firm’s current risk management practices against all the expectations set out in SS5/24. This should include a justification if there are areas where the firm has not aligned fully with the expectations of the SS but where its implemented framework is considered to achieve the same outcome.
2. Limits: A summary table of the firm’s board-approved Funded Reinsurance limits for individual counterparties, for correlated counterparties and the firm’s aggregate limit.
3. Remediation activities: A summary, including a timeline consistent with the implementation approach detailed in the previous section, of the activities that the firm has carried out and intends to carry out to meet the expectations set out in SS5/24.
4. Level of confidence in the modelling: An overview of the perceived level of confidence achieved in the firm’s internal model output, at a transaction level, and how this has been used to shape the Funded Reinsurance investment limits.
5. Risk appetite: An overview of what steps the firm’s board has taken to limit its risk appetite for the amount and complexity of Funded Reinsurance transactions over the coming months, where gaps exist against the expectations set out in SS5/24. 

The PRA have stated that they will expect the board’s assessment of these issues to be informed by an independent opinion from the firm’s Risk Function. Firm’s responses will be used to inform both the PRA’s supervisory engagement with the firm on these issues over the coming months, and the PRA’s assessment of the case for further measures in this area.

Do get in touch with Brighter Consultancy if we can be of help.