Clifford Chance

At the 20th Westminster & City Conference on Bulk Annuities held at the end of April 2023, the mood in the packed hall was buoyant. UK pension schemes have seen their funding position improve greatly as a result of interest rate rises and many are now able to contemplate a de-risking transaction sooner than anticipated. The RSA/PIC jumbo transaction announced in February was fresh in everyone's minds and there was an expectation of more to come.

It fell, though, to Charlotte Gherken (the PRA Director of Insurance Supervision) to sound a note of caution to annuity writers and reinsurers.

As the number of pension schemes targeting buy out increases, insurers keen to take advantage of this heightened but finite demand have expanded their capacity. As a result, the PRA have noted the increased risk appetite of annuity writers. This has included notably an increased interest in insuring deferred annuitants, which is inherently more risky due to the lack of certainty as to the longevity risk. Another issue is the acceptance of illiquid assets from schemes as part of in specie premiums, where the PRA sees insurers' increasing willingness to accept these as leading to increased reliance on third parties (such as property valuation experts) and increased complexity in transaction structuring, (e.g deferred premium structures giving schemes time to dispose of illiquid assets). The PRA went out of their way to say that they are not against this in principle, and that they do support innovation in structuring, but that there is a need for insurers to understand the additional complexity.

Referring back to the PRA's Thematic Review which is being carried out to assess bulk pension annuity writers' risk management processes, it is clear that insurers will need to be able to demonstrate to the PRA that they have robust internal processes to ensure that the additional risks of accepting such assets and entry into complex premium arrangements are understood and consciously accepted.

Charlotte Gherken also referred back to her speech last September about the emergence of funded reinsurance structures and the support being offered to annuity writers by the reinsurance market. The PRA's engagement with market participants and its focus on the contractual arrangements they are entering into have so far led them to identify several areas of particular interest:

• Recapture Events; concerns that recapture events linked to solvency coverage ratios or to other legal/regulatory events may bring uncertainty as to the circumstances in which cedent risks will be recaptured.
• Wrong way risk; the risk that the quality of a collateral portfolio may deteriorate if the financial condition of the reinsurer declines.
• Collateral management; credit rating, valuation issues and MA eligibility uncertainties may not be adequately mitigated by valuation haircuts and margining practices.
• Management actions; material uncertainty as to the costs and benefits of the various management actions open to insurers on recapture.

The PRA sounded a warning in relation to these long term transactions, stressing that with responsibility for pension payments stretching many decades into the future, insurers and the boards need to demonstrate that the risks can be managed over the whole term of the contract.

Additional supervisory measures

The PRA confirmed that they have accepted the government proposals on the range of measures which will create Solvency UK, which now needs to move towards implementation. These measures will include regular stress testing, the results of which will be published for individual firms. There is also going to be a focus on requiring senior managers to testify that the sufficiency of the fundamental spread on their assets will accurately reflect all retained risks, and an update on the MA rules to allow assets with highly predictable (rather than fixed cashflows to be eligible).

The PRA is working with industry groups on several of these measures, which it hopes will improve the quality of the measures, which will be consulted on in two tranches.

The Solvency UK package will bring a return to a more principles-based approach. The PRA argue that in an innovative market place, trying to codify prescriptive guidance requires constant iteration, and that such codification only allows for "one size fits all" rules. In practice that means, however, that great reliance will be placed on the Prudent Person Principle. For insurers this can lead to a lack of certainty, and potentially put senior managers and boards in a difficult position, where they are accused of bad management, when the position they have taken is actually a result of a difference of opinion/ judgment on matters where reasonable people can come to different conclusions.

Similarly, the use of attestations as a supervisory tool, can be problematic, where what is being attested to is a matter of judgement rather than a clear-cut matter of fact. Increased use of attestations will give some senior managers pause for thought (as the PRA clearly intend) and lead to greater reliance on external actuarial and legal advice.

The PRA consultation papers on the new rules will come out in two tranches, the first in June, the second in September. The June papers will be extensive, so insurers should be ready for some significant holiday reading.