Craig Turnbull and Rosie Fantom
The bulk purchase annuity (BPA) market has been extremely resilient to changing economic conditions. Demand remains high, but continuing regulatory focus and the changing longevity views require insurer focus over 2025.
2024 saw the continuation of the momentum from 2023, with a record number of transactions completed. More notably, while 2023 volumes were driven by larger transactions, 2024 saw a thriving market for small to medium schemes, with significant growth in insurer appetite to provide solutions for schemes at this size.
Gilt yields have continued on their upwards trajectory this year and whilst credit spreads have remained tight, the ability of insurers to adjust asset strategies and higher levels of hedging in pension schemes has meant pricing and demand remain strong.
There was also a shift in the provider landscape, with Rothesay's acquisition of Scottish Widows' back book (subject to Court approval), and a number of new entrants joining the BPA market (Royal London, Utmost, M&G and Brookfield).
2025 is likely to see further entrants to the market. Last year we also saw Clara Pensions complete superfund transactions with Debenhams and Wates Group. With the number of new participants in the market and the range of solutions for risk transfer increasing, we can expect to see greater competition and continued growth in this space over the coming year.
Regulatory environment
Following the unprecedented growth in the BPA market and the expansion of insurers' matching adjustment (MA) portfolios, the PRA has continued to strengthen its supervisory focus on this area.
The publication of the policy statement PS10/24 in June introduced a number of changes relating to the MA. This included a requirement for firms to provide an attestation that the benefit from the matching adjustment is appropriate. The MA attestation is intended to improve firms' risk management around the calculation of the MA and is required for the 2024 year-end reporting.
The MA is a core part of the regulatory capital requirements for BPA insurers, and it can be very beneficial for insurers, significantly reducing the amount of capital they are required to hold. Most firms' MA portfolio has evolved to consist of highly illiquid and hard to value assets. As these assets are not rated by external credit rating agencies, the rating and valuation of these assets rely on firms' internal models. The MA attestation process may result in some firms reducing the MA benefit they claim on such assets, though we do not expect these reductions to be material to the overall level of MA benefit produced by MA portfolios.
On the other side of the regulatory reform coin, PS10/24 permits some new forms of investment flexibility for assets in MA portfolios. This may result in increases in some types of assets such as callable bonds and asset-backed securitisations in MA portfolios in 2025.
Longevity models
Demand for longevity swaps remains high, but predominantly from insurers looking to manage the risks associated with their bulk annuity business written.
Longevity assumptions play a vital part not just in longevity swaps, but also for BPA firms as a whole, both from a pricing perspective as well as on the reserving/cash flow matching side.
The Covid pandemic has been a particular challenge to setting longevity assumptions in recent years. Responses to previous CMI consultations have shown that insurers have been more cautious about reducing life expectancy assumptions than pension schemes. The CMI's imminent proposals for CMI_2024 should provide a clearer way to reflect the impact of the pandemic and that, together with the relatively low mortality seen in 2024, may help to narrow that the gap in views.
Pension schemes are needing to consider how data can help secure attractive pricing. For example, good quality death experience data covering a period at least six years so that there is a good volume of data even if the period at the height of the pandemic is ignored.
Funded Reinsurance
Funded reinsurance (funded re) is a quota share reinsurance contract which transfers asset and liability risks on an annuity portfolio to the reinsurer. Funded re contracts differ from typical reinsurance contracts in that they are generally collateralised with a portfolio of assets.
The recent growth in the BPA market has in turn fuelled demand for funded re contracts as a tool for capital and risk management. Funded re allows insurers access to different ways of managing capital, and opportunities to expand the new business capacity, but they also introduce counterparty risks. Financial strength of the counterparty is a key consideration as is the collateralisation and the ease of access to these assets in stressed situations.
The increased use of funded re has raised some concerns with the PRA, including how the insurer would manage the recapture of the collateral assets in stress scenarios and the scale of exposure to a single counterparty. The PRA interest in UK insurers' use of funded re is naturally heightened by the fact that most funded re counterparties sit outside the jurisdiction of the PRA (often in Bermuda).
The last year has seen an influx of regulatory guidance and requirements in regard to funded re. In July 2024, the PRA released PS13/24, which introduces more stringent risk management strategies around funded re arrangements. In December, the Bermuda Monetary Authority (BMA) issued several papers in relation to funded re, including a white paper discussing the inherent risks and highlighting the need for international cooperation to ensure effective regulation and supervision of these arrangements. Last, but not least, the PRA have again demonstrated the continual focus on this area through the 2025 supervisory priorities letter to CEOs. This year, the regulator will require a funded reinsurance recapture scenario to be included in the 2025 life insurance stress test. This will mean that firms will have to provide more quantitative evidence to the regulator of their ability to absorb risks currently outsourced to reinsurers.
We do not currently expect these regulatory developments to materially diminish BPA firms' appetite to use funded re as part of their risk and capital management strategies. It is possible that the funded re pricing offered by reinsurers may see some tightening as a result of new regulatory constraints, and this could have some knock-on impact on insurers' pricing. We encourage pension scheme trustees and sponsors to consider how the use of funded re impacts on the risk profiles and business models of insurers (and we regularly provide advice on how these arrangements can impact insurers' financial strength through our insurer review offering).
In conclusion
2025 looks set to be a busy year across the pensions risk transfer space, particularly as insurers are dealing with increasing amounts of cases to price and also support post transaction. Adding in developing options like funded re and regulatory change into the mix, and it certainly looks like the year is going to be an interesting one as we help both pension schemes and insurers to manage important decisions and respond to change.
Craig Turnbull is partner and head of risk advisory and Rosie Fantom head of bulk annuities and risk transfer partner at Barnett Waddingham
