Invariably this means the majority would have been built in Excel, but with ever increasing data volumes, complexity in catering for many schemes and more runs required for analysis, these calculation engines are probably no longer fit for purpose and significantly increase the risks of mispricing deals through lack of controls, automation and openness of the tools.
To ensure Insurers are not taking on board unknown risks, there is still a window of opportunity to put in place robust, yet flexible, calculation processes that could minimise risk yet also increase the ability to analyse vastly more schemes.
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Are schemes able to get the support from the Employee Benefit Consultants (EBCs) to get prepared to go to market?
Demand for buyout
Let’s start with the first and most obvious area – capacity in the market due to increased demand to buyout. With many schemes coming to market, there are concerns over whether there is the capacity to deal with the demand. Some of the questions being asked are highlighted opposite.
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Do pricing teams have the capacity to price and onboard the deals?
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Are insurers able to originate the required assets in the volumes assumed in pricing?
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Can administration teams cope?
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Are insurers’ risk management processes keeping pace with growth and expanding risk appetites?
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How much new business can insurers support with their existing capital levels? How might this impact on insurers’ reinsurance strategies and what impact may this have on pricing?
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What new challenges are created for insurers by potential ‘mega-deals’? Will we see more appetite for from schemes and insurers for multiple insurers to participate in the larger transactions?
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Does uncertainty around the final outcome of
the Solvency II regulatory reform process have implications for insurers’ asset strategies and pricing?
Are the right systems in place
Due to the nature of the market developing over a short period of time, companies not wanting to miss the boat, and large-scale regulatory changes such as SII and IFRS17, lots of insurers would have built up their pricing and analysis tools initially on a ‘side of desk’ approach.
The details of the MA reform package are only likely to become clear when the PRA consultation is published in September. But the high-level direction of the regulatory reforms have already been set by
the government:
The reform of the UK’s implementation of Solvency
II into a tailored Solvency UK system is now well underway. It is likely to have significant implications for many aspects of UK life firms’ regulatory solvency framework. In particular, changes to the Matching Adjustment (MA) rules could have significant implications for insurers operating in the bulk
annuity market.
Solvency UK reforms
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Insurers will be granted greater investment flexibility than is the case under the current MA rules, and this could substantially widen the MA investment universe.
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Conversely, the PRA will be granted new powers to use in supervising insurer’s MA investment strategies, ensuring this greater investment flexibility does not have any negative consequences for policyholder security.
These reforms are therefore likely to create new investment opportunities and some new regulatory costs for insurers (see our previous blogs on
Internal Securitisations and Solvency UK and
The Fundamental Spread and the PRA's new supervisory tools). On balance, we don’t expect this
to have a significant net impact on the capacity
within the market or on pricing of buyouts.
The letter also explained that the review had identified key risks relating to the quality of collateral, how well it matched the ceded liabilities, and the extent to which firms would be able to transform the
re-captured collateral portfolio into an MA-eligible asset portfolio in the stressed market conditions that would likely accompany recapture.
The PRA sent a letter to the Chief Risk Officers (CROs) of UK life firms on 15 June sharing the findings of their thematic review of funded reinsurance arrangements. The letter noted the growing
appetite for funded reinsurance (i.e. quota share)
in the BPA market and highlighted areas where the PRA considered that the expectations set by their supervisory statements were potentially not being met, stating “we need firms to take actions to improve the way in which they manage the risks in these transactions if they plan to participate in this market”.
PRA letter on use of funded reinsurance in BPA market
Some of this is undoubtedly due to the significant changes in financial markets during the summer and autumn of 2022, which led to rapid changes in schemes’ funding levels and tougher conditions for consolidators to demonstrate that their proposals are consistent with The Pension Regulator’s (TPR’s) gateway principles. It remains to be seen whether
the slow progress to date is purely market-driven,
or possibly symptomatic of any lack of trustee and sponsor appetite for such alternative risk transfer transactions.
We are seeing interest from other parties to enter the market and this is very positive in terms of the market coping with constrained capacity. However, there are questions about the barriers to entry in this already mature market. Indirect entry by offshore reinsurance entities is also a growing trend.
There has always been significant interest from life insurers in being a key player in the BPA market as this is a key area of growth in an otherwise relatively unexciting market. The current surge in new business volumes is further amplifying the interest from potential new market entrants.
New entrants
While stress testing and scenario analysis are useful tools, running exercises that also consider behavioural and people risks helps to ensure a more robust approach to building and enhancing resilience.
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What impacts could AI bring to bear on insurers
and their competitors now and in the future?
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How might interconnected risks and incidents
impact on continuity?
Closely linked yet wider ranging is the need for a considered and iterative resilience strategy. While regulatory obligations may be well under control, have insurers considered more operational considerations or future risks that could impact their continuity and resilience?
Cyber and information security has been a very hot topic for a while. But the recent Capita cyber-attack - which is said to have included the personal data of over 300 pension schemes – has return the topic to the forefront of the sectors mind. Couple this with increased demand and capacity issues, pension trustees need to understand what cyber risk management is in place at the insurers, and insurers need to ensure that their cyber risk management framework is robust.
Cyber and resilience testing
Is cyber risk management led from board level?
Are there robust governance mechanisms built-in
to manage the four key pillars of people, process, technology and leadership? Is cyber resilience embedded across all levels of the organisation,
not just at an IT level?
In the ’alternative risk transfer‘ market (including superfunds and other capital-backed solutions),
2022 might be characterised as a year of unfulfilled expectations. Over a year since Clara-Pensions completed its regulatory assessment, it was disappointing to see the commercial consolidation market struggle to get off the ground with a first transaction.
In particular, the letter explained that the PRA was mindful that counterparty credit risk may not be being adequately modelled in firms’ internal models. It called for more sophisticated modelling approaches to be developed for counterparty credit risk (such as full look-through modelling of collateral portfolios in internal models).
Both insurers and schemes need to balance speed with risk. The Prudential Regulation Authority (PRA) has warned the sector not to ‘over indulge’ in new business and to exercise moderation in the short term. However, insurers will not want to miss out by being overly cautious, and new business volumes have the potential to become a source of tension
in some firms’ supervisory relationships.
With key functions such as administration being outsourced this does mean that operational resilience should be well tested.
The increase in new business volumes will create space for new entrants to the BPA market, and our recent article discusses the opportunities and challenges for insurers entering the BPA market for the first time.