Bank of England plots reinsurance stress tests amid fears of hidden risks

The Bank of England has said it is mulling whether “further measures” are required to shore up major insurers today, amid reports it is preparing stress tests the market’s exposure to offshore reinsurance firms.

The Financial Policy Committee (FPC), which leads the Bank of England’s work on financial stability, said last year it would “keep under review” whether the so-called funded reinsurance market would be included in the year’s insurance stress tests.

The market has been transformed by a flurry of deals between corporates and major life insurers as firms look to offload their pension liabilities. Rising interest rates have boosted the funding position of pension schemes and allowed companies to shift them off their own books in buy-in deals.

However, insurance firms themselves are now offloading some of those liabilities onto reinsurance companies based in markets like Bermuda. The Bank’s financial policy committee warned in a December document that a “rapid growth in volumes and complexity of these arrangements could generate risks in the future”.

The Prudential Regulation Authority, which governs the insurance market, is now preparing to probe the market with stress tests that model the impact of a failure in their funded reinsurance arrangements, the Financial Times reported, citing people familiar with the matter.

“We will continue to monitor how market practice evolves in relation to funded reinsurance and will keep under review whether further measures are required,” a spokesperson told City A.M.

The potential situations modelled by the regulator could involve the collapse of a reinsurer being used by an insurance company, the FT reported. 

A collapse of a reinsurance firm would mean that the insurance company would be suddenly forced to absorb the liabilities again. In its December document, the FPC said that such a situation would mean insurers need to take control of “large portfolios of assets which may not be sufficient to back their long-term liabilities”, while also having to set aside capital for risks they had previously passed on. 

The potential stress tests come ahead of an expected explosion in the bulk purchase annuity deals, which the FPC said in December could top £500bn in the next decade.

“Such greater use would bring an increased risk of a large-scale funded reinsurance recapture event, in the event that a reinsurer failed,” the FPC said.

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