The Bank of England’s Prudential Regulation Authority (PRA) is seeking to ensure that it has a sufficient level of oversight of the longevity risk transfer and reinsurance market as it evolves, stressing the need for transactions to feature a true transfer of risk.
In a letter published by the Bank of England, Chris Moulder, director of general insurance at the PRA, and Andrew Buller, director of life insurance at the PRA, explain the regulators desire to be kept informed of all longevity risk transfer transactions entered into by companies under its regulation.
The PRA’s letter says that it recognises that the longevity risk transfer market has been under development for a number of years, but that with the implementation of Solvency II there may now be “an additional incentive to undertake transactions to transfer longevity risk by way of reinsurance.”
Perhaps hinting that it does not want to see a jump in the use of longevity risk transfer as a way to improve a company’s capital adequacy under Solvency II, the PRA warns that entering into a longevity risk transfer transactions, such as a longevity swap or reinsurance deal, must be for the right reasons.
“We would be concerned if firms became active in this market for reasons other than seeking genuine risk transfer,” the letter reads.
The PRA and Bank of England is not just concerned about longevity risk transfer transactions which are entered into for reasons other than true transfer of risk, it also notes concentration risk among counterparties as a key concern.
Any insurer or cedent that enters into a transaction that transfers or hedges risk with a single or small number of counterparties could expose itself to possibly significant levels of counterparty risk, the PRA notes. Under Solvency II re/insurers have to manage their risks and report on them, as a result the PRA expects counterparty concentration risks to be among those managed and reported on.
However, the Bank of England also wants greater understanding and oversight of the growing longevity risk transfer market, saying that the PRA “Expects to be notified of longevity risk transfer and hedge arrangements and the firm’s proposed approach to risk management well in advance of completing such a transaction.”
This expectation applies both to the buyer and seller of longevity risk protection, the letter states, and as well as providing the regulator with much-needed oversight of the market would also enable it to better control and understand any counterparty concentration risks.
“This will enable supervisors to consider whether the risks of the proposed transaction are being appropriately managed and that the transaction has an underpinning rationale that is consistent with good risk management principles,” the PRA’s letter closes.
Oversight and control of a market under development, such as the longevity risk transfer and reinsurance market, is certainly important. In its letter the regulator is showing that it has noted the rapid growth in longevity risk transfer and that it expects this to continue.
However, some very large longevity swaps and reinsurance deals have been effected with relatively small panels of reinsurance capacity providers in the past, so it will be interesting to see what the Bank’s opinion of concentration risk is.
Longevity risk was a very attractive and sought after risk over the last few years, resulting in some large insurance and reinsurance players taking on significant amounts through major transactions. Of course the re/insurers do this with the understanding that it is diversifying versus their mortality books, a topic the regulator does not mention. It will be interesting to see whether the mortality to longevity diversification question gets raised by the regulator at some point in the future.
By seeking greater oversight and visibility of a developing market the regulator and Bank of England clearly notes its potential for further growth, as well perhaps as its concern that longevity risk transfer could be used under the Solvency II regime for the wrong reasons.