A new discussion paper from regulators seeks input on ways to expand capital sources for UK insurers.
Business is booming for UK life insurers in bulk purchase annuities (BPAs), as pension plans continue to transfer risk. That’s been good news for insurance sales, but it also intensifies the search for capital to back those liabilities and fund growth. To tackle the issue, the Prudential Regulation Authority (PRA) is seeking to revamp regulation that stifles innovation in alternative capital access.
Big Annuity Business, Big Capital Needs
All told, UK life insurers hold over £2 trillion in assets, including about £350 billion backing annuities, and bulk annuity volumes could reach £1 trillion over the next decade. Tapping traditional equity to support those liabilities has become pricey, evidenced by lofty dividend yields on FTSE 100 life companies, and there’s limited support from public investors for long-term guaranteed liabilities.
Insurers are leaning more heavily on reinsurance, strategic partnerships and credit-risk transfers to manage capital needs, but there are natural capacity limits. Recognizing the issue and seeking to support sustainable UK economic growth, the PRA has released a discussion paper seeking market feedback on capital needs, viable structures and supervisory safeguards. The PRA notes that “a thriving and innovative UK life insurance sector has a vital role to play” in sustainable growth.
Tackling a Capital Mismatch with Diverse Structures
The PRA highlights a mismatch between insurers long liabilities, which require “patient capital,” and investors’ shorter lenses with more performance sensitivity. That’s a conundrum for life firms doing business in long-term annuity blocks and pension risk transfers, among other venues. Alternative capital can help, and support the transfer of credit-risk concentrations in matching-adjustment portfolios and providing capital sources for mutual insurers, which can’t access public equity markets.
The PRA has reviewed several structures. Insurance-linked securities and insurance special purpose vehicles have been well-tested for short tail risk from general insurance catastrophes. However, without regulatory reform they aren’t suited to longer-term life risks. Banking significant risk transfers involve synthetic securitizations that off-load credit risk while banks retain asset ownership, an approach that may inspire comparable life insurance structures. Life reinsurance sidecars and joint ventures, widely used internationally, afford investors structured exposure to blocks of assets and liabilities.
A Principles-Based Framework for Evaluation
Because every alternative capital-raising structure has its own nuances, benefits and risks, the PRA asked stakeholders for feedback on six high-level principles to serve as a framework for evaluating individual transactions:
1. The quality and quantity of capital required to support insurance risks should not be lowered through the use of alternative life capital structures.
2. The risk transferred to the capital markets through alternative life capital structures should be contractually-bounded and time-limited.
3. Cedants will need to manage tail and residual risks resulting from their use of alternative life capital structures.
4. Alternative life capital structures should predominantly result in capital relief, not balance sheet financing.
5. A level of risk retention by the insurer is necessary in any such structures and the UK insurer should only make limited use of alternative life capital structures.
6. The alternative life capital structures should not alter the control a UK cedant has over the management of its business.
The PRA initiative is still in the discussion paper stage, but its interest in the topic signals a willingness to provide UK life insurers with greater flexibility to pursue new paths to capital, partnering with asset-management firms that have the expertise to deploy private credit, real assets and alternative-risk capital directly against long-term liabilities. It could also better position insurers to invest in productive UK assets—bringing government, insurer and investor priorities into alignment. The working paper also signals an openness to life insurance sidecars and structured partnerships, validating approaches already used in the US and Bermuda.
In pursuing these deals, insurers will likely have criteria for capital providers. These include understanding the risks and being able to effectively underwrite, as well as knowledge of UK regulation, particularly the matching adjustment. Patient capital that doesn’t require a three- to five-year exit will be key, as will the ability to manage private insurance assets. Also likely to be among the criteria? A global network of similarly minded co-investors with access to more and more diversified capital sources; a network of supporting M&A advisors, banks and reinsurers; and experience in different jurisdictions.
The PRA doesn’t have rules in hand yet for alternative capital arrangements, but it seems clear that the working paper is an early step toward broadening the capital sources for UK life insurers.
