On 9 February 2016 the Prudential Regulation Authority (PRA) published a letter1 setting out its views on the general issues arising from longevity risk transfers (LRT), including its expectations of UK insurers and reinsurers carrying out these transactions as either the buyer or seller of longevity protection.
What is LRT?
Longevity risk is the risk that actual survival rates and life expectancy of policyholders, pension scheme members or other beneficiaries will exceed expectations or pricing assumptions, resulting in greater than anticipated retirement cash flow needs.
The need to manage longevity risk has come to the forefront as insurers have increasingly become aware of their exposure to longevity risk and, the PRA recognises that the Solvency II Directive (2009/138/EC) (Solvency II) may provide an added incentive for firms to transfer longevity risk using reinsurance.
The PRA is concerned that insurers utilising LRTs may expose themselves to significant levels of counterparty risk by entering into LRTs with a single or small number of counterparties and accordingly, that capital held under the solvency capital requirement in relation to counterparty default risk with respect to LRTs may not be adequate to mitigate the risk. Furthermore, the PRA notes that additional mitigating measures may be necessary. In that note, the PRA reminds firms of their regulatory obligations with respect to risk management, particularly under Solvency II, relating to monitoring, managing and mitigating concentration risks.
The PRA rules on concentration risk management are particularly relevant in such circumstances, which can be viewed at http://www.bankofengland. co.uk/pra/Documents/solvency2/ insdirectorsletter11nov2015.pdf.
What you need to do
- Work with your PRA supervisors early on. The PRA expects to be notified of proposed LRTs well in advance of their execution.
- Prepare a thorough risk management strategy that will satisfy the PRA’s scrutiny.
- Make sure the transaction has a clear rationale that is consistent with the firm’s risk management principles.