New PRA rules will force insurers to reassess counterparty exposure

A new framework introduced by the UK’s Prudential Regulation Authority (PRA) for funded reinsurance could force insurers to be more selective in choosing their reinsurance partners and potentially reduce exposure to individual counterparties, Ramesh Indran, managing partner (Insurance) at consultancy 4most, told Monte Carlo Today.

The PRA’s new framework for funded reinsurance was introduced amid concerns that insurers underestimate the complex risks associated with funded reinsurance and rely too heavily on such arrangements.

The changes will significantly tighten the risk management requirements for UK life insurers. Insurers must set internal investment limits that consider the potential impact of an immediate recapture, and they are required to strengthen their collateral management policies, especially when dealing with illiquid assets. The framework also calls for comprehensive recapture plans that must be approved by the board.

In addition, on the modelling side, insurers are now expected to conduct more rigorous assessments of counterparty default risk within their internal models. When entering into new reinsurance agreements, they must carry out thorough quantitative risk assessments and ensure that minimum guidelines are in place for the contractual features of these deals.

“These changes reflect the PRA’s concern that some insurers might be underestimating the complex risks associated with funded reinsurance or relying too heavily on these arrangements. The new framework is designed to ensure that insurers fully understand and effectively manage these risks, with strong governance practices in place,” Indran said.

He notes that the changes are likely to increase operational complexity and costs. “Insurers may need to adjust their reinsurance strategies, potentially reducing exposure to individual counterparties. While aimed at enhancing stability, these requirements may challenge insurers to balance compliance with maintaining market competitiveness.”

The result will have an impact on how UK insurers buy reinsurance. They will need to be more selective in choosing their reinsurance partners, conducting thorough risk assessments to ensure they meet the stricter internal investment limits and enhanced collateral management practices now required. 

“The emphasis on comprehensive recapture plans and better modelling of counterparty default risks means that insurers may need to adjust their reinsurance strategies to align with these new expectations. Ultimately, these changes aim to help insurers manage the complex risks associated with funded reinsurance while staying competitive in the market,” he said. 

To meet the new PRA requirements, UK insurers will need to make several important adjustments. First, they’ll need to establish metrics that accurately set internal investment limits. “These metrics should be calculated independently of any management actions to ensure the integrity of the information used in decision-making,” Indran explained. 

“We can expect a more cautious approach to reinsurance.”

When it comes to collateral policies, insurers must ensure that their strategies don’t jeopardise the overall stability of their business, especially in relation to recapture plans. “It’s crucial that they fully disclose any illiquid assets backing funded reinsurance transactions and have a clear plan in place for recapturing those assets if they can’t be easily sold.”

In relation to recapture plans, insurers should include, at a minimum, clear guidelines for monitoring the financial health of their reinsurers, a detailed strategy for recapturing all assets and liabilities, and an identification of any vulnerabilities in the recapture process.

“The new regulations have indeed raised the bar for UK insurers, setting higher standards for managing volume and risk in funded reinsurance transactions. As a result, we can expect a more cautious approach to reinsurance moving forward. 

“While this may reduce some of the flexibility insurers have had to date, it aims to enhance overall risk management rather than limit genuine risk transfer. The focus is on ensuring that insurers fully consider and manage the complex risks associated with these arrangements,” he concluded. 

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