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UK: PRA publishes Consultation Paper 3/19 “Solvency II: Longevity risk transfers-simplification of pre-notification expectations”

On 5 February 2019, the Prudential Regulation Authority (PRA) published Consultation Paper (CP) 3/19, which proposes to update Supervisory Statement (SS) 18/16 “Solvency II: longevity risk transfers” to simplify the pre-notification requirements for longevity risk transfers and update the key risks the PRA considers arise from longevity risk transfers.

Since Solvency II came into effect the PRA has closely monitored longevity risk transfers to ensure that the transactions are for reasons of genuine risk transfer, as opposed to a means of balance sheet manipulation to reduce the risk margin applying to liabilities which may not benefit from transitional measures. For further information on this topic see our earlier blog post here.

The PRA’s current approach under SS 18/16

At present, the PRA expects to be notified in advance of signing all longevity risk transfer and hedge arrangements, however there is no standard form which firms can use to notify the PRA of its intentions to enter into a transaction.

The PRA also requires firms to detail their proposed approach to risk management before the transaction’s completion. In SS18/16 the risks that PRA has explicitly stated should be detailed in their longevity risk mitigation measures are limited to counterparty default risk and concentration risk.

The proposed updates under CP 3/19

Under CP3/19 the PRA proposes to amend SS18/16:

  1. to reduce reporting burdens for any transaction which is not categorised as “large and/or complex”; and
  2. to ensure that firms should include the basis risk between the terms of the annuity contract and those of the risk transfer in their risks management frameworks.

We examine each of these proposals below.

1. Reduce Reporting Burdens:

The CP differentiates between the pre-transaction notification requirements expected by the PRA for “large and/or complex transactions”, and other transactions.

For “large and/or complex transactions” the pre-notification process as detailed in SS18/16 will continue to apply. For other transactions, the pre-notification process will be simplified by allowing the firm to report to the PRA via a template found in the CP here. For transactions not considered “large and/or complex”, it is proposed that the firm no longer needs to notify the PRA of the transaction before it has taken place, instead the template may be submitted shortly after the reinsurance has been placed.

Transactions which will be considered “large and/or complex” are those which:

  • have a value/ financial impact larger than a typical transaction on a business as usual basis;
  • have a structure that is more complex than business as usual transactions (for example, where the risk transfer is structured using instruments less tested in the market such as insurance linked securities, or by the firm, such as automatic reinsurance pools); or,
  • have a material incremental impact on the firm’s ability to meet its Solvency Capital Requirements under Solvency II.

The proposals contained in the CP seem like a beneficial development for firms as they will reduce the reporting burden for business as usual longevity transactions. This was something that firms and other market participants had commented on in their evidence to the Treasury Committee’s inquiry into EU insurance regulation during 2017.

The PRA note that any risk posed by the reduction in early notification by firms will be mitigated by the fact that the proposal does not reduce reporting requirements for “large and/or complex transactions”, as well as the ability of the PRA to explore transactions notified by the template further if the PRA deems it necessary. This ability of the PRA to request additional information always existed, but at least for firms undertaking transactions which are not “large and/or complex” this information will now not need to be provided prior to entering into the transaction, thereby reducing the burden on firms for business as usual transactions.

2. Inclusion of Basis Risk in Longevity Risk Management Frameworks

The CP updates SS18/16 to highlight a requirement to include consideration of the firm’s basis risk when assessing the residual risks that a longevity risk transfer and hedge arrangements can bring about. Whilst the PRA expects the basis risk between the terms of the annuity contract and those of the risk transfer to be included in firm’s risks management frameworks under the current risk management requirements, these proposals aim to clarify that expectation.

The consultation closes on Monday 6 May 2019.