The Bank of England’s Prudential Regulation Authority has proposed changes to the use of funded reinsurance, which is used by insurance companies when completing a buy-in of a final salary pension scheme using a bulk purchase annuity (BPA) policy.

In order to complete these large deals — involving billions of pounds of savers’ retirement money — the insurance company has to promise to pay the pensions of scheme members both now and in the future.

This is where the insurance company turns to funded reinsurance, a form of offshore finance.

The finance is used to guarantee future pension payouts to savers in the scheme, while the offshore firm profits from the sell-off of UK pension funds in exchange for guaranteeing bulk annuity payouts.

Funded reinsurance involves UK life insurers in the BPA market paying a large upfront premium to an offshore reinsurance counterparty.

That counterparty will invest this in assets to fund future payments to the insurance company, but the assets do not need to be compliant with UK standards, while the offshore entity will still be able to access assets held via the UK insurer.

The PRA’s proposed changes mean that from October 2026 insurers using funded reinsurance arrangements as an asset strategy will need to hold significantly more capital — increasing to around 10 per cent of annuity liabilities from the current 2-4 per cent.

Many reinsurers are linked to North American private capital groups and the Financial Times — FT Adviser’s sister publication — has reported that Apollo, Brookfield and Blackstone, which have a large presence in the Bermuda insurance market, were big players in the UK funded reinsurance market.

The FT also reported that some of the largest UK insurers had conducted billions of pounds’ worth of these deals. 

In 2023, FTSE 100 insurer Legal & General completed £3.2bn of funded reinsurance, while Phoenix Group — now Standard Life — did £1.2bn and Pension Insurance Corporation undertook £1.3bn.

Risk of reinsurance

The PRA first issued an advisory note in January last year in which it said it could foresee an “endemic risk” in using insurance cash from foreign companies to pay out pensions.

The notice was sent to insurance companies, which were told the PRA was concerned about an increase in the use of funded reinsurance.

The PRA’s 2025 life insurance stress test also showed there was a risk with a meaningful impact on life insurers’ solvency positions if the use of funded reinsurance continued to grow.

The PRA said UK life insurers will have completed £40bn of funded reinsurance deals by the end of the year, and it estimates the amount will grow to £110bn during the next 10 years.

In its advisory note last year the PRA said funded reinsurance was coming from companies whose origin was not always clear and “who may be more exposed to a range of illiquid investments including through private asset origination capabilities of affiliated alternative asset managers”.

UK plc to benefit

Martin Rayner, managing director and chartered financial adviser at Compton Financial Services, said if a reinsurer failed, the UK insurer would still remain liable for those pension payments although they would have a thinner buffer to absorb losses. 

He said: “In a worst-case scenario, this could push the insurer into difficulty, ultimately landing costs on the Financial Services Compensation Scheme, which is funded by levies on the wider financial services industry.”

He said the PRA’s proposals would shift more responsibility back onto insurers, better equipping them to absorb losses directly and reducing the chance of problems spilling over to the FSCS or the broader market.

“Overall, it should lead to a more resilient insurance sector, [with] fewer incentives to favour funded reinsurance over direct UK investment.”

“The regulator is now saying, ‘You can still pass some of the work to a reinsurer, but you must keep more of your own money set aside in case it goes wrong’.”

Rayner said there may be some other consequences of the proposed change.

One possible outcome is a reduction in the number of BPA deals. LCP projected that more than £350bn of assets will be transferred from pensions schemes to insurers during the next decade. 

He said: “It ties up capital for the insurer so they can’t do as many deals. Typically this is why having capital set aside is not popular.

“The new rules make each deal more resource-intensive, which may reduce their use.”

Rayner also predicted that insurers may decide to retain more risk domestically.

“That could support greater direct investment by UK insurers, which would be a positive for the UK economy.”

Solvency UK

James Silber, a partner at pensions consultancy LCP, also predicted that insurers looking to finance a buy-in BPA deal may diversify into alternative asset strategies, although it was not clear what those may yet be.

He said: “We welcome the PRA’s proactive focus on an area it sees as a potential source of risk to insurer resilience, particularly against systemic risks.

“We expect the proposals to lead to a moderation in the use of funded reinsurance from October, given the greater capital insurers will need to hold.

“Funded reinsurance is likely to remain a part of the toolkit, potentially with changes to the structures and counterparties, but we also expect to see insurers diversify into alternative asset strategies to optimise pricing.”

Stephen Purves, partner and head of risk settlement at XPS Group, said: “Funded reinsurance has been used selectively by some of the BPA insurers in recent years to help scale up volumes of new business in the bulk annuity market.

“Therefore, in itself, the BoE’s announcement relating to the additional capital requirements around funded reinsurance could reduce capacity and result in small price increases in the market.”

Sam Woods, deputy governor for prudential regulation and chief executive officer of the PRA, said the proposals would protect pensioners and improve insurers’ incentives to invest directly in the UK economy.

The PRA also added that the proposed capital requirements, which are part of Solvency UK, were more advantageous than the capital requirement of 11 to 15 per cent for equivalent assets if they were held by an insurer. 

“Funded reinsurance is growing rapidly and has the potential to undermine the resilience of insurers if not managed properly.

“Today’s proposals aim to iron out the discrepancy in the regulatory treatment for these deals, to protect pensioners and improve insurers’ incentives to invest directly in the UK economy.”

The PRA said proposed changes build on the introduction of Solvency UK, which significantly cut red tape for insurance firms and removed barriers to invest in productive assets to support UK economic growth. 

How does a buy-in work?

Rayner explained: “Imagine a company with a final salary pension scheme wants to remove the responsibility of paying pensions.”

Step 1: The pension scheme pays an insurance company to take on the responsibility of paying members their pensions for life. At this point, the insurer becomes fully responsible.

Step 2: The insurer then passes some of that risk on to another company — the reinsurer. The reinsurer takes a large upfront payment and agrees to help fund future pension payments.

Where the problem lies: If everything goes well, there is no issue. But if the reinsurer runs into trouble, the insurer must still pay all the pensions, despite having less of a financial cushion to absorb the shock.

Samantha Downes is a freelance journalist