The Bank of England (BoE) has warned insurers to be cautious about the risks of bulk annuities, as the market for these products continues to grow.
Bulk annuities are used by pension schemes to transfer their liabilities to an insurance company. This can be a way for schemes to reduce their risk and improve their financial position.
However, the BoE said that insurers need to be aware of the risks involved in bulk annuities, such as the potential for longevity improvements and changes in interest rates.
The BoE said that insurers should only take on bulk annuity business if they have the necessary capital and risk management capabilities.
The BoE’s warning comes at a time when the bulk annuity market is growing rapidly. In 2021, the total value of bulk annuity deals reached a record £35 billion.
The growth of the bulk annuity market is being driven by a number of factors, including the increasing number of pension schemes that are looking to de-risk.
Pension schemes are also being attracted to bulk annuities by the low interest rate environment, which makes them more affordable.
However, the BoE’s warning is a reminder that bulk annuities are not without risk. Insurers need to be aware of the potential for longevity improvements and changes in interest rates, which could make these products more expensive.
Insurers also need to make sure that they have the necessary capital and risk management capabilities to take on bulk annuity business.
The BoE’s warning is likely to lead to some insurers taking a more cautious approach to bulk annuities. However, the market for these products is still expected to grow in the coming years.
Aon welcomes PRA’s engagement
Aon has welcomed the Prudential Regulatory Authority’s (PRA) engagement with the bulk annuity market.
Martin Bird, senior partner and head of risk settlement at Aon in the UK, said: “We are reassured that the PRA is very much alive to the current state of the market and its level of rapid growth, and is encouraging a robust debate on how best to maintain market discipline.”
Bird said that there was no doubt that the insurance sector was experiencing a period of accelerated growth, as many schemes had continued to benefit from the trend of steadily increasing funding levels and were now close to or at a position of being fully funded on a buyout basis.
“This comes at a time when the insurance market has increased capacity to handle this demand, and with insurer balance sheets showing record high solvency positions at the recent round of year-end results,” he said.
But while many schemes were now targeting buyout as the ultimate endgame, he said, there were many considerations to address before making the decision to execute an insurance transaction.
“This includes understanding the differences between the pensions and insurance regulatory regimes, assessing both the existing sponsor covenant and the insurance company covenant, and undertaking a detailed comparison of the relative risks to members’ benefits of deciding to proceed with an insurance transaction or instead to run the scheme on,” Bird said.
On top of this, he continued, for some schemes, buyout might give members or sponsors their only chance to access surplus – which he said was another important consideration.
Bird said that Aon welcomed the PRA’s engagement with the market and its focus on ensuring that the right safeguards were in place to protect policyholders.
“We believe that a robust debate on these issues is essential to ensure that the market continues to develop in a sustainable way,” he said.