Bermuda: Will Brexit Affect The Volume Of Long-Term Business Premiums Ceded To Bermuda?

Last Updated: 25 October 2016
Article by Mark Chudleigh

The volume of life reinsurance premiums has recently soared, particularly business ceded from UK long-term insurers. Bermuda has been well-placed to benefit, but could things be about to change?

There are several drivers for the recent rise in life reinsurance premiums.

Under European Solvency II, in calculating their technical provisions for policies, long-term insurers must include a risk margin for unhedgeable risks such as longevity risk (the risk that beneficiaries and assureds survive longer than expected).

The calculation of the risk margin is acutely sensitive to changes in interest rates, something which has been identified by industry groups, rating agencies and the UK Prudential Regulatory Authority as of questionable suitability. As has been observed in the industry press, the decision of the UK electorate that Britain should leave the European Union has only exacerbated the situation by bringing in its wake Central Bank reductions in benchmark interest rates (including negative interest rates in some jurisdictions).

The risk margin is reduced to reflect reinsurance of the policies, where the reinsurance meets the relevant risk mitigation eligibility requirements of Solvency II. This means that European long-term insurers, particularly those with annuity exposure (which includes UK insurers in particular), have more incentive to reinsure.

Some UK long-term insurers are reported to reinsure 75-90 percent of their longevity risk (Source: Financial Times, 'UK fears that rules harm insurance competition', 7 February 2016).

Solvency II has also induced some European long-term insurers to withdraw from the bulk annuities market, hitherto an important market for pension trustees seeking to de-risk their longevity exposure under defined benefit schemes.

This means that the longevity strain on the trustees of defined benefit schemes, already severe, has only worsened in the post-Brexit, low yield era, resulting in an uptick in demand for techniques, such as pensions buy-outs, buy-ins and longevity swaps, to transfer longevity risk to external risk takers.

As a jurisdiction with a supervisory system that has (since 24 March 2016) enjoyed a confirmed status as equivalent to Solvency II, Bermuda has been a notable beneficiary of these developments.

Bermuda is home to a substantial number of commercial insurers licensed to carry on long-term business, including segregated accounts companies that have been used in a number of innovative longevity-related transactions to transform derivative risk into reinsurance risk.

However, the continued application of the Solvency II risk margin to UK long-term insurers is uncertain, as the UK begins to explore the possibilities for change to domestic regulation opened up by Brexit negotiations. On 13 September 2016, the UK Parliamentary Treasury Committee agreed on the terms of reference for an inquiry into Solvency II. The objectives include an assessment of the impact of Solvency II on the competitiveness of the UK insurance industry. One of the factors identified in evidence to the Committee as ripe for change (if change proved to be consistent with the UK's post-Brexit strategy) is the Solvency II risk margin calculation. It will be the job of the Committee to consider the extent to which the risk margin harms the competitiveness of UK long-term insurers (for example, by inducing them to cede a disproportionate volume of premium in reinsurance).

One can only speculate about the prospects of the committee's conclusions leading to regulatory change in the UK. This will depend on, among other factors, the terms on which the UK leaves the harmonised insurance regulatory framework of European Union (if indeed it ever does).

Furthermore, whatever changes to the risk margin calculation ensue, they will not affect UK pensions trustees (who are not subject to Solvency II), or trustees and plan sponsors in other jurisdictions, whose demand for longevity de-risking will continue un-dinted for so long as the low-yield environment prevails. And, with or without a change in the calculation of the risk margin, longevity risk will remain on the agenda for UK long-term insurers for some time to come.

But it is possible that the recent peak in reinsurance premiums ceded by UK long-term insurers will be short-lived.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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