PRA Proposes Tighter Capital and Risk Framework for Funded Reinsurance

The UK Prudential Regulation Authority (PRA) has published Consultation Paper CP8/26, setting out proposed reforms to the regulatory treatment of funded reinsurance under the Solvency UK regime. The proposals reflect a broader trend of increasing regulatory scrutiny of these arrangements and their potential implications for insurer resilience and financial stability. At a high level, the consultation signals a shift towards treating funded reinsurance more like direct asset exposure than pure counterparty risk.

This direction can also be understood in the context of the PRA’s focus on the increasing complexity of funded reinsurance structures and the practical challenges this can create for consistent supervisory assessment. The move towards more standardised and conservative capital treatments reduces reliance on firm-specific modelling and supports greater comparability across firms.

The emphasis on externally anchored credit assessments and a more differentiated treatment of collateral is also consistent with the PRA’s relatively conservative approach to private credit and other less liquid assets, particularly where valuation, transparency, and stress performance may be less certain. More broadly, the proposals indicate a preference for simpler, more transparent structures and counterparties whose risk profiles can be more readily assessed within the prudential framework.

Funded reinsurance, typically involving the transfer of annuity liabilities together with backing assets to a reinsurer, has become an increasingly important feature of the UK bulk purchase annuity (BPA) market. The PRA estimates that around 15% of new BPA business has recently been supported by funded reinsurance structures.

2. Key Proposals

The consultation introduces a series of targeted reforms aimed at improving risk sensitivity and reducing regulatory arbitrage:

a. Enhanced capital requirements
The PRA proposes to increase the level of capital that insurers must hold against funded reinsurance exposures. For typical transactions, capital requirements could rise materially, bringing them closer to those applicable to comparable asset holdings. 

b. Revised counterparty risk treatment 

A central proposal is to align the calculation of the counterparty default adjustment with the “fundamental spread” used for corporate bonds. This is intended to better reflect both default and downgrade risks associated with reinsurance counterparties. In effect, this brings the treatment of funded reinsurance closer to that applied to direct asset exposures rather than a pure counterparty risk framework.

c. Credit quality assessment framework

Insurers would be required to assign a credit quality step based primarily on the reinsurer’s financial strength rating, with limited upward adjustments (up to three notches) permitted for strong collateral arrangements. This approach reduces reliance on internal credit assessments and places greater weight on externally anchored measures of creditworthiness.

d. Definition and scope

The PRA proposes to introduce a formal definition of “funded reinsurance” and clarify the scope of application, including:

• Inclusion of arrangements backing annuity and capital redemption liabilities
• Exclusion of certain intra-group transactions and temporary arrangements linked to business transfers

e. Differentiated treatment of collateral

The proposals introduce a more risk-sensitive approach to collateral, with less favourable treatment for illiquid or structured assets. This reflects the PRA’s view that such assets may be more difficult to value or realise under stress conditions.

f. Recapture and liquidity considerations

The PRA places greater emphasis on the risks arising in a reinsurer default scenario, including the operational and liquidity challenges associated with recapturing assets and liabilities. These considerations feed into the overall calibration of capital requirements.

3. Timing and Transitional Measures

• Implementation date: This is expected 1 July 2027.
• Grandfathering: ArrangementsA where risks are fully transferred on or before 30 September 2026 would generally be excluded from the new rules.

These measures are intended to balance risk mitigation with minimising disruption to existing transactions.

4. Market Impact

The PRA expects the proposals to:

• Reduce reliance on funded reinsurance, particularly where driven by capital efficiency
• Increase capital requirements for new BPA transactions using such structures
• Encourage insurers to prioritise higher-quality counterparties and stronger collateral terms
• Have a potentially more noticeable impact on pricing and capacity at the margin, particularly for transactions that rely more heavily on funded reinsurance for capital efficiency

At a system level, the PRA notes that it considers that the reforms will improve the resilience of the UK insurance sector and reduce the risk of disorderly outcomes in stress scenarios. The proposals also reflect a broader focus on managing potential concentration and correlation risks associated with increased use of funded reinsurance.

5. Strategic Implications

Insurers and market participants should consider:

• The impact on capital planning and transaction structuring, particularly for BPA business
• Whether to accelerate or restructure transactions ahead of the September 2026 cut-off 
• Reviewing counterparty selection and collateral frameworks in light of stricter requirements
• Preparing for model changes and governance enhancements ahead of implementation

6. Next Steps

The consultation is open until 31 July 2026, with final rules expected thereafter. The PRA has indicated that it will continue to monitor market developments and may consider further measures if risks persist.