Pension funds understand how insurers look after the benefits of pensioners and deferred members in a bulk annuities deal, but do they understand how the sector is regulated? How can pension funds trust insurers for a buyout?

It appears that pension funds know little about insurance regulation, after hearing from mallowstreet’s Getting DB Buyout Ready Indaba event yesterday, when a pension trustee said some of the incentives from Solvency II are “potentially toxic to policyholders”. 

The reforms of Solvency II UK announced last year includes a reduction in the risk margin to support government initiatives, thus reducing the capital required for each insurer, which “are not in the interest of pension fund members”. 

“You let capital out of the system, that increases risk… And since when did pensioners agreed to take on more risk and support the incumbent UK government's economic policy aspirations?”

The speaker acknowledged insurance supervision is performed by the Prudential Regulation Authority, but the body is not directly accountable to policyholders. 

The presenter also noted no matter how much due diligence a pension fund has done on an insurer, there could be unexpected actions taken by the firm in the future. 

“An insurer can sell its business the day after you contract. The insurer can change its ESG standards. I'm not saying it will, but it can change,” said the expert, referring to the case of Prudential offloading its £12bn annuity portfolio to Rothesay, which eventually gained court approval in 2020 after original refusal in 2019.

These claims are all valid, but perhaps there is an initial misunderstanding about how insurance regulation works. 

Apart from Solvency II, which safeguards policyholder protection, insurers protect themselves by transferring their risk to reinsurers. In turn, reinsurers buy cover from retrocession and the insurance value chain goes on and on.

It is true that the PRA has long worried about firms reinsuring significant longevity risk abroad, but the Treasury concluded that cutting the risk margin by 60-70% would have “little impact” on levels of longevity reinsurance, although some might argue that this view is not disinterested.

Re/insurers provide information about their solvency to the regulator on a regular basis, but every year they also publish Solvency and Financial Condition Reports, which provide the general public with an overview of the company's solvency and financial condition covering business performance, its system of governance, the adequacy of its risk profile and a description of its capital management.

Despite all the effort of producing granular information at both group and entity levels, experts query the effectiveness of SFCRs as the public hardly understands these reports. Do pension fund trustees read them? Do they go to insurers if they have a query about their SFCRs?

In addition to Solvency II, this year, almost all re/insurers around the world have to adopt IFRS 17 and IFRS 9 for the first time. While the accounting change mainly concerns investors, the standards provide more disclosure, transparency and comparability of insurers’ accounts. The implementation of IFRS 17, the standard for insurance contracts, and IFRS 9, the standard for financial instruments, means that firms must make a clear distinction between profits that come from investments and those arising from insurance. 

The world’s largest insurers are also subject to the common framework for the supervision of internationally active insurance groups. ComFrame is a set of international standards focussing on the effective group-wide supervision of IAIGs.

One delegate argued that financial institutions rank junior to pension schemes, so in the event of an insurer’s failure, a pension scheme gets the first call on policyholders’ assets and any financial institution will have to wait for the scheme to be fully paid before claiming compensation. 

It is true that there have been troubles in the insurance sector in the past. Look at Equitable Life, which closed to new business in 2000 and transferred all its remaining business to Utmost Life in 2019-20. But simply because failures happened in the past, does it mean pension funds should not strike any more deals with insurers? 

If Solvency II, reinsurance, SFCRs, IFRS 17/9 and international standards are not enough to boost confidence from pension funds, what else can insurers do to convince them that they are not reckless investors?