PRA will continue to challenge annuity providers

Annuity providers can expect continued intense regulatory scrutiny of their investment strategies and approach to the Matching Adjustment (MA), says Charlotte Gerken, executive director, insurance at the Bank of England/Prudential Regulation Authority.

“Annuity writers may rightly feel that they receive significant supervisory challenge from the PRA. This will not change, given the nature and importance of the annuity product, the significant judgements and assumptions that underpin the MA benefit available to firms, and the impact of annuity providers on our policyholder protection objective”, she told the virtual audience at last week’s 18th Bulk Annuity Conference.

She explained that the focus on asset risk in particular was justified by the volatility in investment returns. This does not mean the regulator is taking an overtly conservative approach to the range of assets it considers suitable to underpin bulk annuity portfolios but that it expects providers to demonstrate they fully understand the nature of the risks inherent in different assets.

“MA portfolios have increased since the start of 2018 by 30%, to around £335bn. The range of assets that firms hold in their MA portfolios suggests to us that Solvency II is not of itself a barrier to firms investing in a wide range of asset classes. We see everything from covered bonds to infrastructure; and social housing to restructured Equity Release Mortgages backing annuity liabilities. And whilst the majority of exposures are what might be deemed traditional annuity assets, such as gilts and corporate bonds, less liquid exposures as a proportion of the MA portfolios are large and increasing.

“The risk management of less liquid assets is of particular concern to us. Insurers may be sole or significant investors in specialised lending and will require a commensurate level of expertise to assess, maintain and potentially work-out such assets.”

During the past pandemic-constrained year there has been relatively little in the way of novelty among the assets held in a typical MA portfolio, although individual providers have become more adventurous, she said. The challenge the PRA will put to chief investment officers and boards is to demonstrate that they fully understand the nature of the less liquid assets they might want to include in an MA portfolio.

“Over 2020, we saw very few applications for asset classes not already held in peer MA portfolios, instead seeing firms applying to invest in less liquid asset classes such as ground rents and ERMs. While the asset classes may not be new to us, firms can expect to be challenged when investing in asset classes that are new to them.”

The PRA continues to hold to its sceptical approach to providing incentives to support politically desirable investment programmes such as those being muted by the Treasury as part of a green, environmentally-led recovery.

“We are wary of calls to encourage specific forms of investment with prudential regulatory incentives. We do want to see firms invest in ways that support the wider economy, including to manage the risks arising from climate change. However, when assessing capital requirements, and here I am thinking of ‘green’ assets and ‘productive finance’, we must as a prudential regulator consider the risks in individual assets. A departure from such an approach reduces the resilience of firms and potentially the wider financial system.”

Charlotte Gerken’s full speech, which included a technical analysis of some of the issues surrounding the MA, is available on the Bank of England website.