The financial markets in 2025 are grappling with significant volatility, driven largely by a resurgence in US protectionist trade policies and ongoing geopolitical tensions worldwide. This turbulence across equity, bond, and currency markets is putting pressure on insurance earnings and balance sheets, a scenario that CFOs have been managing since the onset of the COVID-19 pandemic.
In the UK, while higher interest rates over recent years have bolstered the solvency levels of life insurers, many firms are experiencing IFRS losses, primarily due to marked-to-market investments or derivative positions.
Key financial impacts on UK insurers are:
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Foreign Exchange (FX) Movements:
Many Bulk Purchase Annuity (BPA) providers in the UK hold significant non-GBP exposures as they seek to source spread-generating assets outside the UK. To hedge the resulting FX risk, insurers must maintain long-term cross-currency swaps within their matching adjustment portfolios. This requires posting liquid collateral, which limits yield potential or, in extreme cases like the 2022 UK mini-budget, insurers must remain highly liquid. -
Inflation:
Several BPA transactions involve liabilities linked to inflation indices such as the Retail Price Index (RPI), Consumer Price Index (CPI), or Limited Price Indexation (LPI). Providers manage these risks through inflation swaps and invest in inflation-linked government bonds. However, derivative movements can lead to collateral calls, increasing liquidity pressure. -
Gilt Swap Spreads:
Currently, there is a sizable spread between the Gilt rate curve and the SONIA swap curve, with a difference of over 100bps on 30-year durations. UK life insurers, regulated under UK Solvency (a version of Solvency II), must discount liabilities outside their matching adjustment portfolios using swap rates, while government bonds are discounted using gilt rates. The higher gilt rates result in asset values being lower than the corresponding liabilities, creating an asset-liability mismatch and potentially straining solvency capital.
While insurers often navigate these challenges with traditional methods, reinsurance is emerging as an increasingly viable part of the solution to manage financial market volatility.
Enhancing Matching Adjustment Yields Through Hybrid Longevity Reinsurance
In the realm of Pension Risk Transfers (PRT), reinsurance can play a pivotal role in unlocking capital and addressing liquidity needs.
On one end of the spectrum is traditional longevity reinsurance, which transfers longevity risk and reduces solvency capital and risk margins. On the other end lies Funded Reinsurance, which transfers most insurance and asset risks, with or without asset transfer, depending on the deal structure. Hybrid Longevity Reinsurance lies between these two extremes, offering a solution that transfers both longevity and market risks—such as cross-currency and inflation risks—without transferring assets and the related credit risk.
Longevity + FX Reinsurance
Under a Matching Adjustment (MA) portfolio, insurers holding foreign-denominated assets must hedge currency risk, typically using long-term cross-currency swaps that match underlying asset cash flows. However, short-term hedging strategies are not acceptable under MA rules, which restricts flexibility. Longevity reinsurance can help transfer both longevity and currency risks. By structuring premiums in foreign currency (such as USD) and claims in GBP, the reinsurance deal allows insurers to manage currency exposure more efficiently. This can also relax collateral requirements for the currency component, enabling insurers to allocate more in illiquid assets, boosting BPA pricing and enhancing yield.
Longevity + Inflation Reinsurance
As inflation erodes the real value of pension benefits, UK insurers face mounting challenges in managing longevity risks linked to Limited Price Indexation (LPI). Standard longevity reinsurance does not address inflation exposure, forcing insurers to manage this risk separately, often through costly and complex instruments like inflation-linked bonds or inflation swaps. By integrating inflation protection directly into longevity cover, reinsurance can streamline operations and reduce the need for separate inflation hedging. This helps insurers mitigate financial drag from portfolio rebalancing and collateral management, offering both stability and flexibility in an inflationary environment.