Clifford Chance

The life insurance industry in the UK, the US, and Europe is currently facing several regulatory challenges, driven by the increasing involvement of private equity firms in life insurance and the globalisation of the reinsurance market amidst concerns about regulatory divergence and arbitrage.

Regulators are taking steps to address these challenges, such as introducing new rules to govern the relationship between private equity firms and life insurers, developing new frameworks for cross-border reinsurance, and aligning regulatory standards internationally.

The global life insurance industry is likely to face continued regulatory scrutiny in the coming years. It is important for insurers and reinsurers to be proactive in engaging with regulators so that they can better develop (re)insurance regulation.

Private equity moves into life insurance

The life insurance industry has become an increasingly important sector for private equity as it provides a supply of "permanent capital". Cheng Li Yow, a London-based Clifford Chance Partner in the Financial Institutions Group, says: "Sometime ago, regulators were concerned about PE firms owning insurers, but the general view is that PE players are here to stay."

In Italy, there is currently controversy about PE ownership of life insurance businesses following the failure of Eurovita – owned by British private equity group Cinven. A group led by Italy's top four insurers stepped in with a rescue deal, but as Lucio Bonavitacola, a Partner at Clifford Chance in Milan says: "There is generally recognition that private equity brings benefits to the life insurance industry such as fresh capital, innovation and efficiency, but for the Italian regulator IVASS there is a concern that the money goes into illiquid assets – this was an issue for Eurovita."

The US has also seen a wave of private equity firms acquiring life insurance companies. "Initially, the regulator's concern was how long will these new owners be around? Will they want to flip the company and what will that mean for policyholders?" says Frank Monaco, a Clifford Chance Partner based in New York. "I think what has actually happened is that these private equity owners have no intention of relinquishing these assets anytime soon. They love the permanent capital. They love the flow of cash, and they love the collaboration between the business and also their asset management arms and their private equity arms. So, I think that concern has been somewhat allayed." He adds that regulators are now more concerned about what these asset portfolios look like.

PE owners are also being impacted by initiatives undertaken by the National Association of Insurance Commissioners (NAIC) that focus on structured securities and collateralised loan obligations. "The NAIC has proposed a much more punitive risk-based capital (RBC) charge on structures and rather than having the RBC charge assigned based on a third-party credit rating agency, you now go to the securities valuation office of the NAIC and get a rating from them directly," says Monaco. In response, the industry is pushing back against NAIC proposals. "It's an evolving issue, but the view of PE firms is 'okay, we have these assets, they're illiquid, maybe they're a little more complicated, but step back, the vast majority of the asset portfolios are still plain vanilla corporate bonds'. I would characterise regulators as wary, but they're not acting precipitously right now," he says.

Cross border reinsurance

"Regulators are increasingly looking at cross-border reinsurance," says London-based Partner, Cheng Li Yow. "In the UK, the Prudential Regulation Authority (PRA) is very focused on recapture risk, and also the eligibility of assets on that recapture. They are also looking at illiquid assets. What happens when we recapture and how do those illiquid assets work for an insurer? We did wonder whether some of that focus on the use of illiquid assets might be misplaced – is it better for reinsurers or cedents to be thinking in terms of 'are those illiquid assets suitable for us?', 'do they meet our matching adjustment requirements?' as opposed to just saying illiquids are bad altogether.'"

The PRA has several concerns about funded re, including:

• The potential for funded re to be used to reduce insurers' capital requirements without a corresponding reduction in risk. Funded re is typically structured as a long-term loan from the reinsurer to the insurer, which is used to purchase assets. These assets are then used to collateralise the reinsurance contract. This can reduce the insurer's capital requirements, as the assets are not included in the calculation of the Solvency Capital Requirement (SCR).
• The potential for funded re to increase the complexity of insurers' operations and make it more difficult for the PRA to supervise them. Funded re often involves complex structures and multiple parties, which can make it difficult for the PRA to understand the risks involved.
• The potential for funded re to be used to transfer risk to entities that are not subject to the same level of regulation as insurers. This could lead to a reduction in the overall level of financial stability in the system.

Proposed enhancements to Bermuda's regulatory regime

The Bermuda Monetary Authority (BMA) recently published a consultation paper on proposed changes to its regulations on funded re. Simon Grout, Senior Managing Director at FTI Consulting says: "Bermuda is trying to keep the UK, the EU and the US happy, but I think it is going to struggle to keep everybody happy".

The BMA is proposing to introduce a number of new requirements for funded re transactions, including:

• A requirement for insurers to have a clear and robust risk management framework in place for funded re transactions.
• A requirement for insurers to disclose more information about their funded re transactions to the BMA.
• A requirement for the assets used to collateralise funded re transactions to be of high quality.

Dennis Manfredi, a Clifford Chance Partner based in New York says: "I'm not sure if the impact the BMA's proposals will have on insurance companies is clear, but the result seems to be that incumbent reinsurers that have established businesses in Bermuda and have been operating at a standard level will be OK. It will not have a significant material impact on their business. New players coming into the market and those with more aggressive, low capital business plans, that want to play in the margins, may have to go to Cayman or another island."

"The BMA's consultation paper is relevant to the PRA's concerns about funded re because it shows that other regulators are also concerned about the potential risks of funded re and are taking steps to mitigate those risks. The PRA is considering the BMA's proposals and may introduce similar changes to its own regulations on funded re," says Cheng Li Yow.

In addition, the PRA has also expressed concerns about the potential for funded re to be used to misrepresent the financial strength of insurers. The PRA has warned insurers against using funded re to artificially boost their solvency ratios. You can find out more in our briefing: Feedback on the PRA's thematic review work on funded reinsurance.

The PRA has released a consultation paper on its requirements for funded re. For more information on the PRA's proposals, please refer to our briefing, Navigating Funded Reinsurance in the UK: Insights from the PRA's CP24/23 Consultation Paper.