Does insurer financial strength matter?

Yes, insurer financial strength really matters

Despite the unprecedented market volatility following COVID-19, demand for pensions risk transfer solutions such as buy-in and buy-outs has remained high, with total transaction volumes of up to £25bn expected across 2020. Now, more than ever, schemes need to consider the financial strengths of individual insurers when deciding which insurer to transact with.

Historically, this decision has been driven by price, supported by the perception that the insurance regulatory regime ultimately underwrites insured benefits. Distinctions in financial strength between insurers has often been ‘relegated’ to a second-order consideration.

The life insurance regulatory regime is strong, but it is not risk-free, and the COVID-19 pandemic is arguably the first real ‘test’ of the regime and the Solvency II framework. Within this regime, each insurer has meaningful flexibility to adopt its own risk and reward profile.

COVID-19 has brought the topic of counterparty risk into sharper focus, as observed in global credit markets. The implications of a deep recessionary environment would differ across the individual insurers given their underlying differences. The next 12 to 24 months could represent a real test of existing contingency plans and risk-management frameworks of the insurers in the market.

Whilst additional member protection, beyond that provided by insurers themselves, is provided by the Financial Services Compensation Scheme (FSCS), the UK courts have clearly established that the mere existence of the FSCS does not mean that the transfer of liabilities between insurers is always appropriate. The decision to sanction a liability transfer between two insurers ultimately relies on a relative assessment of the insurers across a range of relevant factors.

There is ample evidence to support the view that it is not sufficient or appropriate to rely on potential support that could be provided by the insurance regulatory regime (e.g. the FSCS ‘safety net’) when undertaking risk transfer exercises such as buy-ins and buy-outs. To do so would be akin to trustees relying on the PPF rather than taking account of specific employer and scheme characteristics when making scheme funding and investment decisions.

A robust brokering process should consider the financial strength of the insurers from the onset. UK life insurers are different from one another, and it is important that trustees and sponsors understand what makes each insurer ‘tick’ when deciding which provider to exclude from the process. The choice of an insurer will have long-lasting implications on the welfare and livelihoods of members, so the decision should not be made purely on price.

We originally wrote about this important topic as part of a longer piece in Rothesay Life’s publication “The journey to buy-out.” Link to the article.

Authors: Adolfo Aponte and Michael Luo

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