An annuity is a very serious business: Part Two1 Speech given by David Rule, Executive Director of Insurance Supervision Westminster and City Bulk Annuities Conference 10 April 2019  1  Chapter 2, Sense and Sensibility, Jane Austen, 1811  A year ago, I spoke to this conference about the risks facing insurers active in the bulk purchase annuity market. In particular, I discussed the treatment of unrated, direct investments under the Solvency II Matching Adjustment, with a particular focus on equity release mortgages. A year later and the movement of defined benefit pension liabilities from employers to insurers has continued apace. Around £ billion of risk was transferred in 2018, if you include buy outs, buy ins and longevity swaps (Chart 1).2  Most commentators expect the market to continue to grow. On the  demand side, more employers might be in a position to afford a buy out if improvement in life expectancy stalls, interest rates rise and asset values increase (Chart 2). On the supply side, the possible emergence of superfunds could create an alternative to insurers. Meanwhile, the current level of transactions is still dwarfed by the scale of remaining defined benefit (DB) liabilities of some £ trillion, of which nearly £ trillion are closed to new members.3 Today I want to discuss more generally the risks associated with insurers taking on significant annuity obligations. I will then show how, in my view, the PRA’s implementation of Solvency II does a good job of addressing these risks.

I am mindful here of the Financial Stability Board standard against mechanical reliance on ratings.7 “The goal of the FSB principles is to end mechanistic reliance on ratings provided by 7  http://www.fsb.org/work-of-the-fsb/policy-development/additional-policy-areas/reducing-reliance-on-credit-ratings/ 7  All speeches are available online at www.bankofengland.co.uk/publications/Pages/speeches/default.aspx  7  ECAIs by banks, institutional investors and other market participants by reducing the “hard wiring” of ECAI ratings in standards, laws and regulations and by providing incentives for firms to develop their own capacity for credit risk assessment and due diligence”  This standard does also say that  supervisors should closely check the adequacy of firms rating processes and guard against upward bias. That is what we seek to do. Turning to restructured equity release mortgages specifically, we developed our Effective Value Test (the ‘Test’) to help determine whether insurers appear to be taking an inappropriately large Matching Adjustment benefit. This followed very extensive engagement with industry and more widely, including discussion and consultation papers. We recently issued a follow-up consultation paper8 to provide greater clarity to insurers on, for example, how often they should calculate the Test and in what circumstances the PRA will update key parameters in the Test, such as the deferment rate. The consultation paper also proposes that firms would be asked to use the Test ‘in stress’ as a validation technique, to help provide assurance that their internal models are assessing appropriate capital requirements against risks from these assets.