Through the provision of long-term finance that is naturally enabled by the long-term liabilities taken on, insurers also play a vital role in supporting risk-taking and growth in the real economy. There are two trends within the UK life insurance sector that I’d like to cover today, their benefits but also the risks arising from them: The first trend – in two parts – relates to reinsurance: (a) the continued high level of longevity reinsurance; and (b) the emergence of more complex so-called ‘funded reinsurance’. The second trend concerns the continued growth of untraded or illiquid assets in life insurers’ portfolios. There are good business and risk management arguments for both of these strategies, which can  Page 3  also lead to improved pricing for customers. However, over-indulgence in either – or indeed both – could actually result in concentration risks increasing at individual firm-level and in the system as a whole. I’ll look first at why and how these trends have developed, and then set out what the Prudential Regulation Authority (PRA) expects of insurers’ boards and senior management in relation to their risk management. Longevity reinsurance For firms writing new annuity business, the continued use of longevity reinsurance is one area where concentration risk may arise. The long-term nature of longevity risk – i.e. exposure to the risk that annuitants live longer than expected – makes annuity writing capital-intensive, which has a strong impact on pricing. A longevity reinsurance industry has developed to manage this impact.

Let me now turn specifically to financial regulation. To the extent that financial regulation contributes to procyclicality and excessive risk-taking, supervisors could design their regulation in a counter-cyclical fashion to reduce procyclical behaviour of financial institutions. Reflecting this thinking, discussion to date on the role of financial regulation to address procyclicality has focused on four areas. The first is to reduce procyclical tendencies of the Basel II capital regulation by aligning capital requirement more with a longer-term perspective of risk. On this, key measures under discussion include: (1) building capital buffers by capital conservation measures; (2) reducing procyclical effects of minimum capital requirement by adopting through-the-cycle risk parameters to achieve a less pro-cyclical capital ratio; (3) promoting forward-looking provision that can cover loan losses that are not yet incurred but expected, with supporting accounting rule and valuation; and (4) using additional capital charge for the large and more complex banks based on indicators of systemic relevance. The second area of focus is the use of macroprudential supervision. The aim is to use prudential measures, when needed, to restrain the build-up of risk either in the overall financial markets or in specific asset class. Examples here include use of loan-to-value ratio on real estate loans and margin requirements for derivatives and securities transactions. Also, a recent idea of using leverage ratio to help take account of the unknown risk beyond those identified by the risk-adjusted capital regulation also falls into this category.