Funded reinsurance: The PRA closes the capital gap

The use of funded reinsurance has expanded rapidly in recent years as UK life insurers have sought capital-efficient ways to support growing bulk purchase annuity (BPA) volumes in a higher interest rate environment. This growth has been underpinned by increasing use of collateralised structures backed by private credit and other illiquid assets, alongside a competitive global reinsurance market with significant capacity. Against this backdrop, the PRA has become increasingly focused on whether the current Solvency UK framework appropriately captures the economic risks being transferred and retained within these arrangements, particularly in relation to counterparty credit risk, collateral quality and the potential for correlated stress events across reinsurers.

CP8/26 – Funded reinsurance reflects the PRA’s concern that the existing Counterparty Default Adjustment (CDA) methodology may be underestimating the risk inherent in funded reinsurance structures, particularly where collateral portfolios are concentrated in similar asset classes and downgrade risk is not explicitly captured. The consultation therefore represents a response to both the observed growth in the market and the findings from recent supervisory exercises, including stress-testing results that highlighted the potential systemic impact of simultaneous recapture events. More broadly, it signals the PRA’s intent to reduce regulatory arbitrage between funded reinsurance and directly held assets, and to ensure that capital requirements more closely reflect the underlying economic exposures on insurers’ balance sheets.

PRA concerns

The PRA considers that favourable capital treatment has been an important driver of growth in funded reinsurance. Firms currently hold materially lower capital against funded reinsurance exposures than against economically comparable directly held assets. In the PRA’s view, that differential is not justified by a corresponding difference in underlying risk.

The PRA’s concern is focused on the current CDA framework. The current CDA methodology is high-level and principles-based. It makes no specific reference to downgrade risk, which the PRA considers a material deficiency given the nature of funded reinsurance exposures.

The PRA is also concerned by increasing concentration in private credit-backed structures and the similarity of investment strategies across counterparties. A severe market stress affecting private credit valuations or liquidity could therefore affect multiple reinsurers simultaneously and increase the likelihood of recapture events across the sector.

The 2025 Life Insurance Stress Test illustrated the potential impact. The PRA reported that recapture of exposures from a single funded reinsurance counterparty reduced aggregate industry SCR coverage ratios by around 10 percentage points and reduced surplus capital by approximately £3 billion. The PRA’s view is that those effects could become materially more significant if funded reinsurance volumes continue to grow.

What the PRA is proposing

The PRA’s proposals focus primarily on the CDA which it sees as the main source of divergence between the treatment of funded reinsurance and economically comparable directly held assets. 

1. Revised CDA calculation

The main proposal is that the CDA for funded reinsurance should be aligned to the Solvency UK Fundamental Spread for financial corporate bonds, calibrated by reference to the relevant credit quality and maturity profile of the reinsurance cashflows.

This would bring the valuation approach for funded reinsurance recoverables closer to that used for directly held assets under the matching adjustment framework. The PRA's rationale is that the Fundamental Spread already captures the risks retained by annuity firms on directly held assets, specifically default and downgrade risk. Since the risks a cedant retains under a funded reinsurance arrangement are economically similar to those on a directly held asset portfolio, using the same spread framework for the CDA ensures the valuation of funded reinsurance recoverables reflects those risks consistently. The PRA considers that the current CDA methodology does not fully capture those risks.

Also, under the current framework, the lower CDA produces a higher reinsurance recoverable on the balance sheet, which in turn reduces capital requirements relative to holding assets directly. Aligning the CDA more closely to the Fundamental Spread would materially reduce the capital differential between funded reinsurance and directly held assets.

The PRA estimates that, for an average current counterparty, the revised approach would reduce funded reinsurance asset values on Solvency UK balance sheets by around 7%, compared with current CDA reductions typically below 0.5% to approximately 2%. For a BBB-rated counterparty with weaker collateral protections, the reduction could increase to around 13%.

Taking the CDA, SCR and risk margin together, the PRA expects overall capital requirements for a typical funded reinsurance transaction to increase from approximately 2–4% to around 10% of best estimate annuity liabilities.

2. Credit quality step methodology

The consultation also introduces a more prescriptive framework for determining the credit quality step (CQS) used in the CDA calculation.

Firms would begin with the reinsurer’s Insurer Financial Strength rating and may apply up to three upward notches depending on the characteristics of the collateral arrangement:

• one notch where collateral fully covers the premium at inception and is adjusted only for market movements and claims experience;
• one notch where the worst-case collateral portfolio is fully matching adjustment eligible and cashflow mismatches do not create material risk; and
• one notch where the weighted average credit quality of the worst-case collateral pool exceeds that of the reinsurer itself. 

Where no external IFS rating exists, firms would start from CQS 3 less one notch, broadly equivalent to BBB-.

In practice, the framework creates a clear distinction between different risk profiles across counterparties and collateral structures. The PRA estimates that an AA-rated reinsurer qualifying for all three notches would attract a CDA of around 3%, compared with approximately 13% for a BBB-rated counterparty with no qualifying collateral features.

For a typical BPA transaction with 15% of liabilities ceded through funded reinsurance, the PRA estimates that required backing assets would increase by around 1.5% for an average counterparty. The increase rises to approximately 4% for a BBB-rated reinsurer and falls to around 0.1% for a strong AA-rated counterparty with robust collateral protections.

At market level, and assuming no change in behaviour, the PRA estimates additional annual initial capital requirements of approximately £700 million. This remains modest relative to aggregate BPA own funds of around £80 billion, although the effect on individual firms is likely to differ significantly depending on existing structures and counterparty mix.

The consultation may also have implications for BPA pricing and execution dynamics over time. If transaction costs rise materially for some counterparties, insurers may place greater emphasis on retaining assets on balance sheet, diversifying reinsurance panels, or restructuring collateral arrangements to preserve capital efficiency. The extent to which those adjustments ultimately affect end-market pricing is likely to depend on both competitive conditions and the availability of alternative sources of long-term capital.

3. Savings provision for existing arrangements

Arrangements where risks are fully transferred on or before 30 September 2026 would continue to benefit from the current framework under a proposed savings provision.

The PRA indicates that, at current volumes, it does not consider the existing stock of funded reinsurance arrangements to present a risk to its objectives. The proposals are instead directed primarily at limiting further build-up of risks from future growth in the market.

For firms currently negotiating transactions, the timing point is significant. Transactions completed after 30 September 2026 would fall within the revised framework from 1 July 2027, including the higher CDA requirements.

4. Excluded arrangements

The PRA proposes to exclude two categories of arrangement from the new framework.

The first is certain intra-group quota share structures where the reinsurer holds a mirror portfolio of matching adjustment eligible assets and the arrangement does not generate surplus at group level. The second is temporary Part VII portfolio transfer bridge arrangements entered into pending legal transfer of insurance business under Part VII FSMA.

The proposed intra-group exclusion is limited to arrangements meeting specified conditions derived from the characteristics described in paragraph 3.27 of CP8/26. These include the absence of additional surplus creation at group level and the use of mirror portfolios of matching adjustment eligible assets aligned to the ceded liabilities. Arrangements falling outside those criteria would remain within scope.

5. Formal definition of funded reinsurance

The consultation would introduce a formal definition of funded reinsurance into the PRA Rulebook Glossary. The proposed definition covers collateralised reinsurance arrangements supporting annuity and capital redemption business.

The inclusion of capital redemption business extends the framework beyond traditional annuity structures and reflects the PRA’s focus on long-term asset-intensive liabilities more generally.

Firms writing capital redemption business should therefore review existing arrangements against the proposed definition, particularly where funded reinsurance has not previously been considered within scope of the PRA’s framework.

6. Governance expectations

The PRA also proposes governance requirements relating to the CDA methodology and the determination of the relevant credit quality step.

Under the proposed Chapter 5 of SS5/24, firms would be expected to document the methodology, obtain approval from an SMF holder, likely to be the CRO in many cases, and provide the framework to the governing body.

The proposed expectations suggest a greater degree of formal governance around notching decisions, collateral quality assessments and supporting credit analysis than many firms may currently apply.

7. Changes to SS5/24

The PRA also proposes amendments to SS5/24 clarifying that firms may use the published Fundamental Spread, rather than a forward-looking spread, when calculating the CDA under stress.

Additional guidance is included on assessing cashflow matching and collateral portfolio quality for the purposes of the notching framework.

The SCR framework itself is not being directly amended. The PRA nevertheless acknowledges that changes to the underlying balance sheet treatment are likely to affect internal model outputs. Firms using internal models are therefore likely to need to assess the downstream impact on capital requirements well in advance of implementation.

8. Consequential amendments

A number of consequential amendments are also proposed across SS5/24 to align existing supervisory expectations with the revised framework and the proposed definition of funded reinsurance.

These amendments are largely technical rather than substantive. Firms will nevertheless need to review the revised supervisory statement in full to ensure that existing governance, risk management and collateral assessment processes remain aligned with the updated expectations.

Timing

The proposed savings provision means that timing will be an immediate consideration for firms with transactions currently in negotiation. Arrangements completed on or before 30 September 2026 would remain subject to the existing framework, while transactions completed after that date would fall within the revised regime from 1 July 2027.

Firms are therefore likely to begin reassessing counterparty selection, collateral structures, pricing assumptions and capital planning well in advance of implementation. 

The consultation is also likely to accelerate an ongoing divergence in market positioning between highly-rated global reinsurers and smaller or lower-rated counterparties. Structures supported by stronger collateral frameworks, higher quality assets and more established operational capabilities appear likely to retain a relative capital advantage under the proposed regime, while weaker structures may become materially less competitive on pricing. In practice, this may reinforce existing concentration trends within the funded reinsurance market rather than reduce them entirely.

The PRA has also indicated that further measures remain under consideration. In particular, it has reserved the possibility of additional supervisory measures including potential volume limits following the 2028 Life Insurance Stress Test if concerns around concentration or systemic exposure persist.

The PRA’s consultation paper does not come as a surprise and CP8/26 is therefore likely to be viewed as part of a broader supervisory direction of travel rather than a standalone intervention. The overall message from the consultation is that the PRA expects funded reinsurance activity to remain subject to increasing scrutiny as the market continues to develop.

The consultation closes on 31 July 2026, with implementation proposed from 1 July 2027.

For further information on any of the topics raised please contact the authors or your usual Freshfields contact.