Reinsurance to mitigate a volatile world: Unlocking liquidity and capital efficiency

The financial markets in 2025 are navigating a storm of volatility, largely triggered by a resurgence in U.S. protectionist trade policies and continued geopolitical tensions across different parts of the world. As equity, bond and currency markets experience volatility as a reaction to this, insurance earnings and balance sheets have come under pressure, a situation which has been frequently handled by insurance CFOs since the onset of COVID19.

Within the UK, while the higher interest rates over the last couple of years have bolstered the solvency levels of life insurance companies, a number of firms are observing IFRS losses mainly from marked to market investments or derivative positions.

Some of the notable financial markets impacts on the top of the mind of CFOs in the UK are the following:

1. Foreign Exchange (FX) movements: Many of the Bulk Purchase Annuity providers in the UK have sizable non-GBP exposures as they try to source spread generating assets outside the UK. Within the matching adjustment portfolio, insurers are required to hold long dated cross currency swaps to hedge the resulting FX risk. The insurers need to post liquid collateral due to movements in these positions. This results in insurers needing to hold liquid assets which dampens the yield on the portfolio or in extreme scenarios, as per the UK mini-budget in 2022, insurers must remain very liquid.
    
2. Inflation: Many BPA transactions include liabilities that are linked to inflation indices such as the Retail Price Index (RPI), Consumer Price Index (CPI) or through Limited Price Indexation (LPI). BPA providers manage inflation related risks through inflation swaps. BPA providers also invest in inflation linked government bonds which help alleviate some of inflation risk. Derivative position moves can further result in collateral calls, furthering the need for liquidity for BPA providers.
    
3. Gilt swap spreads: Presently, the Gilt rate curve and SONIA swap curve are seeing a sizable spread towards the longer end of up to 90bps for a 30Y duration. What this does is UK life insurers regulated under UK Solvency, the UK-specific version of Solvency II, have to discount their liabilities outside matching adjustment portfolio using swap rates and discount their government bonds using gilt rates. The higher gilt rates result in asset values being lower than the corresponding liabilities discounted with swap rates, resulting in ALM mismatch and likely drag on solvency capital.

While insurers navigate challenges through traditional means, most of the time reinsurance is not the natural choice. The article discussed how reinsurance can be part of the toolkit as insurers try to navigate financial market volatility.

In the context of supporting Pension Risk Transfer offering from insurers, reinsurance can play a pivotal role in unlocking capital and liquidity requirements.

On one end of the spectrum there is longevity reinsurance in its simplest swap format to transfer longevity risk and reduce the associated solvency capital and risk margin. On the other end there is Funded Reinsurance transferring most of the insurance and asset risks (with or without asset transfer) depending on the specific format, with added considerations around counterparty and recapture risks.

Hybrid Longevity Reinsurance can be defined as the reinsurance solutions lying between vanilla Longevity Reinsurance and Funded Reinsurance, providing longevity and one or more market risks transfers, such as cross-currency risk or inflation risk, but without the transfer of the assets and the related credit risk.

• Longevity + FX Reinsurance: Under a Matching Adjustment ("MA") Portfolio, insurers holding foreign-denominated assets are required to hedge the currency risk. The typical hedging instrument is a long-term cross-currency swap matching the underlying asset cash flows until maturity, while short-term rolling hedging strategies are not acceptable under MA rules. Whilst collateral eligibility has been relaxed in the latest years with the inclusion of corporate bonds in collateral arrangements (such as Credit Support Annex, "CSA"), it still prevents more illiquid investments or requires more cash allocation within the MA portfolio. A longevity reinsurance structure where premiums are paid in foreign currency (for example USD) and claims received in GBP can transfer longevity and currency risk – both connected to each other. Reinsurers can in turn have more flexibility in managing the cross-currency exposure as they are not subject to MA requirements in the specific book and the risk can diversify better within their balance sheets. This added flexibility may also result in more relaxed collateral terms on the FX component of the cover, enabling ceding companies to allocate more in illiquid assets and therefore boost BPA pricing. The solution also allows ceding companies to search for yield pick-ups in foreign markets without worrying about the currency hedge and liquidity implications.

• Longevity + Inflation Reinsurance: As inflation continues to erode the real value of retirement benefits, insurers managing UK pension liabilities face increasing complexity, particularly with longevity risks linked to Limited Price Indexation (LPI). Standard longevity reinsurance typically does not cover inflation exposure, leaving insurers to manage it independently, often through cumbersome and costly and scarce instruments like inflation-linked bonds or inflation swaps. Reinsurance has the potential to integrate inflation protection directly into longevity cover by adjusting the indexation of the claim leg as close as possible to the BPA terms. By doing so, it reduces the need for insurers to separately hedge inflation risk, streamline operations, and lowers the financial drag from portfolio rebalancing and collateral management. The structure offers both stability and flexibility, helping insurers manage long-term risks more effectively in an inflationary environment.

With such a competitive BPA market, insurers are continuously looking for assets with illiquidity and complexity premiums while ensuring MA eligibility. Assets like callable bonds, subordinated bonds or structured finance debentures can carry attractive spread pick-up over comparable corporate bonds but often fall short of MA eligibility due to lack of cashflow fixity combined with limited "Spens" clause. The Highly Predictable Cash Flow regulation comes to help the inclusion of such assets but with various limitations still to be understood, such the 10% cap on MA benefit, the allowance to cover the reinvestment and rebalancing costs, the amount of modelling and governance to manage those positions within the MA portfolio.

Once more, reinsurance can be a tool to bridge this gap by creating cashflow fixity on the asset side and removing liability uncertainty arising from longevity at the same time. By grouping the reinsurance swap with the structured asset, insurers can undertake MA tests on a "net of reinsurance basis", thus recognising asset cash flows in full and enhancing the yield of the MA portfolio.

One anomaly in the current environment is the spread between Gilt yields and swap rates—reaching as high as 90+bps for long durations. Under UK Solvency, for businesses outside of Matching Adjustment portfolio, this creates a valuation mismatch wherein insurers discount liabilities using swap rates while Gilts can move differently. Some insurers are applying a capital buffer to cover for the Gilt/swap spread risk, partially mitigated by the volatility adjustment.

To the extent that a reinsurer can discount liabilities using a proxy of the Gilt yield curve, this creates an opportunity for Funded Re-type of arrangement on non-MA eligible books, such as long-term protection, disability or BPA business not eligible for MA (deferred annuities for instance). The benefit of higher discounting can be passed over to the cedent which can see an immediate capital benefit, also in the form of reduced capital charge for Gilt/swap volatility. The arrangement can be structured in different forms looking holistically at capital, liquidity and accounting metrics.

These innovative reinsurance ideas represent a strategic shift in how insurers manage balance sheet efficiency:

• Liquidity Optimisation: Reduced collateral requirements improve liquidity under normal and stressed scenarios.
• Portfolio Yield Enhancement: Greater inclusion of illiquid or higher yield assets boosts investment returns under MA frameworks and ultimately BPA pricing.
• Capital Relief: Lower liability valuations and risk margin releases improve solvency ratios by leveraging gilt swap spread.

As regulatory scrutiny intensifies and market conditions remain competitive, insurers can look beyond traditional reinsurance as an alternative way to source capital and liquidity. Innovative solutions such as hybrid longevity-market risks transfer reinsurance supporting also the possibility to enhance asset eligibility and leveraging the spread between gilt and swap rates offer a compelling toolkit for insurers seeking to optimise capital, manage liquidity, and enhance portfolio resilience through transfer of risk.

In today's environment, reinsurance is no longer just about risk, it's about strategic balance sheet management.