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The Bank of England is hardening its approach to the use of complex offshore financing by UK life insurers to lower capital requirements on the pension portfolios they are taking on from companies.

Vicky White, the BoE’s director of prudential policy, used a speech on Thursday to give the clearest signal yet that the central bank plans to curb the industry’s use of offshore reinsurance deals.

In these “funded reinsurance” deals, both insurance liabilities and the assets backing them are ceded to a reinsurer, often in a foreign jurisdiction such as Bermuda. The BoE is worried that this is a form of “regulatory arbitrage” that allows insurers to cut the capital they have while the risk remains the same.

White said insurers have taken advantage of “a quirk in regulatory treatments” to reduce the capital they have to cover pension liabilities, adding that the BoE’s aim was “making sure that we act now to get the treatment right for the future”.

Talking at a Bank of America event in London, she said the bank also worried these offshore deals were “driving investment away from those UK productive assets which support the growth of the UK economy, and towards internationally based reinsurers”.

Potential changes include “explicit regulatory restrictions or limits on the amount and structure” of funded reinsurance, she said, adding that the BoE could also consider “measures to address any underestimation of risk, or potential regulatory arbitrage”.

UK life insurers had agreed at least £6bn of funded reinsurance deals as of last year and White said the market was growing “very fast”.

The BoE’s decision to act is an admission that its “principles-based approach” — relying on broad expectations and guidance rather than hard rules — is not working in this case, where US private capital groups have moved into the market.

Apollo, Brookfield and Blackstone, which have a large presence in the Bermuda insurance market, have all expanded into the UK “bulk annuities” business, where companies offload their pension liabilities and the assets backing them to insurers.

In July, Apollo-backed insurer Athora said it was planning a £5.7bn acquisition of the privately owned Pension Insurance Corporation, while Brookfield announced a £2.4bn deal for Just Group, and Blackstone has agreed an up to $20bn partnership with L&G.

“If you’d turned back time,” said one insurance lawyer, “American private capital groups would have said, we’ll keep an eye on owning an annuity company directly but we’d rather do it by reinsurance out of the US or Bermuda, because that’s much cleaner. We don’t have to get our hands dirty with insurance policies or deal with millions of pensioners. We just like to get big pools of assets and invest them.”

However, as regulators have issued multiple warnings on the risks of funded reinsurance, the lawyer said the groups are changing their strategy by coming into the market directly.

The bulk annuities market is booming, with UK demand for such deals expected to reach £500bn over the next decade, according to consultancy LCP.

BoE officials are concerned that the rules on how offshore reinsurers manage the collateral backing millions of British pensions are weaker than UK regulations. 

White said officials had found “examples of large cash flow mismatches, as well as large unhedged currency exposures in current FundedRe transactions, far beyond what we would see in typical UK annuity firms’ direct investments”.

The BoE will discuss its concerns with the industry “later this autumn”, White said, adding that it had “not come to any firm views”.