PRA proposes funded re valuation and SCR changes

What does this mean?

Funded re has been high on the PRA’s agenda for several years.

In the Solvency UK balance sheet, reinsurance is recognised as an asset, which represents the liability ceded by having the reinsurance contract in place. The asset’s value is adjusted to reflect expected losses arising from counterparty default risk. This adjustment is the counterparty default adjustment (CDA). 

This approach differs from that used for direct investments which is based on a Fundamental Spread (FS) calculation. The PRA believes this difference creates skewed incentives to take out funded re. 

In the CP, the PRA proposes that the CDA applied to funded re is changed to be the FS for a financial corporate bond with the corresponding credit quality step (CQS) and maturity of the associated cashflows. 

The CQS to be used for this calculation will start with the financial strength rating applied by an external rating agency to the funded re counterparty (or CQS 3 minus one notch if it is unrated). This can then be uplifted by up to three notches, where a single notch upgrade to the CQS can be made for each of the following:

1. Having collateral isolated from the counterparty balance sheet which fully covers the premium at inception and is adjusted for market value and claims experience.
2. Having collateral which is 100% eligible for the Matching Adjustment (MA) in line with the firm’s permissions and minimal mismatch between collateral and contractual cashflows.
3. Having high quality collateral which is a credit-enhancing factor for the reinsurance arrangement if the weighted average rating factor of the worst-case collateral portfolio indicates the collateral has a higher credit quality than the counterparty. 

To calculate  the solvency capital requirement (SCR), firms will need to consider how the new CDA will change in stressed conditions. 

Funded re arrangements where all risks have been fully transferred to the reinsurer on or before 30 September 2026 are not subject to the new rules.

These changes will not be applicable to reinsurance taken for the purpose of transferring economic risk ahead of a transfer of business under Part VII of FSMA. 

What do firms need to do?

Funded re is used to partially fund the capital required for new schemes. Firms will need to consider if alternative sources of funding are required, or whether to alter target transaction sizes or new business volumes.   

Firms also use reinsurers to access a wider range of investments opportunities. They will need to consider if this impacts the expected yield and terms they can offer.

The changes may alter pricing dynamics, particularly for large schemes. Firms will also need to consider whether schemes will transfer before 30 September 2026 – if there is uncertainty this will need to be reflected in commerical terms.   

Firms will need to develop a CQS mapping methodology and related processes. The approach is subject to new governance which needs to be put in place. Reporting systems also need to be updated. 

Next steps

The consultation closes on 31 July 2026. The proposed calculations are intended to be applicable from 1 July 2027.