Life Insurance Stress Test: 2025 Results

Executive summary

The results of the 2025 life insurance stress test (LIST 2025) indicate that the sector is resilient to a severe financial market stress scenario that impacts insurers’ investment portfolios through a decline in risk-free interest rates, falls in equity and property prices, along with widening spreads and subsequent defaults and downgrades.

LIST 2025 is the third time that the PRA has asked UK life insurers to participate in a stress testing exercise. This is the first exercise conducted under the new Solvency UK regulatory regime implemented in 2024. For the first time, in addition to sector-level findings, the PRA will publish the individual firm results for the core scenario. Individual firm disclosure is one of the new measures within Solvency UK to promote good risk management practices and to improve insurer accountability and transparency. Like previous insurance stress test exercises, LIST 2025 is not a pass-fail exercise and will not be used to inform the setting of capital requirements or buffers.

LIST 2025 covers eleven of the largest UK life insurers active in the bulk purchase annuity (BPA) market.^{footnote [1]} These insurers, that account for more than 90% of annuity liabilities, contribute significantly to the UK economy by providing long-term financial security to policyholders and by making investments in a broad range of assets which support economic activity.

The 2025 exercise focuses on the solvency positions of individual UK life insurance legal entities as at 31 December 2024. LIST 2025 does not extend to wider group-level impacts. In addition, the exercise defines a standard set of management actions that participants can choose to recognise in stress to help offset the impact on their solvency positions. In practice, firms may have additional management actions available beyond those recognised in the exercise, but allowing a standard set of actions for LIST 2025 is designed to ensure consistency and comparability of results.

In the PRA’s core financial market stress scenario – designed to be severe but plausible – firms experience an aggregate £8.6 billion reduction in capital surplus above regulatory requirements, with £12.9 billion of assets downgraded to below sub-investment grade. Despite this deterioration, participating firms maintain sufficient capital resources, with the aggregate solvency capital requirement (SCR) coverage ratio falling from a strong starting point of 185% to 154% post-stress. All firms continue to meet their regulatory capital requirements, underscoring the sector’s robust starting position and ability to absorb significant shocks of the kind tested in the exercise.

The impact of credit rating downgrades and defaults, as well as the fall in interest rates, are among key drivers of the decline in SCR coverage in the core scenario. UK life insurers are also materially exposed to residential property value falls, as significant providers of funding for equity release mortgages (ERMs, also known as lifetime mortgages).

In addition to the core scenario, LIST 2025 also includes two exploratory scenarios to capture evolving risks in the BPA market. These scenarios are designed to support the development of industry modelling capabilities in two areas: (a) asset concentrations, as firms continue to optimise the risk/reward profile of their investments; and (b) funded reinsurance (FundedRe), given its growing use in the BPA market.^{footnote [2]} The results confirm the industry’s ability to model these scenarios effectively. The PRA will consider how to build on these exploratory scenarios in future exercises.

The aggregate results of the exploratory asset concentration scenario show that the sector remains resilient to the additional stress specified in the exercise. While this partly reflects the way in which firms’ investment portfolios are currently diversified across asset classes, there were also some limitations to this scenario which the PRA will consider in future exercises.

The findings on FundedRe highlight that recapturing reinsured liabilities under stress can significantly affect life insurers’ solvency, albeit that firms could absorb these impacts as at 31 December 2024. Consideration of this risk is especially important given FundedRe’s relatively early stage of adoption – meaning further growth could amplify its impact. The results are consistent with the PRA’s previous statements on how the risks within FundedRe could build up over time, particularly if exposures continue to increase, structures become more complex, and collateral becomes less liquid and harder to value. The PRA is considering whether further action is needed to ensure the regulatory capital treatment of FundedRe transactions is appropriate.^{footnote [3]}

While the results of LIST 2025 show the life insurance sector is resilient to the type of scenario tested in this exercise, regulatory exercises such as LIST 2025 are designed to supplement and not replace firms’ own solvency and risk management assessments. Firms’ boards and senior management remain responsible for identifying and managing the risks they face, and for ensuring these assessments remain forward-looking to reflect any changes in the external environment or to firms’ business profiles. The PRA continues to expect all firms to maintain robust risk management capabilities, including use of their own stress and scenario testing, to test their resilience to a range of downside scenarios and to inform their capital planning.

1: Key elements of the LIST 2025 exercise

1.1: Purpose and objectives

The life insurance stress test supports the PRA’s statutory objectives to maintain safety and soundness of PRA-authorised firms; and to contribute to the securing of an appropriate degree of protection for policyholders or those who may become policyholders. The stress test provides a quantitative, forward-looking assessment of the resilience of the sector and the individual firms within it.

The three objectives of the 2025 stress test are:

• to assess sector and individual firm resilience to severe but plausible events;
• to strengthen market understanding and discipline through individual firm publication; and
• to improve insight into risk management vulnerabilities.

Unlike the Bank of England’s stress testing of the UK banking system, the PRA life insurance stress test is not used to inform the setting of capital requirements or buffers. UK insurers’ capital requirements are determined by the Solvency UK framework, and firms set their buffers above these requirements based on their own risk appetite and business plans.

This is not a pass-fail exercise, nor is it aimed at checking compliance with regulation. Rather, it provides a richer understanding of the sensitivity of UK life insurers’ balance sheets and potential actions firms could take in a severe but plausible stress, with the findings informing the PRA’s supervisory activities. Results disclosure also provides market participants with an additional transparent measure of sector and firms’ resilience and facilitates market education around firms’ balance sheet evolution in stress. The transparency that the individual firm results disclosure provides is one of the features of the new Solvency UK regime (see Box 1).

1.2: Structure

To capture both current and emerging risks in the BPA market, the 2025 exercise includes one core and two exploratory scenarios. The core scenario focuses on the most material financial risk exposures for the annuity writers, including credit risk. The exploratory scenarios in LIST 2025 capture evolving risks in the BPA market and are designed to support the development of industry modelling capabilities in two areas: (a) asset concentrations (see Annex 1); and (b) FundedRe (see Annex 2).

1.3: Financial markets (core) stress scenario

The core scenario published by the PRA in January 2025 (see Section A in LIST 2025: Scenario specification, guidelines and instructions) is designed to assess sector and firm resilience and reflects the most material financial risk exposures likely to be relevant for UK life insurers active in the BPA market. It is not a forecast of financial conditions.

The three-stage scenario represents the development of a severe but plausible financial markets stress. The stages are designed to help improve transparency for market participants on how the regulatory balance sheets of UK life insurers may evolve in stress.

Stage 1 represents an immediate financial markets shock – risk-free interest rates decline, spreads widen, and equities fall sharply. This stage tests firms’ ability to absorb a sudden repricing of risk across their portfolio.

The stress develops to its peak in Stage 2, with a wave of credit ratings downgrades, defaults, and both residential and commercial property values falling. This stage captures the effect of the prolonged market stress and deteriorating credit asset quality on solvency positions and MA portfolios. In contrast with the sharp shock in Stage 1, the Stage 2 stresses emerge over a longer timeframe, potentially more than a year. As a result, the ‘peak-to-trough’ calibration can appear strong compared with one-year historical movements.

In Stage 3 markets start to stabilise and liquidity improves. This stage focuses on how firms respond – the scenario allows recognition of a range of management actions. The firms are also required to recognise the cost of partially restoring the credit risk profile of their MA portfolios.

Figure 1: Core scenario

The financial markets stress represents one severe but plausible scenario. Although not calibrated to a specific historical financial event, the scenario takes into account previous market shocks from the past 20 years, including the worst year of the global financial crisis, as well as recent annual concurrent stress test scenarios for banks and building societies. It broadly targets a 1 in 100 severity.

Chart 1: LIST 2025 calibrations^(a)

Footnotes

• Sources: Bank of England, Bloomberg Finance L.P., ICE BofAML Global Research, ONS and PRA calculations.
• (a) The chart shows LIST 2025 core scenario variables calibration in comparison to the worst one-year experience during the global financial crisis and 2024 UK banking system desk-based stress test demand shock scenario, as well as LIST 2022 scenario stresses.

1.4: Features of the stress test

Modelling insurers’ balance sheet in stress

The PRA specifies the scenario assumptions and a common methodology for firms to apply and relies on the firms to undertake the modelling and analysis required. Firms are required to set out their modelling approaches and any assumptions made (beyond those set out by the PRA) in their ‘Results and Basis of Preparation’ qualitative report submissions.

The PRA performs quality assurance, and validation of firms’ stress test submissions, to ensure that the methodology and scenario has been applied appropriately and consistently, with resubmissions requested where this was not the case. The PRA does not overlay or substitute firm submissions with any PRA-modelled results.

The stresses for all stages are applied to firms’ 31 December 2024 balance sheets.

Solvency UK regulatory framework

In the LIST 2025 results, firms are asked to reflect the new Solvency UK regulatory framework in place at year-end 2024.

Acknowledging that this is the first time insurers are applying the new Solvency UK regime in a stress test context, the PRA recognises that many firms may still be updating their internal models or enhancing approaches to attestation on the adequacy of the FS and voluntary FS increases (see Box 1).

To accommodate this transitional phase, LIST 2025 allows certain simplifications in the treatment of new regulatory features. For example, for the purposes of consistency, firms are asked not to change their 31 December 2024 voluntary FS increases as part of their submissions.

Individual legal entities versus group

The LIST 2025 exercise focuses solely on the solvency positions of individual UK insurance legal entities. These insurers are often part of a wider group, and the results make no allowance for parental support to the regulated entity. The PRA will consider how to extend the stress testing methodologies to cover insurance groups in future exercises.

Prescribed rebalancing

To capture the fact that firms manage their business to a credit risk appetite, LIST 2025 instructions ask all firms to rebalance 25% of each MA portfolio downgraded assets to their original rating, at a prescribed cost, in Stage 3 of the scenario. This rebalancing involves the sale of downgraded assets and the purchase of assets of the original credit rating.

This prescribed rebalancing aims to capture the gradual return to pre-stress credit quality in a simplified but consistent and comparable way across firms.

Management actions

To help provide comparability between firms, the PRA also defines a specific set of management actions that firms are able to take credit for in the exercise (see Annex 1 in LIST 2025: Scenario specification, guidelines and instructions).

The extent to which participating firms choose to use management actions permitted in the exercise varies according to their individual strategies for managing their balance sheets and capital position. Consequently, some firms elect not to use permitted management actions available to them.

Some other potential management actions that firms are not allowed to take credit for in LIST 2025 exercise are new reinsurance arrangements, new capital raises or injection of capital from shareholders, where part of a wider group. In practice, firms may be able to use some of these additional management actions depending on the nature and extent of any actual stress scenario.

Transitional measure on technical provisions (TMTP)

TMTP is a transitional adjustment to insurers’ technical provisions for business written before the introduction of Solvency II. The LIST 2025 results are reported after the recalculation of TMTP. While TMTP remains an integral component of firms’ own funds, dampening the impacts of a financial stress, its materiality has reduced significantly following Solvency UK reforms to the risk margin in 2023 (which reduced both its size and sensitivity to changes in interest rates), and the move to a higher interest rate environment.

In aggregate, the participating firms recognise £4.7 billion of TMTP benefit at 31 December 2024 (around 5% of eligible own funds) and £5.2 billion following the LIST 2025 core scenario. This represents a material reduction since the LIST 2022 exercise, where the amount of TMTP represented 22% of eligible own funds at 31 December 2021.

2: Core scenario: overview of results

2.1: Headline sector results

The results of this exercise indicate that the major UK life insurers are resilient to a severe but plausible financial markets stress scenario that incorporates a decline in risk-free interest rates, falls in equity and property prices, along with widening spreads and subsequent defaults and downgrades.

LIST 2025 core scenario is a severe stress, with the credit stress alone accounting for £12.9 billion of assets downgraded to sub-investment grade across participating firms. The scenario results in a reduction in aggregate surplus above the regulatory capital requirements from £30.5 billion to £21.9 billion (31 percentage points reduction in SCR coverage ratio).

Owing to their strong starting capital position, reflected in an aggregate 31 December 2024 SCR coverage ratio of 185%, insurers have sufficient resources to withstand the shocks of this severe but plausible scenario.^{footnote [4]} The aggregate SCR coverage ratio at 154% following the stress remains well above regulatory requirements. All participating firms continue to meet their regulatory capital requirements at each stage of the financial market stress.

Movement in both eligible own funds and solvency capital requirements contribute to the reduction of the aggregate SCR coverage ratio, with the eligible own funds reducing by 6% and the SCR increasing by 13%.

The PRA defines a standard set of management actions that participants can choose to apply in stress. Not all firms choose to recognise management actions in their own results, but in aggregate, management actions improve the SCR coverage ratio by 5 percentage points.

Chart 2: Movement in sector aggregate SCR coverage ratio^(a)

Footnotes

• Sources: Participating insurers’ LIST 2025 submissions and PRA calculations.
• (a)The sector aggregate SCR coverage ratio is the aggregate of participants’ eligible own funds divided by the aggregate of their SCRs. It allows for recalculation of TMTP at each stage.

Chart 2 illustrates how the industry’s aggregate SCR coverage evolves across the stages of the core scenario:

• Stage 1 – Initial market shock: SCR coverage declines by 5 percentage points to 180%, indicating that firms’ solvency remains resilient to the immediate financial market shocks. In this stage, the initial reduction in SCR ratio is primarily driven by the fall in interest rates, largely offset by the impact of widening spreads (the impact of widening spreads is further illustrated in Annex 3).
• Stage 2 – Developing market shock: SCR coverage drops significantly to 154%, reflecting exposure to credit rating downgrades and defaults on bonds and falls in residential property values – key asset classes used to generate cash flows for annuity payments to policyholders.
• Stage 3 – Markets stabilise: SCR coverage is unchanged at 154%. This is largely due to management actions offsetting the impact of narrowing spreads and the prescribed portfolio rebalancing.

These results highlight the sector’s sensitivity to the interest rates down stress, credit rating downgrades and defaults, as well as property stresses.

2.2: Key drivers of the results

Downgrades and defaults

The impact of downgrades and defaults in the stress scenario is one of the largest drivers of change in SCR coverage. When the assets that the insurer holds are downgraded, the MA benefit decreases, resulting in lower own funds (see Annex 3 for further details on the MA as a feature of the Solvency UK regulatory regime). In addition, the downgraded assets attract a higher capital charge compared to their credit ratings prior to the stress, which increases the firm’s SCR. Defaults directly reduce an insurer’s own funds because the insurer has to replace the defaulted asset, and is assumed to receive only a fraction of the value through recovery.

Consequently, firms’ SCR coverage declines driven by both the increase in SCR and the reduction in own funds.

Property stress

The impact of the property price fall in the stress scenario is a large driver of change in SCR coverage. This is principally a result of the residential property price fall, which reduces the value of firms’ ERM holdings. The impact also extends to ERM securitisations that must meet the PRA’s Effective Value Test (EVT), which fully accounts for the increased cost of the ‘no negative equity guarantee’ (NNEG) following the residential property stress.^{footnote [5]} The EVT is one of the guardrails used by the PRA to protect policyholders by ensuring insurers meet strict standards on valuation and matching long-term liabilities with these types of assets.

The impact from the commercial property price shock is less significant, because these holdings tend to be indirect – for example, as security for loans and bonds, which were subject to the downgrade stress instead.

Interest rates fall

The fall in interest rates increases the present value of annuity liabilities and their backing assets; this increases the balance sheet, resulting in higher capital requirements. The SCR increase is partially offset by an increase in own funds, as firms hold additional assets or derivatives to limit this risk. The overall effect is a decrease in SCR coverage ratio.

Falling inflation expectations

A significant portion of UK life insurers’ liabilities relates to the payment of pensions and annuities, many of which include future increases linked to inflation. Insurers typically mitigate this exposure by holding assets that closely match the inflation-linked nature of these liabilities. The LIST 2025 results show a low impact from the inflation stress, confirming the effectiveness of the current matching in this scenario.

Management actions

Firms have applied permitted management actions in line with their capital management strategies and investment risk appetites.

In aggregate, management actions increase the post-stress SCR coverage ratio by 5 percentage points. Firms assume a diverse set of permitted management actions, including reallocation of assets from shareholder funds to MA portfolios and associated repositioning of hedges (for example, interest rate hedges).

Several firms have also applied actions to de-risk their portfolios as market conditions improve in Stage 3, however the use of such trading management actions is limited. In addition to the £3.4 billion sub-investment grade bonds sold (PRA estimate), as a result of the portfolio rebalancing prescribed by the scenario, the sector trades a further £0.9 billion sub-investment grade bonds for higher rated assets.

Prescribed rebalancing

The LIST scenario prescribes rebalancing as a means of representing, in a simplified way, the expectation that firms will gradually rebalance their bond and loan portfolios back towards the original credit quality. This creates a cost, as the firm has to sell lower quality bonds and replace them with more highly rated ones. In the LIST 2025 scenario, this cost reduces eligible own funds by £0.8 billion (after tax). At the same time, the impact on the SCR coverage ratio is modest, with only a 1 percentage point drop. This is because of an offsetting effect of lower capital requirements as a result of the improvement in assets’ credit quality.

The limited benefit, under the new Solvency UK regime, of rebalancing in stressed, illiquid conditions was noted by many firms as an important finding in LIST 2025.

With-profits funds

Some of the firms participating in LIST operate with-profits ring-fenced funds.

The often substantial own funds held within these ring-fenced arrangements cannot be used to absorb losses elsewhere in the firm. The regulatory SCR coverage reflects this by excluding any surplus eligible own funds above the SCR for these ring-fenced segments. However, this surplus still provides protection against losses arising within the ring-fenced funds themselves.

The exclusion of surplus eligible own funds for with-profits funds can result in a lower regulatory SCR coverage ratio. Consequently, firms with significant with-profits businesses typically target lower regulatory SCR coverage compared to those without. Some of the firms publish metrics additional to the regulatory SCR coverage ratio. These metrics provide shareholders and with-profits policyholders with information on the fund in which they have invested, and may be used by firms to support their management of the business.

In a stress, this exclusion of surplus own funds from the regulatory SCR coverage ratio can dampen the impact of the scenario, depending on the financial strength of the with-profits funds. The magnitude of this effect on the regulatory SCR coverage ratio, compared to firms with no with-profits business, will depend on both the size, indicated by the share of a firm’s total SCR attributable to this business, as well as the risk profile of the with-profits fund.

3: Qualitative findings

Governance and quality assurance

Firms were required to provide confirmation by a holder of a Senior Management Function (SMF) that: (a) the results had been subject to internal challenge and discussion and the CRO had provided the holder of the SMF with assurance that the results are of sufficient standard for the board to be able to place reliance on them as providing a reasonable representation of the firm's financial position following the PRA scenarios; and (b) the results are of a standard equivalent to that which is sufficient for unaudited public disclosure (for example, forward-looking financial statements). All participating firms provided evidence of meeting these requirements.

Overall, the PRA welcomes greater board visibility and engagement in this area, compared to LIST 2022. All participants in LIST 2025 provided evidence of board scrutiny and discussion.

Operational insights

Many insurers recognised the benefits of having developed – or continuing to develop – enhanced stress testing capabilities as they participate in the PRA-run exercises. These enhanced capabilities, particularly in testing multivariate stresses, allow firms to explore a broader range of scenarios. This, in turn, helps to identify more complex risk exposures and manage those risks more effectively. For example, the impact of small mismatches can be significantly amplified under a multivariate stress scenario compared to assessing individual risks in isolation.

The participants indicated that they intend to use results of the stress test in their own risk and solvency assessment (ORSA) and recovery plan processes, particularly to inform the further development of management actions and hedging strategies.

Annex 1: Exploratory scenario findings – asset concentrations

The growth in the BPA market, coupled with additional flexibility provided by Solvency UK reforms to permit a wider range of assets in insurers’ MA portfolios, has the potential to further accelerate changes in firms’ asset exposures. As a result, the PRA included an exploratory scenario on asset concentrations, to test the industry’s ability to model and assess idiosyncratic asset risks and financial implications of concentrated exposures.

The 2025 exploratory asset concentration scenario applies an additional (to stresses in the core scenario) 20% credit rating downgrade shock to the most material asset class within firms’ MA portfolios, other than corporate and sovereign credit exposures. The definition of asset classes is based on classifications specified by the PRA for the Matching Adjustment Asset and Liability Information Return (MALIR) set out in section 10.83 of Chapter 2A of the Reporting part of the PRA Rulebook. The asset class for each individual firm has been subject to PRA agreement.

This scenario is exploratory and does not target any particular level of likelihood.

Key findings

All firms demonstrate their ability to undertake the granular modelling required to assess the financial impact of asset class concentrations within their portfolios.

For a number of firms, the largest asset class concentration is in ERMs, which on average accounts for 16% of the MA portfolio asset value. Under the scenario specification, this results in around 3% of their MA portfolio assets being subject to downgrade. Other classes subject to the additional downgrade stress across LIST participants are Social Housing, Ground Rent, Financing Lease on Commercial Properties (including sale and leaseback loans) and Other Commercial Real Estate Lending (CREL).

The additional downgrades in this scenario result in the aggregate SCR coverage across all firms falling by only 1 percentage point from 154% (in the core scenario) to 153%.

While this outcome may indicate that firms’ portfolios are well-diversified, this interpretation should be treated with caution for the following reasons:

• No correlation across asset classes: The scenario design applies a downgrade stress to an individual asset class based on MALIR definitions in isolation, rather than to all assets that could be impacted by similar risk factors and therefore exhibit correlated performance. For example, the scenario assumes no correlation between income-producing real estate, commercial real estate loans, student accommodation, and commercial property leases. Therefore, the results are likely to underestimate the impact of concentrated exposures and interconnected risks in practice.
• Varying sensitivity to downgrades: Asset classes with higher concentration in lower-rated bonds have more material sensitivity to credit downgrade stress. This underscores the need for insurers to maintain enhanced credit risk monitoring capabilities and prudent management of credit concentrations, especially for asset classes and portfolios with substantial allocation to lower-rated assets.
• Portfolio flexibility: When only a small proportion of the portfolio is affected by downgrades, there is greater flexibility to switch out the downgraded assets for other suitable annuity-backing assets, while maintaining the matching tests. This can limit any reduction in the MA or increase in the SCR, mitigating the overall impact.

The PRA plans to consider these issues and limitations further in future LIST scenario design.

Annex 2: Exploratory scenario findings – FundedRe recapture

The implications of the growing use of FundedRe remain high on the PRA’ supervisory and policy agenda. The Financial Policy Committee (FPC) has previously expressed concerns that FundedRe risks creating a systemic vulnerability in the form of a large concentrated exposure to correlated, credit-focussed counterparties. While it judged in 2023 that the risks to UK financial stability from the use of funded reinsurance arrangements by UK insurers were limited, it noted that rapid growth in volumes and complexity of these arrangements could generate risks in the future. In July 2024, the supervisory statement (SS) 5/24 – Funded reinsurance set out the PRA’s expectations on firms’ management of risks from FundedRe. The PRA is also considering, in line with the speech given by the Director of Prudential Policy on 18 September 2025, whether further action is needed to ensure the regulatory capital treatment of FundedRe transactions is appropriate.^{footnote [6]}

The PRA used the LIST 2025 exercise as a complementary way to test industry’s ability to assess and monitor the impact of recapturing the transferred risks under stressed conditions. For this exercise, firms using FundedRe were required to show the impact of recapture of all FundedRe arrangements with their most material counterparty, following the stresses in the core financial markets scenario. The chosen counterparty of the FundedRe recaptured is the one expected to have the largest adverse impact on the SCR coverage ratio at the immediate point of recapture, and subject to PRA agreement.

This scenario is exploratory and does not target any particular level of likelihood. Only insurers with material FundedRe exposure participated in this scenario.

Key findings

Collectively, firms’ results show the recapture of £12.3 billion of liabilities in the scenario, representing approximately 50% of their aggregate FundedRe exposure as at 31 December 2024. The recapture increases their MA portfolio net liabilities by approximately 6%.^{footnote [7]}

The aggregate SCR coverage for the firms recapturing FundedRe falls by 10 percentage points – from 154% (in the core scenario) to 144%. A 6% increase in SCR was the main contributor to the SCR coverage decline. Eligible own funds decreased by 1% with most of this reduction driven by an increase in the risk margin.

The impact of this scenario reflects the collateral composition, and scale of FundedRe exposures at 31 December 2024. The PRA instructed firms, when applying asset stresses from the core scenario, to make no allowance for any forward-looking changes to the investment mix on recapture of actual assets held in collateral pools at 31 December 2024. Most of this recaptured collateral was assessed by participating firms to be MA-eligible, enabling direct placement in firms’ MA portfolios. This is an important factor mitigating the impact of FundedRe recapture in the LIST 2025 results.

The scenario also does not apply any currency stress to recaptured collateral. A currency stress with sterling appreciating against other currencies would have increased the impact of the stress, as a high proportion of collateral was US dollar denominated assets.

Recapture increases the levels of risk already on firms' balance sheets (primarily credit and longevity risk); this impact is not always proportional to the size of the recaptured liabilities. While the results from this exploratory exercise indicate that participants are resilient to the failure of their most material FundedRe counterparty (based on December 2024 exposure levels), it also shows the potential non-linear impact if the proportion of FundedRe exposure grows or the collateral backing those becomes more complex and illiquid, and less suitable for the MA portfolios. This highlights the continuing importance of firms’ own stress testing of recapture risk in line with the PRA’s expectations in SS5/24.

The results provide insights into firms’ approaches to modelling FundedRe recapture under stress, including their ability to apply a look-through approach to stressed collateral and considering costs of rebalancing and trading management actions (such as entering new cross-currency hedges) required to move the recaptured assets into the MA portfolio. The PRA will follow up with individual firms where improvements in the methodology are needed.

Overall, the findings underscore the mitigating effect of MA-eligible assets in the current collateral pools, highlighting the importance of robust collateral risk management. The exercise also identified some gaps in how firms consider and allow for the costs of recapture, which will become increasingly important in the event of continued growth in the use of FundedRe and potential changes to the underlying collateral. These findings will inform future policy work in this area.

Annex 3: Dynamics of the Matching Adjustment through a credit stress scenario

Rationale for the MA

The MA is an important feature of the Solvency UK prudential regime. Insurers can apply to the PRA to use the MA for certain long-term business such as annuities. The effect of the MA is a valuation approach for eligible liabilities that neutralises the impact of short-term volatility in spreads on the matching assets.

The prudential rationale for the MA is to recognise that insurers with long-term liabilities (such as annuities) can be buy-and-hold investors: provided they match the cash flows of their assets to those of their liabilities, they should be able to avoid selling these assets prior to maturity. They are not therefore exposed to changes in the market price of credit risk in the same way as other investors.

As a result, the MA acts to reduce volatility in insurers' capital positions, which would otherwise create the potential for procyclical investment behaviour in the event of short-term movements in market prices. It provides a strong incentive for life insurance firms to match their asset and liability cash flows, which reduces prudential risks. 

Mechanics of the MA

The MA framework includes an allowance for the risks retained by the insurer on the assets matching its liabilities.

The MA is applied as an increase to the liability discount rate. It is calculated by deducting a fundamental spread (FS) from the spread on the assets held by insurers to back their MA liabilities. This deduction then leaves part of the return on matching assets for firms to recognise up front, on the basis that part of the return reflects risks to which a buy-and-hold investor is not exposed – liquidity risk for example. The FS is intended to capture the compensation for risk of default or downgrade of an asset – to which even a buy-and-hold investor is exposed.

The size of the FS depends mainly on the assets’ credit rating or a comparable internal credit assessment by a firm. The PRA publishes an FS for different asset types in accordance with a methodology and calibration set out in legislation.

Under Solvency UK, the PRA requires a senior manager of firms applying the MA to attest annually to the PRA that the MA can be earned with a high degree of confidence, and that the FS used by the firm reflects compensation for all retained risks on their actual portfolio of assets. The purpose of this is to ensure that firms are accountable for the MA being applied. Where firms judge the standard levels of published FS to be insufficient for their retained risks, they may choose to increase the FS.

Illustrating MA evolution through a credit stress

The Chart A3.1 shows how the MA portfolio spread, FS and MA move through the credit stress in the core scenario in LIST 2025. This provides an illustration of how these metrics can be expected to change in a similar real-life credit stress event.

In combination with Chart 2, this shows how the regime helps insulate insurers’ regulatory balance sheets from the impact of short-term credit spread movements, until there is a crystallisation of credit risk (reflected by downgrades and defaults) that would reduce the security of cashflows projected to meet policyholder obligations and which therefore needs to be reflected in the regulatory balance sheet.

Chart A3.1: MA evolution in LIST 2025 core scenario^(a)

Footnotes

• Sources: Participating insurers’ LIST 2025 submissions and PRA calculations.
• (a) Sector aggregate metrics are simple average of participating insurers’ results. For the purposes of LIST 2025, the firms were asked not to change their 31 December 2024 voluntary FS increases in stress.

Stage 1 – initial volatility in spreads

In Stage 1 of the scenario, spreads increase suddenly, resulting in the value of assets reducing. The reduction in the asset value would be directly relevant to an investor needing to sell the asset at that time; in contrast, an insurer with MA approval holds assets with cashflows matching liability obligations to policyholders and therefore the risk of needing to sell an asset before its maturity date is very low.

This is reflected in the MA framework. The published FS does not change in response to short-term fluctuations in asset prices without a change in credit rating; and the increase in spreads directly results in higher MA. The higher MA acts to counterbalance the fall in asset values – essentially a ‘look-through’ approach to short-term volatility. It results in lower Technical Provisions (TPs) that represent an insurer’s policyholder liabilities.

The own funds (which are based on the excess value of assets over liabilities) decline but only by a small amount, as the fall in TPs offsets most of the fall in asset values. The smaller balance sheet leads to a reduction in solvency capital requirements (SCR). This reduction is proportionately more than the reduction in own funds and as a result, SCR coverage improves (see ‘Spreads widening’ in Chart 2).

In the stylised LIST 2025 scenario, the assumption that the FS applied by the firms does not change following spreads widening is a simplification. Under Solvency UK regime, firms have the ability to increase the FS beyond the published level in an actual stress, if they judge that the increase in spreads reflects an increase in retained risk (for example, credit risk). Such voluntary FS increases would result in lower MA and dampen any benefit of spread widening.

Stage 2 – crystallisation of credit risk

Stage 2 illustrates how a crystallisation of credit risk, accompanied by reduction in credit ratings and increased defaults, leads to a direct reduction in insurers’ SCR coverage.

When the assets that the insurer holds are downgraded reflecting that the assets’ credit quality has reduced, there is a consequential increase in the FS. This reduces the MA and in turn increases the value of TPs and results in lower own funds. In addition, downgraded assets will attract a higher capital charge and so a firm’s SCR will increase. Consequently, SCR coverage declines, driven by both the increase in SCR and the reduction in own funds (see ‘Downgrades and defaults’ in Chart 2).

Stage 3 – markets start to stabilise

In Stage 3, two main effects drive changes in the MA portfolio as the credit markets start to stabilise (see ‘Spreads narrowing’ and ‘Rebalancing’ in Chart 2).

First, as spreads begin to fall, some of the impacts from spread widening that took place in Stage 1 are partially reversed. Lower spreads result in higher asset values. In the absence of further rating changes, the FS does not change and the decrease in spreads directly results in a lower MA and a lower liability discount rate. This increases TPs but by less than the increase in asset values, leading to some improvement in own funds. The larger balance sheet results in an increase in SCR that is proportionately higher than the increase in own funds. As a result, SCR coverage declines.

Second, the scenario requires a gradual (25%) rebalancing of a firm’s portfolio back to higher rated assets. This involves selling lower rated, higher spread assets (which typically attract a higher overall level of the MA) and reinvesting in higher rated, lower spread assets (which typically attract a lower level of the MA). As a result, rebalancing further reduces the MA of the overall portfolio, leading to a higher value of liabilities and a fall in own funds. While the SCR reduces due to improvement in the overall credit quality of the MA portfolio, the fall in own funds is more material and SCR coverage declines further.

Table A3.A summarises the drivers of the SCR coverage ratio changes explained above.

Concluding remarks on the MA

The three-stage progression of the credit stress scenario illustrates the role of the MA mechanism in the Solvency UK framework.

The regime design recognises that UK life insurers should not need to be forced sellers of assets following short-term fluctuations in the value of the assets in their MA portfolio. However, once falls in MA portfolio asset values are accompanied by defaults and credit rating downgrades, this leads to a direct reduction in insurers’ SCR coverage ratios. Insurers also have the ability to respond to any increased asset vulnerabilities in the period between initial spread widening and credit rating changes, through voluntary changes to the FS.

Finally, Stage 3 in LIST 2025 scenario underscores the adverse impact of a slow and partial recovery, with the overall credit quality of the MA portfolio remaining lower than before the stress.

Together, these stages emphasise the importance of proactive risk management and robust stress testing to ensure insurers remain resilient across the full credit cycle.