PRA sets out best practice for insurer management of solvency-based Termination Rights in buy-ins

On Friday 4 July, the PRA wrote to the Chief Risk Officers of all UK insurers writing bulk annuities.

The letter says that “most firms need to do more to demonstrate they have adequately considered the full range of risks” of providing solvency-based termination rights in Bulk Purchase Annuity (BPA) contracts (i.e. buy-ins). This follows the PRA flagging in January that they planned to look at such rights more closely over 2025. 

But what does this actually mean for schemes who are considering entering into, or already have, a buy-in contract?  

• A solvency-based termination right gives the Trustees an option to terminate the buy-in and take back a return of premium (potentially less a haircut) if the insurer breaches a pre-agreed solvency level and doesn’t fix it within a set period. Exercising the option means the scheme receives a transfer of assets from the insurer and either has to replace the buy-in or run-on for a period.     
• Solvency-based termination rights have been relatively common for larger transactions historically but insurer appetite has reduced in recent years and they are now rarely offered for schemes below £1bn. The PRA states that c£50bn of buy-ins to date have included solvency-based termination rights. 
• On the back of the PRA’s letter, we expect that insurers will remain very selective over where they agree to provide solvency-based termination rights. The letter encourages insurers to set exposure limits to such termination rights which could further limit insurers’ ability to offer them.    
• Large schemes need to think very carefully about whether they request solvency-based termination rights when approaching the market and, if it is an important feature for them, they are able to clearly articulate why. 
• The letter also highlights a range of areas for insurers to consider around the application of such rights (e.g. around timings and flexibility over the asset portfolio paid). These are all areas which the insurers have been very much on top of in our conversations but it might lead them to being less accommodating in the contractual terms they are prepared to agree. Negotiating the key contractual terms ahead of exclusivity will continue to be important. 
• The letter does not cover termination rights that may be offered in other scenarios, for example where an insurer has failed to pay the monthly pension payroll. These basic termination rights tend to be more common (but again only on larger transactions) and it could be read that the PRA does not see them as a particular area of concern, given they have not been highlighted.  
• The letter has no direct impact on schemes that already have termination rights in place. Indeed, the letter may give them increased confidence that the termination right will be met in the (unlikely) event it ever needed to be used. 

The decision to request termination rights has always been something we approach with care at LCP. Termination right can offer an individual scheme valuable optionality, but there are already strong protections for policyholders in the insurance regime and termination rights introduce risks for the insurer which could lead to wider instability if not managed effectively by insurers. 

A key theme in the PRA’s letter is insurers being able to avoid the infamous “run on the bank” scenario. Insurers need to be able to manage the impact on their residual asset portfolio when terminations occur – in terms of concentration of asset risks and illiquidity – particularly where several terminations could occur simultaneously (eg if multiple buy-ins have the same solvency trigger levels). 

We very much welcome the PRA highlighting these risks and continuing to be proactive to an ever-changing BPA market.