Five key questions trustees should ask about insurer financial strength

Choosing the right insurer for a buy-in transaction is one of the most significant decisions that trustees of a defined benefit scheme will ever make. It’s essential to understand how the insurer and the UK regulatory regime will deliver long-term security for your members.

While it can offer clear benefits in terms of security, the setup of insurers is highly complex and the regime is not intended to be a zero-failure regime. How can trustees and sponsors ensure they’re making informed and confident decisions? By asking the right questions.

I have set out below the five key questions I think that all trustees and sponsors should be asking their advisers when assessing insurers’ financial strength.

1. How robust are the insurers’ solvency reserves?

Solvency capital is the cornerstone of financial strength. An insurer’s ability to meet its obligations under stressed conditions by holding loss-absorbing capital is a vital measure of its long-term stability. Before transacting you should examine:

• Solvency metrics: How does the insurer’s Solvency Capital Ratio (SCR) compare to industry benchmarks?
• Capital adequacy: Does the insurer hold sufficient reserves beyond regulatory minimums?
• Stress testing: Has the insurer demonstrated resilience under adverse market conditions?

Assessing the robustness of solvency reserves allows trustees to gauge the insurer’s capacity to meet commitments, even under stress and volatility.

2. How does the insurer manage its risk sensitivities?

Insurers are exposed to various risks, from market fluctuations to operational challenges. Areas of investigation for your potential insurer counterparty should include:

• Investment portfolios: What type of assets is the insurer holding and what risks does this give rise to? Are assets diversified and aligned with the insurer’s liabilities?
• Reinsurance arrangements: Does the insurer rely heavily on funded reinsurance, and what are the associated risks?
• Credit risk: How exposed is the insurer to defaults or downgrades?

By understanding these sensitivities, you can understand the factors that might impact the insurer’s strength over time.

3. What does the insurer’s ownership structure mean for its financial strategy and resilience?

The ownership structure of an insurer—whether public, private, or mutual—can have significant implications for how it accesses and uses capital. Trustees should consider:

• Access to capital: How easily can the insurer raise additional funds in times of stress? For example, all of the insurers currently in the market are likely to be able to raise further capital through issuing debt but publicly listed insurers typically have more reliable long-term access to equity capital.
• Use of surplus capital: Does the insurer retain surplus capital to strengthen its solvency levels, or is this used for other purposes, such as shareholder dividends?
• Long-term stability: How does the ownership model impact decision-making and the insurer’s ability to manage risks over time?

Understanding the implications of an insurers ownership structure provides trustees with valuable insights into its financial resilience and strategic priorities.

4. What protections does the Solvency II framework offer?

Whilst understanding an insurer’s financial strength is crucial, trustees are ultimately relying on the Solvency UK framework (previously Solvency II until this year) and the effectiveness of the Prudential Regulation Authority’s (PRA) supervision to ensure the insurers are financially resilient, not just at outset, but over the long-term . Therefore understanding how this regulatory regime works is vital for informed decision making.

Key elements of the regime include:

• Governance and oversight: The PRA ensures that insurers appoint suitably qualified individuals to key roles and maintain effective governance structures.
• Close supervision: Large insurers are closely monitored by dedicated teams at the PRA, providing oversight tailored to the insurer’s risk profile and activities.
• Capital management: The PRA oversees capital management practices, including the approval of dividend payments, to ensure that insurers maintain adequate reserves to protect policyholders.

By understanding these safeguards, trustees can gain greater confidence in the regulatory regime’s ability to protect member benefits and manage long-term risks effectively.

5. How does your insurer counterparty compare to others in the market?

Financial benchmarking of key metrics between insurers can help trustees and sponsors understand how different insurers are positioned in terms of capital adequacy and risk resilience. Key indicators to consider include:

• Solvency ratios
• Investment portfolio composition
• Credit ratings

Conclusion: Asking the right questions is the first step

For trustees and sponsors, selecting the right insurer is about more than ticking boxes—it’s about securing the future of your scheme and protecting member benefits. By asking these five critical questions, you’ll be better equipped to navigate the complexities of the buy-in market and have confidence in what is, for many trustees, the most important decision they will ever make.

While financial strength is a critical component, trustees and sponsors should also assess other aspects such as the insurer’s administration capabilities and ESG credentials. These factors can significantly impact member experience and ensure alignment with the scheme's broader values and priorities.