The PRA's Letter to Chief Risk Officers on Solvency-triggered Termination Rights

The Prudential Regulation Authority ("PRA") has issued a letter, dated 4 July 2025, to Chief Risk Officers of life insurers active in the bulk purchase annuity ("BPA") market. The letter focusses on the use of so-called "solvency-triggered" termination rights ("STTRs") in BPAs.

This communication follows a thematic review by the PRA and sets out its concerns, its expectations and the next steps for insurers. In particular, the PRA is concerned that the widespread exercise of STTRs could introduce significant risks to insurers' balance sheets, particularly in periods of financial stress. In addition to a number of mitigation actions, a key requirement is that the PRA now expects prompt notification of any new BPA transactions containing STTRs.

In this client alert, we summarise the letter, its background and some wider thoughts with respect to this theme.

Background and Context

STTRs in BPAs are not new, but the PRA rightly identifies that there has been growing demand for them from defined benefit pension scheme trustees in recent years. These rights allow trustees to terminate a BPA if the insurer's "solvency position" – meaning its capital coverage ratio i.e. the ratio of own funds to its solvency capital requirement ("SCR") – falls below a specified threshold (e.g. 100% of its SCR) and is not cured within an agreed period. On termination, the insurer must pay the trustees an agreed termination amount ("Termination Amount").

The PRA estimates that UK life insurers' total exposure to STTRs now stands at around £50 billion, with some firms holding a material proportion of their Matching Adjustment portfolios subject to these termination provisions.

Key Risks

The PRA's letter highlights several potential risks to insurers associated with STTRs, including those summarised below. The PRA expresses doubt that it is possible to mitigate such risks fully and that this "should influence insurers' approaches to offering STTRs in large volumes".

• Liquidity Impact: Insurers may face liquidity challenges if required to transfer Termination Amounts comprising a disproportionate share of liquid assets, especially in stressed market conditions. This liquidity risk could be accentuated by any uncertainty around the insurer's ability to transfer illiquid assets to the trustees in a period of stress, given the relative complexities in transferring illiquid assets.
• Asset Concentration: The composition of Termination Amounts could lead to increased asset concentration in insurers' residual portfolios, potentially breaching internal limits or regulatory requirements. Where the insurer has funded reinsurance arrangements in place, this risk could be accentuated if there are any timing/other issues with respect to the collateral to be recaptured under that funded reinsurance arrangement i.e. if the collateral is not received in time and/or is not able to form part of the Termination Amount payable to the trustees.
• Contractual Ambiguity: Unclear or ambiguous STTR terms may give rise to disputes, particularly regarding asset valuation, transferability and cost allocation.
• Operational Challenges: The execution of STTRs during periods of financial stress could strain management resources and complicate recovery actions.
• Resolution: The potential for mass STTR terminations could adversely impact firms' resolution planning and the viability of liability run-off.

Risk Management

The PRA acknowledges that some firms have taken steps to mitigate these risks, such as preserving flexibility over the asset composition of Termination Amounts and aligning contractual provisions with the timetable for expected buy-out. However, the PRA concludes that most firms need to do more to demonstrate comprehensive risk management, including:

• Contractual terms. Ensuring contractual terms allow sufficient flexibility to shape Termination Amounts in line with the underlying asset portfolio.
• Exposure limits. Setting and monitoring aggregate exposure limits to STTRs, grounded in scenario analysis of both the associated liquidity impact and the impact on asset concentrations.
• Funded reinsurance. Whilst the PRA acknowledges that insurers have considered sequencing and interaction with funded reinsurance, it emphasises that it would be prudent to assume a "worst case" scenario for funded reinsurance collateral return. In addition, insurers should reflect the impact of needing to retain such collateral if it is not included within the Termination Amount.
• Resolution Planning. The PRA notes that the potential impact of STTRs on resolution planning was not being fully considered.
• Assurance. Increased assurance that contractual terms will operate as intended, with clear dispute resolution mechanisms.
• Implementation planning. The PRA underlines the need for advance planning and having a termination plan in place.

Matching Adjustment (MA)

The PRA also reminds firms that the contribution of the MA portfolio to the composition of any Termination Amount should be limited to the amount of assets that the MA portfolio holds in respect of the relevant BPA. In this regard, the PRA notes: "Including that contract's contribution to the….SCR in the cost neutrality assessment would be appropriate only in exceptional circumstances." In assessing the impact of STTRs on MA eligibility, the PRA encourages insurers to consider:

• The amount payable from the MA portfolio.
• The impact on the MA portfolio of one or multiple terminations.
• Any detrimental impact for policies remaining in the MA portfolio post termination.
• Any reliance on support from the non-MA portfolio.

Some wider thoughts

As noted at the top of this article, STTRs have been around for a long time in BPAs and the typical STTR package has become increasingly refined. It is interesting and instructive to consider certain other perspectives and sub-areas of this topic:

• The fact that STTRs in the BPA space have, according to the PRA's letter, never been tested is testament to the robustness of life insurers. This is particularly so given the threshold is commonly set at a 100% SCR capital coverage ratio. In general, the life sector has a very good record on insurer failure and the PRA's strong resolution and recovery regime provides further comfort here.
• While it is clearly right to be focussed on the interaction of collateral recapture under funded reinsurance and the Termination Amount required to be paid pursuant to the exercise of an STTR, as a wider point it is important not to overlook the benefit that collateralised funded reinsurance clearly brings to an insurer in such a termination scenario. Again, the PRA's strong focus on funded reinsurance provides further comfort here.
• What is the actual termination amount payable by a life insurer following the exercise of an STTR? Is such an event properly considered as insurer-fault, or should it be seen as something sitting between that and a more "neutral" event? If the negotiated position on a given transaction is that it is not an insurer-fault event, such that the insurer can return the liabilities for a reduced amount, what is the impact on the insurer – and its capital coverage ratio – if it is paid?
• The trustees' perspective: the position of the trustees and, more importantly still, the members of often very large pension schemes, does not seem to be at the core of the debate. Trustees and their advisors, particularly on very large deals, will likely and understandably push for such termination rights. The rationale being dual-pronged: first, that the breach of the trigger (which will come hand in hand with a notification requirement) will thus provide the trustees with "early warning" of the insurer's potential impending failure. Second, of course, that the termination right will give them a contractual right to an early exit. However, there are some associated points to consider here:
  
  • With regard to the "early warning" benefit, in practice, the position is somewhat more nuanced: some insurers, particularly those that are listed, will often look to tie the solvency termination trigger to their publicly available capital coverage ratio. This essentially means the ratio of own funds to SCR as reported – annually – in an insurer's Solvency and Financial Condition Report. By definition, if the trustees' contractual right is only to be notified of this and of any interim position communicated publicly (i.e. on a major deterioration, through a release to the market), then there is less substantive early warning.
  • As to the second benefit, as noted above, key to this is the termination amount that the trustees would actually receive. During the period of buy-in, the trustees will be paying their members directly, in reliance on cashflows purchased by way of a one-off premium already paid to the insurer. If the termination amount received is insufficient to purchase alternative cover, the trustees will then be faced with a decision as to whether to "get out early" with a shortfall or whether it is better to rely on the PRA's insurer resolution procedures and safeguards and, ultimately, FSCS protection for its members. The trustees would also need to consider the length of time required to receive the Termination Amount and to find alternative cover. The latter is unlikely to be a quick or easy process. Still, the termination right does give the trustees a choice.

For further information or advice on the implications of the PRA's expectations when it comes to STTRs, please contact Tom MacAulay and George Belcher, partners in our Global Insurance Industry Group, or Ali Siddiqui, Associate in our Global Insurance Industry Group, or your usual Mayer Brown contact. We will be following up in due course with a wider client alert on the position and security of a scheme member in the context of a BPA (buy-in and buy-out) as compared with the member's position on a run-on basis.