2  All speeches are available online at www.bankofengland.co.uk/publications/Pages/speeches/default.aspx  2  I see four main risks: 1. longevity risk - the risk that annuities to pensioners need to be paid for longer and therefore at a higher cost to the insurer because people live longer than expected; 2. market risk - the risk that asset returns are insufficient to pay the pensions: for example, because the insurer holds assets of shorter maturity than its liabilities, market interest rates fall and the insurer cannot afford to buy sufficient bonds to produce the income needed to meet its annuity obligations to pensioners; 3. credit default and downgrade risk - the insurer suffers losses because the assets in which it has invested default or downgrade; and, perhaps most importantly 4. management and governance risk - in the absence of regulation the owners and managers of an insurer may be incentivised to maximise their own short-term returns rather than managing the business in the long-term interest of the annuity holders. The interests of owners and managers are not necessarily aligned with those of the policyholders because owners share the benefits of taking more risk in a good outcome but have limited exposure to losses in a bad outcome because of their limited liability. Policyholders might be unable to monitor how an insurer is run because of the long-term and complex nature of pensions business.
I am mindful here of the Financial Stability Board standard against mechanical reliance on ratings.7 “The goal of the FSB principles is to end mechanistic reliance on ratings provided by 7  http://www.fsb.org/work-of-the-fsb/policy-development/additional-policy-areas/reducing-reliance-on-credit-ratings/ 7  All speeches are available online at www.bankofengland.co.uk/publications/Pages/speeches/default.aspx  7  ECAIs by banks, institutional investors and other market participants by reducing the “hard wiring” of ECAI ratings in standards, laws and regulations and by providing incentives for firms to develop their own capacity for credit risk assessment and due diligence”  This standard does also say that  supervisors should closely check the adequacy of firms rating processes and guard against upward bias. That is what we seek to do. Turning to restructured equity release mortgages specifically, we developed our Effective Value Test (the ‘Test’) to help determine whether insurers appear to be taking an inappropriately large Matching Adjustment benefit. This followed very extensive engagement with industry and more widely, including discussion and consultation papers. We recently issued a follow-up consultation paper8 to provide greater clarity to insurers on, for example, how often they should calculate the Test and in what circumstances the PRA will update key parameters in the Test, such as the deferment rate. The consultation paper also proposes that firms would be asked to use the Test ‘in stress’ as a validation technique, to help provide assurance that their internal models are assessing appropriate capital requirements against risks from these assets.