The Bank of England is warning insurers to exercise caution as they look to take on more business from pension schemes seeking to offload risk.
Charlotte Gerken, executive director for insurance supervision at the bank, cautioned that insurers need to be mindful of the risks associated with bulk purchase annuities, especially as deals become larger and more complex.
Gerken also noted that rising interest rates have improved funding levels of pension schemes, making them cheaper to offload to an insurer, but warned insurers against stretching their capabilities in the short term.
According to Gerken, UK life insurers could take on more than £500bn ($623.70bn) of pension liabilities over the next decade. She said that "the decisions that insurers make now will have long-term consequences for the performance and development of the broader economy".
Gerken also noted that the sector will need to hedge its pension risks with an interest rate, cross-currency, and inflation swaps, increasing the sector's links to the wider financial system.
She urged insurers to understand the liquidity risks they face as they take on vast sums of assets and liabilities. The Bank of England had to buy UK government bonds last September after liability-driven investment funds used by pension schemes struggled to find enough liquidity to pay collateral on skyrocketing gilt yields.
"This is a big structural change in the control of long-term investments in the UK, and the decisions that insurers make now will have long-term consequences for the performance and development of the broader economy," Gerken said in a speech. "Insurers, therefore, need to understand, as they take on these vast sums of assets and liabilities, how they may become greater sources or amplifiers of liquidity risk."