(Bloomberg) -- Private equity’s advance into the insurance sector exacerbates the risk of “fire sales” that disrupt the functioning of financial markets, the Bank of England warned.

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A growing number of PE firms in the US have acquired life insurers, while British insurance firms have transferred some of their risk to PE-backed reinsurers, the central bank said in its twice yearly Financial Stability Report published Friday. The PE-backed firms tend to target higher returns via greater risk-taking, often by investing in illiquid private assets, the BOE said.

Officials are concerned that a potential sharp and correlated deterioration in these investments could amplify risks across global insurers. That could spark “asset fire sales” which disrupt corporate funding markets, the BOE warned.

“Loss of policyholder confidence could also create a liquidity stress,” the report said.

The central bank said it supports the Prudential Regulatory Authority’s work to mitigate risk in the sector. The global regulatory response may require enhanced disclosure of PE activity in the insurance sector, it said.

The BOE’s concern lies in a scenario where PE-sponsored corporate assets fall sharply. Life insurance subsidiaries are increasingly holding debt sponsored by the same PE firm that owns the insurer, the report said.

In such a scenario, the firms may see a fall in solvency ratios that triggers termination of reinsurance contracts, meaning the original insurer must take on the risk again — known as a recapture event. The subsequent increase in capital requirements may force insurers to sell assets at steep discounts to raise cash, exacerbating market stress.

The findings come at a busy time for insurance dealmaking. Britain’s Pension Insurance Corp., an insurer and provider of bulk annuities, was exploring a sale last year. PIC, whose backers include CVC Capital Partners Plc, drew interest from buyout firms including Apollo Global Management Inc., according to reports at the time.

In Italy, Cinven-backed insurance consolidator Eurovita went into administration in 2023 after it fell short on solvency requirements when bond-market volatility hit portfolios and clients were seeking to pull money.

--With assistance from Fion Li.

(Adds recent M&A examples in final two paragraphs.)

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