Insurers oppose EIOPA’s Ultimate Forward Rate decision

Insurance lobby groups have expressed their disapproval of EIOPA’s new Ultimate Forward Rate (UFR) methodology will be applied for the first time in the calculation of the risk-free interest rates of January 2018.

In line with the methodology, and reflecting the significant changes in the long-term expectations of interest rates in recent years, the calculated value of the UFR for the euro is 3.65 percent, EIOPA said. Annual changes will not be higher than 15 basis points. In a first step of the phasing-in the current UFR of 4.2 percent will therefore be lowered in January 2018 to 4.05 percent.

Gabriel Bernardino, chairman of EIOPA, explained the decision: “This methodology strikes the right balance between a stable UFR and the need to adjust it in case of changes in longterm expectations about interest rates and inflation. The methodology ensures that the UFR moves gradually and in a predictable manner, allowing insurers to adjust to changes in the interest rate environment and ensuring policyholder protection.”

The decision affects re/insurers when they set up provisions for their liabilities. These provisions are discounted with risk-free interest rates (RFR). The RFR are derived from prices of interest rate swaps and government bonds that are traded in deep, liquid and transparent markets. For long maturities where such instruments are not available the RFR are derived by means of extrapolation towards the UFR.

Commenting on the EIOPA decision, Olav Jones, deputy director general of Insurance Europe, said: “The European insurance industry maintains there is no need to make rushed changes to the UFR, because Solvency II already takes a very conservative approach and has several safeguards. When calculating their liabilities under Solvency II, insurers are required to assume that the current low interest rates will remain in place for the next 20 years1. However, this is generally considered to be an extreme scenario, not a base case. As a result, insurers currently have to value 10 year liabilities using an interest rate of just 0.6%; even for 50 year liabilities the rate is below 2.7%.”

“Insurers must also hold capital in case of even lower rates. In addition to this, Solvency II has very significant governance and reporting requirements that are designed to ensure that company management take action early to address any problems, and if they do not, ensures supervisors have the powers and information for early intervention.”

“The UFR is part of the valuation system of Solvency II. There are already concerns that this valuation system does not correctly reflect insurers’ long-term business and will have a detrimental impact on insurers’ ability to invest long-term. Changes therefore should only be finalised and implemented as part of the review already planned for completion by 2020 when the overall system and its impact will be assessed.”

AMICE (Association of Mutual Insurers and Insurance Cooperatives in Europe) has also voiced its concern over the EIOPA decision as it believes that it does not take consideration of the fuller Solvency II framework and timing issues.

EIOPA’s decision to change the methodology at this point, in advance of the Solvency II LGA (long-term guarantee) review in 2020 and without taking account its direct and indirect impact on other elements of Solvency II, has the potential to unnecessarily change solvency positions, the lobby group said.

Furthermore, AMICE calls for EIOPA to reconsider the revised implementation date announced, and to incorporate it instead into the forthcoming LGA review.

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