Rushed changes to the ultimate forward rate (UFR) risk pushing insurers towards sub-optimal investment strategies, which could unnecessarily negatively impact policyholders’ returns, according to Insurance Europe, the European insurance and reinsurance federation.
Insurance Europe argues that changing the UFR before the Solvency II review is also unnecessary. This is because it said the current framework already has several additional layers of protection in place to ensure policyholder claims will be paid.
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In its response to a European Insurance and Occupational Pensions Authority (EIOPA) consultation on possible changes to the methodology for calculating the UFR, Insurance Europe said there is no need to change it for either prudential or policyholder protection reasons.
‘Misunderstanding’
Igotz Aubin, head of prudential regulation at Insurance Europe, commented: “Calls for hurried changes to the UFR appear to be based on a misunderstanding of its purpose and how it impacts Solvency II liability valuations.
“The UFR of 4.2% is not the risk-free rate used for Solvency II valuations; rather it is a parameter used to generate them. The actual risk-free rates are far lower. For example, the risk-free rate for euros in June at year 10 was 0.32% and even at year 60 was 2.76%.”
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By GlobalDataInsurance Europe believes that changing the UFR now could also cause unintended adverse consequences for both policyholders — by pushing insurers towards locking their products into long-term low returns — and for the European economy, by creating unnecessary difficulties and encouraging sub-optimal changes to investments at a time when insurers’ capacity to invest and provide financial stability is especially important.
The insurance federation said it should also be noted that the UFR is defined in Solvency II as a long-term, stable parameter and its current calibration was agreed at political level during the Omnibus II negotiations.
Therefore, the current low interest rate environment does not constitute a change in long-term expectations for interest rates, especially given that the current low rates are linked to current European Central Bank policy, which is intended to be temporary.
Interest rate challenge
Aubin added: “While low interest rates are creating real challenges for the industry, companies have been taking action — in some cases, for many years — to adapt their products, investment mix, hedges and capital levels. Solvency II makes this a requirement for all companies, creating multiple layers of buffers and protection, as well as introducing very detailed monitoring and powers to allow supervisors to ensure the necessary actions are being taken.”
Insurance Europe also believes that when the UFR is eventually reviewed — given its key role as an anchor for solvency liability calculations and the potential significant impact of any change — that an impact analysis should be undertaken before any methodology and implementation planning is finalised.
According to Insurance Europe, this analysis should include an assessment of:
- The impact on the overall level of prudence in the Solvency II framework, to avoid creating unintended and unnecessary burden.
- Potential pro-cyclical effects and other unintended consequences for policyholders and the wider economy, in particular regarding insurers’ capacity to invest in long-term projects and distribute long-term savings retirement products.
- Back testing to ensure that the objectives of producing a stable long-term rate, and avoiding additional volatility in liability calculations, have been achieved.
