Introduced in January, new Solvency II rules for insurers in Europe include the “ultimate forward rate” or UFR, an interest rate of 4.2% that is used for discounting liabilities over a 20-year period.
According to Reuters, the European Insurance and Occupational Pensions Authority (Eiopa) is working on a new method for compiling the UFR which would reduce it to 3.7% to better reflect the European Central Bank’s (ECB) ultra-low interest rate.
As a result, insurers will be forced to hold more capital, driving up the price of life insurance.
Gabriel Bernardino, Eiopa’s chairman told the European parliament’s economic affairs committee that rock-bottom interest rates were likely to persist, adding that the pensions watchdog was due to take a final decision changing the UFR by early next year.
“We don’t believe it’s prudentially sound to wait until 2019, 2020 to make any kind of adjustments on this,” said Bernardino.
He added that any cut is likely to be introduced slowly, capped at the rate of 20 basis points a year, while all changes would need approval from the EU’s executive European Commission.
Earlier this month, Ned Cazelet, chief executive of Cazalet Consulting, which provides strategic advice, market intelligence and support to financial institutions, told International Adviser the current UFR was “lunacy”, with many German insurers using the rate to disguise the value of their actual long term liabilities.
“So what the insurance companies are doing is discounting at a higher rate, depressing their liabilities and overstating their solvency and financial strength. The 16-year window [to adopt Solvency II] is farcical, especially when we have a UFR of 4.2% when the bonds are actually generating around 0.4%,” he explained.
“German 10-years are in negative territory. But what we’ve also got are these insurance companies writing long-term contracts that go on for 20-25 years and in big parts of the European Union there are no bonds that go that far.
“And if there are no bonds for that length of time, there are no interest rates to use to discount the liabilities. This has forced the regulators to come up with some sort of discount rate such as the UFR,” added Cazelet.