The ultimate forward rate (UFR), a key factor in calculating insurers' long-term liabilities under Solvency II, could be revised down from 4.2% to 3.7% for the euro following a review by the European Insurance and Occupational Pensions Authority (Eiopa).
The authority has issued a consultation paper inviting industry feedback on the proposed methodology, which could see firms applying the updated 3.7% rate as soon as 2017.
While it is widely recognised that the UFR is unrealistically high in the current economic environment, lowering the figure is controversial as it will cause insurers' liabilities to balloon (IERM, 4 August 2015, ESRB locks horns with Eiopa over Solvency II UFR).
The current rate of 4.2% at the 60-year point for most currencies was derived in 2010 for the fifth Quantitative Impact Study (QIS5). It was based on the expectation of a 2% long-term inflation rate plus a 2.2% long-term interest rate, but QIS5 did not specify the methodology used or how the rate would be updated.
Under the proposed methodology, the UFRs for various currencies in 2016 would be:
|
Currency |
UFR |
|
CHF |
2.7% |
|
AUD, CAD, EUR, CZK, GBP, HRK, HKD, ISK, JPY, MYR, NOK, NZD, PLN, RON, SEK, SGD, THB, TWD, USD |
3.7% |
|
COP, CLP, HUF, MXN, KRW |
4.7% |
|
BRL, CNY, INR, RUB, TRY, ZAR |
5.7% |
Eiopa proposes to review the UFR on an annual basis using its new methodology, but will only apply a new rate if it carries a difference of more than five basis points (bps) from the previous year. An annual change limit of 20bps would also be applied.
Implementation of the new methodology could be phased in or applied immediately; if the authority uses the current rate of 4.2% for 2016, then firms would apply a rate of 4% in 2017, 3.8% in 2018 and 3.7% in 2019. Alternatively, Eiopa suggests a lower annual change limit of 10bps for the first five years, which would take until 2021 to reach 3.7%. A third option of applying a rate of 3.7% from 2017 with no phasing in period is also suggested.
Other changes to the UFR methodology requiring industry feedback include:
- using a weighted average of historical data with geometric weights for estimating the expected real rate;
- the use of short-term real rates to exclude the term premium; and
- the use of inflation targets to allocate currencies into four buckets rather than using an inflation target of 2% and past inflation rates.
The consultation period will end on 18 July and Eiopa plans to decide on the outcome of the review in September. The current UFRs will not be changed before the end of 2016.
The consultation paper and the template for comments can be viewed here.