UFR in the present low interest environment
The supervisory framework for insurers uses the UFR for calculating the term structure insurers may use for converting long-term liabilities to present value. The UFR (currently 4.2%) is a calculated level that the term structure for maturities exceeding twenty years grows towards. This approach has been chosen because the market for financial products with very long maturities is less extensive, liquid and transparent. Consequently, market rate information about it is insufficient to set the term structure.
The difference between the current UFR and the low market rates seen over the past years has increased steadily. As a result, the impact of the current low interest environment on insurers is only partly visible in their financial reports and means the solvency position of insurers gives too optimistic a picture of their financial position.
EIOPA has therefore initiated a consultation round to survey opinions about a new method for determining the UFR. The impact of the new UFR method may be relatively large for Dutch life insurers, as on average they have many long-term liabilities.
The new method that EIOPA proposes in its consultation round strives for a balance between on the one hand a stable UFR and on the other the need to adjust the UFR in line with realistic long-term expectations of interest rates and inflation. EIOPA's present proposal, based on current market conditions, would lead to a UFR of 3.7%, phased in using a maximum of 0.2 percentage point a year. This would bring the UFR level slightly closer to what currently applies in the Netherlands for pension funds; unlike the UFR for insurers, which is determined at a European level, the UFR for Dutch pension funds is set at a national level.
DNB supports EIOPA in its efforts to establish a more realistic method to determine the UFR for insurers and is of the opinion that the Dutch UFR method as used for pension funds is the most suitable. In 2013, the Dutch UFR Committee concluded it was the most realistic manner to determine the actuarial rate and the method was embraced by the Cabinet for use by pension funds. Compared to the EIOPA proposal, the UFR method for pension funds takes on board more market information, also for longer maturities. This ensures a better link to the underlying changes in the economy. Although the present consultation round only relates to determining the height of the UFR, DNB will encourage EIOPA to review other aspects of the UFR calculation method as well in due course. One of these is the longest maturity that can still be considered as liquid, the last liquid point (LLP), presently set at 20 years. Taking a later LLP from which the rate will grow towards the UFR will decrease the difference between the UFR and market rates. A longer convergence period – at the moment 40 years – will also reduce the difference between market rates and the UFR.
Insurers and other stakeholders have until 18 July 2016 to respond to the present proposal. In September of this year, EIOPA will take a decision about the new method. The present UFR will remain unchanged at least until the end of 2016 to ensure the transition to Solvency II runs as smoothly as possible.