The European Parliament’s Committee on Economic and Monetary Affairs (ECON) has published a letter received from Gabriel Bernardino, European Insurance and Occupational Pensions Authority (EIOPA) Chair, concerning EIOPA’s review of the methodology for calculating the ultimate forward rate (UFR) under the Solvency II Directive (2009/138/EC).

Risk-free interest rate term structures are used by insurance and reinsurance undertakings to discount the technical provisions they set up for their insurance and reinsurance obligations under Solvency II. UFRs are parameters used to determine risk-free interest rates, which are not directly derived from observed market rates but need to be extrapolated. For example, in the case of the term structure for obligations denominated in euro, the UFR influences the risk-free interest rates for maturities of more than 20 years.

The Solvency II Delegated Regulation requires that the UFR take account of expectations of the long-term real interest rate and of expected inflation. For most currencies, including the euro, it is currently set at the level of 4.2% as the sum of these two components. The long-term real interest rate is derived from long-term averages of past real rates (2.2%). The inflation rate is based in particular on the inflation target of the European Central Bank (2%).

EIOPA carried out a consultation on the UFR methodology in April 2016. In November 2016, ECON wrote to EIOPA suggesting that an additional impact assessment was required on the impact of the consultation proposals.

Mr Bernardino’s letter sets out the findings of that additional impact assessment. The letter explains that EIOPA has, in particular, assessed the impact of changing the UFR by 20 basis points and by 50 basis points. EIOPA found that the impact of the changes was very small and manageable by insurance and reinsurance undertakings.

The letter goes on to say that:

  • EIOPA is currently assessing how to address the concerns raised by ECON concerning annual changes of the UFR, and in particular the size of the annual limit for changes and measures to reduce the frequency of UFR changes and to increase the stability of the calculated UFR.
  • EIOPA is considering delaying the first application of the UFR methodology, which was originally envisaged for the end of June 2017. Implementation is now expected to take place in late 2017/early 2018.
  • The intention is for EIOPA’s Board of Supervisors to have decided upon the UFR methodology and its first application at a meeting at the end of March 2017.

A copy of Mr Bernardino’s letter can be found here