There is a certain element of Catch-22 for any insurance company trying to plan for life post LIBOR. The liquidity and term structures among markets linked to RFRs cannot develop properly without further involvement from investors, lenders, and borrowers, and yet many have decided to hold back for the time being as they lack a robust term structure and sufficient liquidity. For insurance companies, this may become a problem:
The pricing for some long-dated insurance products may become complicated and change the business case for those companies that have low margins of profitability following the move to an RFR.
Those insurance companies with businesses overseas could face a more complicated transition than their purely domestic counterparts. Each of the alternative rates is at a different developmental stage and will follow different adoption schedules.
Insurance companies seeking to hedge against risk face indirect exposure to the winding down of the LIBOR. The switch to RFRs may create stumbling blocks for entire business sectors that have utilised the LIBOR as a reference point for asset-liability management, discounting, structuring derivates hedge programmes, and actuarial evaluations since inception.
The RFR transition is likely to lead to severe disruption across internal operations and systems, from updating master data, to interest rate calculations and the assessment of value using multiple rate curves
Corporations are expected to identify a mass of indirect exposures to the LIBOR transition and review every contract that is linked to the benchmark rate, with an expectant clear impact on their valuation and risk processes
Overlap with IFRS 17
Of course, IBOR migration is not the only issue on the horizon for many insurance corporations. The implementation of the new accounting standards enshrined in the new International Financial Reporting Standard (IFRS 17), effective from 2021, may be considered a more urgent priority. Indeed, many insurers have major programmes actively in place to ensure the successful adoption of IFRS 17 that may already be absorbing substantial financial, actuarial, and other resources.
To this extent, understanding any common themes evident between IFRS 17 and the IBOR transition may be a wise time- and resource-effective exercise. For example, the valuing of the balance sheet on a market-consistent basis lies at the heart of IFRS 17, which has a similar range of balance sheet and P&L impacts as those identified from the IBOR transition – particularly with regards to liabilities. Insurance companies should therefore consider how their IFRS 17 and IBOR transition programmes can productively co-exist. There may well be a useful synergy to be found from taking a coordinated approach to these two complicated and time-consuming challenges.
Moreover, whilst IBOR transition planning for most companies is generally at its nascent stage, the IFRS 17 programme may already be well developed. This is another reason why thought should be spent now to clarify the impact of the IBOR transition and draw up an actionable plan. Such insights could help reduce the risk of re-visiting work in the longer term when the need to switch to RFRs becomes a compelling priority.