Transition From LIBOR Will Impact Existing Annuity Contracts

By John Hilton

The phase-out of the London Interbank Offered Rate (LIBOR) is coming and is set to cause major disruption for insurers.

LIBOR is the primary benchmark for short-term and variable interest rates used to determine interest rates on a variety of financial instruments. Those include not only investments held by insurers, but existing annuity contracts with credited rate equal to LIBOR plus a margin.

"LIBOR is a widely used benchmark for short-term interest rates," said Pat Allison, assistant managing life actuary for the National Association of Insurance Commissioners. "There's approximately $200 trillion of financial contracts that reference the U.S. dollar LIBOR."

LIBOR was set to go away at the end of 2021, but that date has been pushed back. The overnight, one-month, three-month, six-month and 12-month U.S. LIBOR rates will continue to be published through June 30, 2023.

Regulators are pushing to address a replacement for LIBOR sooner rather than later. The NAIC Life Actuarial Task Force heard a presentation on the options today.

The Alternative Reference Rates Committee is a group of private‐market participants formed in 2014 by the Federal Reserve Board and the New York Fed. It backs transitioning from U.S. dollar LIBOR to its recommended alternative, the Secured Overnight Financing Rate.

"It's an overnight secured rate and, it's also produced by the public sector using a transparent methodology," Allison explained. "So there's a lot of reasons that have been cited by the ARRC as to why they are really wanting to move towards SOFR as a replacement."

There are alternatives, she added, one of them being the Bloomberg Short-Term Bank Yield Index.

The market for derivative products tied to SOFR is developing. The average daily volume of SOFR futures contracts has increased by approximately 75% since 2019, according to the CME Group.

In order to set up the transition, the NAIC has added this language to its Valuation Manual: "When the NAIC determines LIBOR is no longer effective, the NAIC shall recommend a replacement to the Life Actuarial (A) Task Force which shall be effective upon adoption by the Task Force."

Regulators will need to determine whether the process for calculating Long‐Term Benchmark Swap Spreads needs to be changed. At present, daily swap spread data is extracted from a rolling 15-year period. A new benchmark will not have that 15-year lookback, Allison noted.

Industry is generally supportive of moving to SOFR, said Brian Bayerle, senior actuary for the American Council of Life Insurers. But he urged regulators to continue "monitoring" other options such as Bloomberg.

InsuranceNewsNet Senior Editor John Hilton has covered business and other beats in more than 20 years of daily journalism. John may be reached at john.hilton@innfeedback.com. Follow him on Twitter @INNJohnH.