By Huw Jones
LONDON (Reuters) - A European Union watchdog will cut an interest rate used to price liabilities at euro zone insurers such as Munich Re (DE:MUVGn), AXA (PA:AXAF) and Allianz (DE:ALVG), a step that could mean some firms having to hold more capital.
The European Insurance and Occupational Pensions Authority (EIOPA) said on Wednesday it would reduce the theoretical interest rate known as the ultimate forward rate (UFR), used to discount an insurer's liabilities over time.
Insurers have work out their liabilities from policies going forward up to 60 years, but there are no reliable euro market interest rates extending beyond 20 years, hence the need for regulators to compile an extrapolated rate covering the 40-year gap.
EIOPA is proposing to cut the UFR, currently set at 4.2 percent, to 3.65 percent over time from January next year. It would only be applied to liabilities denominated in euros.
The regulator said the annual change in the UFR would not be more than 15 basis points, meaning the UFR will fall in January to 4.05 percent from 4.2 percent.
Regulators believe a reduction would better reflect current historically low interest rates, and the impact will be to increase liabilities because the rate at which they are discounted is lower.
"This methodology strikes the right balance between a stable UFR and the need to adjust it in case of changes in long-term expectations about interest rates and inflation," EIOPA Chairman Gabriel Bernardino said.
"The methodology ensures that the UFR moves gradually and in a predictable manner, allowing insurers to adjust to changes in the interest rate environment and ensuring policyholder protection."
Higher liabilities could lower an insurer's solvency ratio, a closely-watched benchmark of overall health, forcing it to raise more capital to reassure investors.
Insurers say regulators should review the sector's solvency rules more broadly, rather than focus on changing just one number.