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GNAIE: Use The Right Discount Rate

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Forcing insurers to use a “risk-free discount rate” to discount life insurance contract liabilities could cause huge problems in the insurance and pension sectors, according to Douglas Barnert.

Barnert, executive director of the Group of North American Insurance Enterprises, New York, made that argument recently at an actuarial conference in Mumbai, India, that was organized by the International Actuarial Association, Ottawa, Ontario, and the Institute of Actuaries of India, Mumbai.

Life insurers should estimate the value of life contract liabilities using an “earned discount rate” comparable to the yields they really get rather than a hypothetical risk-free rate.

“Using a risk-free rate for discounting such liabilities would result in a reported loss for many contracts at issue,” Barnert warned, according to a summary of his remarks provided by the GNAIE.

A risk-free rate requirement could lower the current estimated value of pension plan assets and force pension sponsors to pump in assets, even though nothing about the plans has changed and the risk-free rates appear to have little connection with actual expected rates, Barnert said.

Using the risk-free rate quirement also could lead to “inappropriate uneconomic earnings volatility,” Barnert said.

“Such volatility will largely be driven by an incorrect measurement emphasis on liquidity that will not typically be realized by a life insurer due to the long-term nature of its obligations,” Barnert said.