A major deadline is rapidly approaching for life and annuity issuers, and many aren’t taking the necessary steps to be fully prepared.
It has been a few years since regulators announced that the London Interbank Offered Rate (LIBOR) would be discontinued by December 2021. The average interest rate at which major global banks borrow from one another, LIBOR is linked to around $400 trillion in financial instruments, including derivatives, options, floating rate notes, loans, securitizations and other short-term products.
(Related: SEC Preps LIBOR Transition Exams)
Many of these agreements are owned within the investment portfolios of life insurance companies and are indexed on LIBOR rates. These instruments will need to be revised to account for the new rates being used. In addition, on the liability side, life insurance companies may have some impacts on their annuities policies or other policies that contain guaranteed rates that reference LIBOR.
And yet, while banks seem to be quickening the pace of their own transitions, many life insurers have been stuck in the starting block and are underestimating what a Herculean lift the transition away from LIBOR will be.
Here are five things many life insurers are behind on and should address sooner than later:
1. They should understand their current exposure to LIBOR.
Insurers need to understand what financial instruments have exposure to LIBOR and what the fallback rate is in each of these contracts. This is no small task given the variety of products across the investment book as well as on the liability side with indexed products, broker compensation agreements, and reinsurance treaties.
2. They should develop a strategy to remediate their investment portfolio within the compressed timeline.
Insurers should start discussions with their delegated asset managers and banks to identify the remediation solutions to pivot their portfolios away from LIBOR. Identifying new long-term assets that will meet asset-liability matching requirements and renegotiating loan agreements with banks and counterparties will take time.
3. They should upgrade systems and perform scenario tests.
Companies will need to upgrade their platforms and databases front-to-back to be able to accommodate the multiple new rates. Performance, finance and risk models will have to be reviewed as they will be impacted with new discounting rates and methodologies.
4. They should address the resource crunch in the contract remediation space.
Insurers are unlikely to have enough staff to handle the volume of contract reviews and they are competing for outside resources with banks and other firms. They can bridge this talent gap by embracing technology to help. Contract analytics platforms that leverage artificial intelligence and natural language processing can bring efficiency in discovering and remediating LIBOR-impacted contracts.
5. They should anticipate misconduct.
In addition, insurers must carefully consider how they communicate rate changes in annuities and impacted policies to customers and agents. The language used in the policy as well as marketing and communications materials will be important and should not lead to misconduct, including mis-selling or failing to meet the client’s best interest. The training of sales representatives to mitigate potential conduct risks is critical, and this is yet another area that insurers will need to prioritize.
While the runway is shrinking, insurers still have time to get their act together and ensure they are prepared for the December 2021 deadline.
David Gane is the North America LIBOR Insurance lead in Accenture’s finance and risk practice.