Insurance Insights

Caught in the Act, the Elimination of LIBOR

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Hot Take:

Hot Take

The UK Financial Conduct Authority (FCA) announced in mid-2019 that financial institutions would have no further responsibility to publish LIBOR rates after December 2021, which essentially ends LIBOR as a global contractual benchmarking interest rate. This action comes from two primary reasons (a) the results of the G20 central bank governors’ request for an investigation into rate-rigging that had been alleged in the LIBOR process, and (b) transaction volume has not been sufficient in the unsecured wholesale bank borrowing marketplace. This article explores the background, impact, and considerations that should be underway in planning to shift your LIBOR-based transactions to another viable rate application.

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The London Interbank Offer Rate or LIBOR rate-setters were found to be colluding or fixing the rates so LIBOR wasn’t the free market rate we understood it to be. Because of that, LIBOR is being replaced by the financial markets with alternative reference rates (ARRs). In the US market, financing institutions and insurers are looking to the Secured Overnight Financing Rate (SOFR) to replace LIBOR as the ARR of choice. The financial markets, including insurers, will make significant changes going forward. This is because LIBOR is referenced in many contracts as the rate to be used in hedging strategies and other insurance-related contracts.

When is this happening? It’s happening now as the LIBOR-based markets start to decline. They are expected to decline by 2021 entirely but may happen sooner if the LIBOR-based markets’ capital dries up.

What does this mean for you? Well, the waters are murky when it comes to using SOFR over LIBOR.  Yet, some insurance company contracts tend to be long and based upon certain interest rates.  It will be necessary for insurance companies and financial markets to review their current contracts and decide how to restructure those longer agreements that will move past 2021 and are tied to LIBOR. Further, the challenge remains on how to change them to another viable ARR, such as SOFR.

Where can you look for guidance? Organizations such as the International Swaps and Derivatives Association (ISDA) is working to help derivative markets have a smooth transition by providing “fallback language” that might be used as an alternate for the underlying assets. Organizations such as the Alternative Reference Rates Committee (ARRC) – is also providing such language and encouraging the use of SOFR, rather than taking a wait-and-see approach.

There is plenty of advice out there on the impending change. The war cry is to be proactive and reactive and to first assess the risk related to the products held or liabilities associated with LIBOR. Next, determine the best course of action and which ARRs would fit the insurance company or financial institution.  Once you’ve assessed the possible impact, you should model some potential outcomes and then decide when you will transition and which ARRs will be utilized.