The alternative extrapolation method for Solvency II curves: Will Alpha accelerate the deflation of the UFR-benefit?

As part of the 2020 review of the Solvency II regulations, EIOPA has introduced an alternative method to extrapolate long-term interest rates.

It remains complicated, will enforce hedging on long term maturities up to 50Y and introduces a new parameter which might stab insurers in the back.

Please read our briefing note with more details on this alternative methodology, the impact on hedging strategies and an analysis of the main dynamics in comparison to the use of the Smith-Wilson method and an approach without extrapolation method.

The method is not entirely new and is, for example, already part of the Dutch pension fund legislation. It will also create a new set of parameters to play with. Take a good look at parameter Alpha. In the impact study and proposals, EIOPA is using a much higher value than the Dutch regulator is using for pension funds from 2021 onwards. If we set it at the same level, the curve is suddenly below the LLP 30Y curve and the impact is similar to a reduction of the UFR to a level of 1.70%. Could this be a Trojan horse?