A new report by AM Best notes that insurers are facing numerous challenges in the transition period away from the London Interbank Offered Rate (LIBOR), and are continuing to identify LIBOR exposures as key dates approach.
The rating agency observed that insurers are weighing their options and cautiously entering instruments and hedges based on the Secured Overnight Financing Rate (SOFR) as LIBOR is phased out as a benchmark for short-term interest rates, due to the unknowns and limited liquidity.
With the changeover, insurer debt structures could be impacted, especially those with floating-rate obligations currently tied to LIBOR.
And although SOFR has been identified as the replacement for the US dollar-based LIBOR rate, non-LIBOR rate alternatives also are being considered by companies, including Ameribor rates.
The key difference between SOFR and Ameribor, according to AM Best, is that the latter is generated from unsecured transactions, which may result in rates that more accurately reflect the cost of funds.
Analysts at AM Best believe that one of the most significant risks that will emerge when LIBOR is transitioned to other reference rates is the potential for litigation.
Some fallback provisions require the use of alternative bank reference rates in the event LIBOR is no longer available, and issues may arise if the parties involved have not agreed to replacement reference rates.
The rating agency warns that fallback provisions requiring discretionary recalculations of reference rates also may also lead to litigation, as finding rates reasonably comparable to LIBOR may be difficult.
Legislative efforts are under way to minimize litigation risk, potentially establishing recommended benchmark replacement rates as reasonable substitutes for LIBOR. However, the adoption of safe-harbor benchmarks also could face court challenges.
AM Best notes that exposure to LIBOR liabilities is lower in the United States than in the United Kingdom, where significant levels of insurers’ reserve liabilities are LIBOR-based.
Key issues for insurers will be the nature of fallback provisions, term structures for new reference rates, market liquidity, capital requirements and consistent supervisory guidance to eliminate cross-border issues.