Regulatory risk-free yield curve properties and macroprudential consequences

The regulatory risk-free yield curve has a direct impact on the behaviour of insurers. It affects their provisioning and may influence hedging and investments choices. As a result, its design and derivation from market data are important. This report considers the macroprudential consequences of the regulatory risk-free yield curve with a view to informing the ongoing work at the European Insurance and Occupational Pensions Authority (EIOPA) on the methodology for deriving this yield curve, as well as the upcoming Solvency II reviews. Macroprudential requirements for the regulatory risk-free yield curve call for the use of a market-based curve. The requirements used for insurance regulation are: (1) realistic estimates of liability values, (2) consistent derivation and application of the curves, (3) adequate risk management incentives, and (4) prevention of procyclical behaviour. The first three requirements are better achieved when the regulatory risk-free yield curve is based on market data. The fourth requirement may conflict with the market valuation of insurers' balance sheets. As there is some initial evidence on the procyclical behaviour of insurers (Bank of England, 2014; De Nederlandsche Bank, 2015), potential procyclical effects should be monitored and further work needs to be undertaken to consider how these effects and/or their causes could be addressed through, for example, macroprudential policy measures beyond the basic risk-free yield curve.