Ready or not, the end of the London Interbank Offered Rate (LIBOR) is coming, and it’s a very big deal. Roughly US$350 trillion in financial contracts have interest rates that are tied to LIBOR benchmarks—for now. But the LIBOR benchmark is scheduled to go away at the end of 2021, and its impending end has set in motion an overhaul in the world’s financial infrastructure. It’s a very big deal, with implications for your business, processes, and technology.
In the US, many financial instruments now tied to USD LIBOR will be pegged instead to the Secured Overnight Financing Rate (SOFR), an alternative reference rate (ARR) calculated using US treasury repo transactions. In the UK, they’ll be linked to a different ARR: the Sterling Overnight Index Average (SONIA). Other countries and markets have recommended their own replacement benchmarks for use once LIBOR has been phased out.
Given the pandemic’s economic effects and how much work many insurers still have to do to move away from LIBOR, some companies seem to still be gambling that LIBOR’s cessation will be delayed. But COVID-19 can no longer be seen as a novel; rather, it has to be viewed as a sad-but-lasting feature of our economy that we all must adapt to. In that spirit, regulators and industry working groups are sending clear messages that COVID-19 will not delay LIBOR’s retirement. If anything, they’re actively sharing best practices and coalescing around approaches to accelerate the transition. They’re also setting timelines for transition milestones, such as those published by the Alternative Reference Rates Committee (ARRC) for moving to SOFR.
The pace of progress remains uneven across the insurance industry. We’ve seen that insurers with in-house asset management units tend to be more likely to be taking proactive steps given their responsibility for transitioning out of LIBOR-based instruments. But virtually all insurers face operational and economic risks if they don’t have a solid plan in place for adopting ARRs. Firms that use third-party asset managers, for example, are responsible for customer communications around those assets and must coordinate the transition with their vendors as deadlines begin to compress.
We expect the ARRC’s guidance will help senior management take a closer look at the LIBOR transition and give a boost to internal collaboration. The coming transition is fundamentally about risk management—which is the defining purpose of the insurance industry. By making it a strategic priority and continuing to recalibrate efforts as necessary, insurance companies can turn the risks of moving away from LIBOR into opportunities for growth.
There are certain activities that virtually all financial firms will want to pursue during the coming LIBOR transition, from strategy through execution. While some of this work can be done in parallel, it can be highly interdependent. Many early movers have used a test-and-learn approach to refine their plans, as they’ve frequently found that the steps are more involved than they’d expected.
While all financial entities will have work to do as they prepare for the benchmark shift, insurance companies will want to focus on these specific areas: