UPDATE 1-EU policymakers clash over valuing insurers' liabilities

* EU watchdog says will decide by early 2017 on change

* German insurers would be among those hardest hit by change

* Industry body says too soon to tweak benchmark (Adds industry comment)

LONDON, Aug 31 (Reuters) - European Union policymakers clashed on Wednesday over whether to cut a benchmark used by insurers to value billions of euros in liabilities to better reflect very low central bank interest rates.

New “Solvency II” rules for insurers in the 28-country bloc were introduced in January and include an “ultimate forward rate” or UFR, an interest rate for discounting liabilities which go out more than 20 years.

It was set at 4.2 percent, reflecting interest rate expectations in 2010, before the financial crisis prompted central banks to slash rates to negative territory in some cases.

The European Insurance and Occupational Pensions Authority (EIOPA) is working on a new methodology for compiling the UFR, which would reduce it to 3.7 percent.

Cutting the rate would force insurers to hold more capital as they could not discount liabilities to the same extent as now. This would likely push up the cost of life insurance.

EIOPA Chairman, Gabriel Bernardino, told the European Parliament that ultra-low interest rates appeared to be the new norm and the EU watchdog was due to take a final decision on methodology by early next year.

“We don’t believe it’s prudentially sound to wait until 2019, 2020 to make any kind of adjustments on this,” Bernardino told the parliament’s economic affairs committee.

Any cut would be introduced slowly, capped at the rate of 20 basis points a year.

Change would need approval from the EU’s executive European Commission and one of its officials cautioned against amending rules that were only introduced in January.

Handled badly, changing the UFR could cause disturbances in the market and harm policyholders, Nathalie Berger, the European Commission’s head of insurance and pensions, told the committee.

There was a difference between reviewing the UFR rule and actually changing it without thoroughly testing the impact on markets, she said.

“Our view is that this is so important that we would like first of all to be able to have robust data on how Solvency II is working in practice,” Berger said.

“We would advise against going for rushed decisions.”

Dutch insurer Delta Lloyd has said cutting the UFR would reduce its solvency ratio by 21 percentage points. German life insurers would also face a big hit, rating agency Fitch has said.

Insurance Europe, an industry body, said making Solvency II more conservative by lowering the UFR would “seriously limit insurers’ ability to maintain their role as Europe’s largest long-term institutional investors.”

The UFR is meant to be a long-term benchmark and it was too soon to change it, Insurance Europe said.

Sven Giegold, a German Green Party member of the economic affairs committee, said only one national regulator, BaFin of Germany, and the insurance lobby want to delay revising the UFR.

“There shouldn’t be a special deal for Germany in this regard,” Giegold said.

But German centre-right committee member, Burkhard Balz, said changing the UFR was a major decision and the sector needed a clearer picture first of what it would mean. (Reporting by Huw Jones; Editing by Mark Potter and Susan Fenton)