Towards a new UFR curve - or not?

This advice proposes changing the method used for generating the ultimate forward rate (UFR) yield curve so that the curve remains much closer to a full market curve than under the current UFR approach. The Dutch Central Bank (DNB) and the Dutch Cabinet have already endorsed this new approach, which is intended to be introduced on January 1, 2021. This has led to much opposition in the Dutch Parliament, Senate and unions, creating uncertainty about the broader support for this advice. We analyze the new UFR proposal in more detail in this article. Whilst the introduction of the new method would currently lead to lower funding ratios, it should also make it easier for pension funds to stabilize their UFR funding and interest rate hedging ratios over time.

A brief history of UFR usage

Ultimate forward rates (UFRs) are intended to be stable estimates of long-term interest rates and are used to value long-term liabilities. They allow investors to adopt assumptions for long-term interest rates that differ from those implied by the market. Long-term market rates may be skewed by shorter-term supply and demand issues, a lack of reliable data, or by central banks’ market interventions, e.g. quantitative easing. There may thus be a need for a more model-based approach when deriving interest rates for long maturities.

The use of UFR-adjusted interest rate curves is required by several regulators when determining the discounted value of liabilities. An important example is insurers following Solvency II regulation. Pension funds in certain countries also discount liabilities using a UFR-adjusted interest rate curve, Denmark and the Netherlands being two important examples. Dutch pension funds have used UFR-adjusted curves since 2012 and important reforms to the methodology were introduced in 2015. The Commissie Parameters’ proposals represent the next stage of reforms for the UFR method.

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