Ultimate Forward Rate (UFR): Why we are seeing a change to the rate curve

Ultimate Forward Rate (UFR): Why we are seeing a change to the rate curve

Fri 16 Mar 2018

On 6 February 2018, EIOPA published its latest risk-free interest rate curve to be taken into account for the purposes of Solvency II calculations. Based on calculations for January 2018, the curve is slightly different from previously published curves. This is reflecting significant changes in the long-term expectations of interest rates in recent years which calculates the value of the theoretical Ultimate Forward Rate (UFR) for the euro as 3.65%.

In a first step of the phasing-in, the current UFR of 4.2% for the euro was lowered in January 2018 to 4.05%.

Let’s first remind ourselves of the methodology used by EIOPA to construct the risk-free rate curve. Firstly, this uses market data, namely the euro zone swap rate curve, to which a credit risk adjustment is applied. Then it is followed by smoothing in accordance with the Smith-Wilson method, both for interpolation of maturities lacking market data and for the extrapolation of rates beyond the maturity that EIOPA regards as the ‘last liquid point’ (LLP).

The extrapolation methodology assumes that forward rates will converge on an ultimate rate. This rate is known as the Ultimate Forward Rate (UFR), at a given speed (alpha).

Until now, the LLP in the euro zone was 20 years, the convergence was 40 years and the UFR was 4.2%. The UFR was calculated at 4.2% for the Quantitative Impact Study (QIS) 5. This is the sum of a 2% inflation rate target and the real expected rate of 2.2%. The reduction in inflation rates recorded has induced EIOPA to revisit and clarify the calibration of the UFR.

On 5 April 2017, EIOPA published the methodology to be applied to calculate the UFR as from 1 January 2018. This was preceded by a consultation exercise and by a test phase among a sample of insurers.


Each year at the end of March, EIOPA will calculate an effective UFR. Then, it will be used to extrapolate rate curves from January of the following year.

To avoid too great a change in the UFR each year, any upward or downward variation will be limited to 15 bps.  Moreover, the effective UFR will only change in the event of a fairly significant variation in the theoretical UFR.

Methodology for calculation of the theoretical UFR

The UFR methodology remains the same as that applied in QIS 5.

The theoretical UFR is equal to the sum of the expected real rate and an estimation of the expected long-term inflation rate. The expected real rate is identical for all currencies. It is calculated on the basis of an average of annual real rates since 1961.

Using this methodology, the theoretical UFR for 2018 stands at 3.65% for the euro zone. Therefore the effective UFR will be 4.05%, or 4.2% – 15 bps.

What impact can we expect on the solvency of insurers?

The impact on French insurers should be limited. Using a sample of 336 insurers and reinsurers, and based on results at the beginning of the reporting period at 1 January 2016, EIOPA estimates that the 20 pbs fall in the UFR would bring about a reduction in the solvency ratio from 203% to 201%.