Variable Ultimate Forward Rate Curve

Abstract

The volatile and relatively low interest rates in the market lately challenge the nominal funding ratio of pension funds. To alleviate the problem, the Dutch central bank will likely replace the discounting yield curve for the liability valuation, from the DNB RTS curve (a complete use of the market traded interest rates) to the Smith and Wilson (2001) UFR curve (a use of the market traded interest rates until the last liquid point, and a constant forward rate from a moment in the future onwards). However, the Smith and Wilson (2001) UFR curve will result in negative performance during a period of high interest rates and has relatively high risk. I propose to shift the last liquid point in the UFR curve after the pension fund’s duration and make the ultimate forward rate varying across the time. This alternative generates positive performance and lower risk.

Keywords: pension funds, UFR curve, variable ultimate forward rate, last liquid point, alpha

JEL Classification: G12, G18, G23