Ultimate forward rate and extrapolation
The rate toward which the regulatory curve is extrapolated beyond the last liquid maturity, an administered parameter that sets the value of the longest liabilities.
In 2017, the European authority began lowering the euro ultimate forward rate, then 4.2 percent, in annual steps of at most fifteen basis points. Bond markets stop being liquid long before the horizon of life insurance liabilities, often around twenty years for the euro, while annuities are paid out to fifty. Beyond that last liquid point the regulatory curve no longer reads prices. It converges toward an ultimate forward rate the supervisor sets from long-term assumptions about real growth and inflation. The parameter is decisive, and it is administered, which is unusual: one extra point of ultimate rate mechanically lowers the present value of long liabilities and improves reported solvency, without any asset changing value. Hence the capped annual steps, so that a change of method does not read as a balance sheet shock. For an analyst, the ultimate rate marks the exact point where solvency measurement stops being a market observation and becomes an avowed prudential convention. Any international comparison therefore starts by checking which one is in use.
In 2017, the European authority began a gradual reduction of the ultimate forward rate applied to the euro, initially set at 4.2 percent, in annual steps capped at fifteen basis points to avoid a cliff effect on balance sheets.
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