Financial Sustainability: Are there enough assets?
Lukas Riesen and Stephan Skaanes ask whether Swiss pension funds can financially afford their promises
Every pension fund member should understand the financial sustainability of their pension fund.
Considering negative interest rates, the question arises whether Swiss pension funds can fulfil their obligations. There is no general answer, since the financial sustainability of a pension fund depends on various parameters.
On one hand, the financial situation is an essential factor (does the pension fund have adequate reserves?), and on the other, the structural situation should be taken into account (the proportion of active members and pensioners). The financial situation is measured by means of the funding ratio. This compares current assets to liabilities of the pension fund. A funding ratio of 100% means that the assets should be sufficient to cover all the liabilities while a funding ratio below 100% is a warning signal since assets do not cover liabilities.
For the following reasons, the financial sustainability of a pension fund cannot be evaluated by the funding ratios that are currently disclosed:
• An essential part of a pension fund’s liabilities are future payments. In order to determine the funding ratio, each pension fund has to determine today’s value of these payments. Therefore, a discount rate is required (the actuarial interest rate). In Switzerland, this discount rate is not standardised and each fund can choose one. The lower the discount rate, the more conservatively balanced the liabilities. A safe valuation would be based on the current interest rate level.
However, in practice, values between 0.5% and 3% are used. Therefore, different funds may save different amounts of assets for the same liabilities. The resulting valuation differences are anything but small. According to a general rule, a difference of 1% in the discount rate leads to a difference of 10% in the actuarial reserves of the pension liabilities, which means the publicly stated funding ratios of pension funds cannot be compared.
• Another shortcoming is that the funding ratio does not take into account structural situation. In Switzerland, pension cuts are statutorily impossible. In cases of underfunding, active members and the employer have to bear the recapitalisation costs. A lower proportion of pensioners means that the fund can be recapitalised easier. This has to be taken into account.
A risk-bearing funding ratio enables a standard measurement of the financial sustainability of a pension fund. This value consolidates information on the financial and structural situation in one figure. The liabilities are valued in the same way and structural differences between the pension funds are taken into account. On this basis, a direct comparison of pension funds is possible, independent of the number of pensioners and different balance sheet valuations. If the risk-bearing funding ratio is above 100%, guaranteed annuities can be paid without involving risk bearers (active members and employers). If the risk-bearing funding ratio is below 100%, the active members may face lower benefits or recapitalisation measures.
A recent study1 calculated the risk-bearing funding ratios of 279 Swiss pension funds with total assets of approximately CHF565bn (€519bn) based on annual reports.
The 261 pension funds with full capitalisation have an average risk-bearing funding ratio of 91.7% as at the end of 2015. Therefore, as at the end of 2015, the remaining assets after financing current annuities is lower than the vested benefits of the active members. The average risk-bearing funding ratio is lower than the average disclosed actuarial funding ratio of 105.7%. This can be explained by the low interest rate level, which is not yet fully included in the actuarial funding ratios.
The figure shows the high heterogeneity of the financial situation of pension funds. The range includes values considerably lower than 50% as well as pension funds, which have a value of 150% or higher.
The risk-bearing funding ratio shows that the actual financial situation of many pension funds is lower than the disclosed funding ratios suggest. Moreover, the value shows the differences among pension funds. This is due to unequal pension liabilities. By means of the risk-bearing funding ratio all insured persons have a simple instrument at their disposal in order to evaluate the financial sustainability of their pension fund.
1. Säule 2016: Analyse der Geschäftsberichte von Pensionskassen, PPCmetrics, 2016
Lukas Riesen and Dr Stephan Skaanes are partners at PPCMetrics AG