A Secure Pension Fund Is Not Obvious at First Glance

When comparing pension funds, the focus is usually on just a few key figures. However, due to high uncertainty in the financial markets, other criteria are now coming to the fore. What SMEs should pay attention to when conducting a security check of their fund.

In the picture: Sébastien Délétroz, Head of Sales Romandie, Head of Market Region French-Speaking Switzerland at Tellco

How secure is our pension fund? That is the question on the minds of many employers and employees in light of the turbulence in the financial markets. Important indicators of a fund's health are the funding ratio, return, and interest rate. These key figures usually take centre stage in pension fund comparisons – but they only tell half the story. Anyone wishing to assess a fund’s security must take additional criteria into account.

Insufficient Provisions Entail Risks

One should not be dazzled by a high funding ratio. This figure indicates how well a pension fund’s liabilities are covered by its assets. The higher the value, the safer the fund – or so it would seem. However, the necessary reserves are not always in place to cover obligations in the long term. Pension funds must pre-finance certain risks, such as rising life expectancy or falling interest rates. These risks should be fully financed through provisions.

The level of provisions, however, lies at the discretion of the board of trustees. Funds with insufficient provisions carry hidden risks and may easily run into difficulties during crisis years. Due to the looming recession in the United States, funds must prepare for the scenario of falling interest rates. On the one hand, this calls for higher provisions, as it may become more difficult for funds to generate returns. On the other hand, higher provisions reduce the net assets of the pension fund, which are used to calculate the funding ratio. This means: a pension fund with high provisions may show a lower funding ratio.

The Technical Interest Rate Is Often Too Optimistic

The funding ratio must also always be viewed in relation to the technical interest rate. This reflects the long-term return expectations of the pension fund. In recent years, many pension funds have increased the technical interest rate – for example, from 1.75% to 2.25%. With higher return expectations, they need less capital to cover their liabilities. As a result, they were also able to improve their funding ratio.

But caution is advised! This does not make the funds any more secure. On the contrary: with the current market corrections, the risk increases that returns may fall short of expectations. Given the high volatility in the financial markets, a technical interest rate above 2 percent seems hardly realistic anymore. In the current highly uncertain situation, a conservatively set technical rate is a key stabilising factor.

Value at Risk Reveals Investment Risk

Another important aspect is return. High returns are positive – as long as the investment risk taken by the pension fund is kept under control. This is where the Value at Risk (VaR) metric comes in. It measures the maximum potential loss in a portfolio during a bad market year. A VaR of 12 percent at 95 percent confidence means: in 19 out of 20 years, the loss will not exceed 12 percent. The higher the VaR, the riskier the investment strategy and the higher the expected return. However, this also requires sufficiently high fluctuation reserves. Only then can market corrections be absorbed without reducing benefits or increasing contributions.

The size of the fluctuation reserves also depends on structural risk capacity: the higher the proportion of active insured persons and the lower the share of pensioners, the lower the reserve requirements. There are funds that are considerably more stable simply because of their insured structure – especially pension schemes with a high proportion of temporary employees, where younger staff make up the majority of the insured.

It Pays to Take a Closer Look

A stable pension fund cannot be recognised simply by a high funding ratio, high interest rate, or return. Only those who scrutinise risk management, investment strategy, and the structure of the insured population will gain a comprehensive picture.

Good to Know:

• A high funding ratio says little if provisions are too low or return expectations are too optimistic.
• Failing to adequately account for long-term risks such as increasing life expectancy or falling interest rates endangers the fund’s stability.
• A high Value at Risk necessitates significantly higher reserves.