Under the title 'Trends in Pension Funds', pension fund consultant Complementa has presented its latest study «Risk Check-Up 2023». In it, it is optimistic for this year, but warns of further challenges.
2022 was a challenging year for Swiss pension funds. In addition to geopolitical tensions, such as the Ukraine war, there was a significant increase in inflation rates. Central banks therefore quickly and very significantly tightened their monetary policy by raising interest rates. Consequently, both bonds and equities yielded negative returns. The Complementa study shows that pension funds posted a negative return of -8.6% on average in 2022. By contrast, 2023 got off to a good - albeit volatile - start. Pension fund investments returned +2.8% in the first four months. The annual return for the past decade was around 3.7%. The average funding ratio has therefore risen from 104.5% at the end of 2022 to 106.8% at the end of April 2023. «However, the positive development since the beginning of the year is countered by further challenges; among them are the still elevated core inflation rates in many countries and the lowered growth prospects», Complementa experts warn.
Interest on pension capital likely to fall
In 2022, the pension funds paid an average interest rate of 2.0% on employees' pension capital - based on the good investment year 2021. This was above the minimum BVG interest rate of 1.0% set by the Federal Council. The interest rate for 2022 is likely to be significantly lower.
Technical interest rates rise again
In recent years, technical interest rates (implicit interest rate promises for pensioners) that were significantly higher than the effective interest rate level were reported in each case. The recent rise in interest rates has narrowed the gap. In contrast to previous years, pension funds have increased technical interest rates in some cases. These currently average 1.7%, whereas last year they were calculated at 1.6%.
Conversion rates are further reduced
In addition to the interest rate level, pension funds are confronted with the increase in life expectancy of the population. The long-term trend is continuing at an average of 5.3%, the conversion rate in 2023 will again be almost 0.1 percentage points lower than in the previous year. The pension funds are thus moving further away from the BVG minimum conversion rate of 6.8% in the mandatory system, which doesn't take sufficient account of increased life expectancy. According to Complementa, the actuarially correct conversion rate with a technical interest rate of 1.75% is 4.8%.
A conversion rate that is set too high leads to retirement losses that younger cohorts must pay indirectly through lower interest rates. «Pension funds have already decided on reductions for the next five years to counteract this redistribution. As a result, the average conversion rate is likely to fall to 5.0% by 2028», Complementa knows.
Pension funds should be able to achieve a return above the target value
Complementa estimates that pension funds currently must generate a return of at least 1.9% to keep the funding ratio constant. However, the experts assume that pension funds can achieve a return above this target value in the long term with the current investment mix, although short-term fluctuations can never be ruled out. The higher return prospects must also be seen in the context of the lower funding ratios, which means that many pension funds will prospectively have to increase their reserves further.
Investment mix is broad and diversified
Pension funds rely on a global and broadly diversified investment mix, as the study further shows. At 29.3%, the equity ratio at the end of 2022 was slightly above the historical average of the past 20 years. Due to the low level of interest rates, bond holdings have been reduced significantly over the past ten years. Whereas in 2013 just under half of the assets were still held as fixed-income investments or as liquidity, at the end of 2022 this figure was significantly lower at 36.3% (2021: 37.1%). Since then, the freed-up portions have been distributed among equities, foreign real estate and alternative investments such as private equity, infrastructure investments and private debt. The real estate allocation is already above 20% for the fifth consecutive year (currently 24.3%), and alternative investments have also settled close to 10% in recent years (currently 10.1%). For the investment year 2022, Complementa also points to the «base effect», which has contributed to the increase in illiquid investments. The second pillar also invests every second Swiss franc abroad, the experts say, which is in line with the level of recent years, with pension funds hedging currency risks to a large extent. The remaining foreign currency risk currently amounts to 17.5%.
Diversification should also be examined regarding banking relationships
In addition to the interest rate turnaround, pension funds are also concerned about the event of March 19, 2023: the demise of Credit Suisse. Since, according to Complementa, Credit Suisse was a very important player for Swiss pension funds, for example in asset management as well as custody and account management, this topic area is clearly of concern to pension funds. One general concern is the development of the competitive situation, for example through a reduction in supply. Various pension funds have so far countered this by spreading out the banking services they purchase among various providers (multi custody approach). This is a target-oriented approach, says Complementa: «Diversification should be examined not only in terms of asset allocation, but also in terms of banking relationships.»