Thanks to the stock market boom: 300 pension funds pay pension bonuses – but in a stress scenario, the reserves of many funds would not be sufficient

2024 was an excellent year for the stock markets. This also made it a good financial year for pension funds. Swiss pension funds, which together manage approximately CHF 1,200 billion, achieved an average investment return of over 7 percent last year, according to data published on Tuesday by the Swiss Federal Supervisory Authority for Occupational Pensions.

The following statements concern the majority of pension funds – those without a government guarantee. These achieved an average investment return of 7.4 percent in 2024. Approximately half of this return was used to pay interest on the savings of employed persons and half to build up reserves. At an average of 3.8 percent, insured employed persons received the highest interest rate of the last 15 years. The average interest rate since 2010 has been approximately 2.3 percent per year.

In 2024, pension funds also approved a bonus for retirees significantly more often than a year earlier. 240 pension funds, which together hold a good third of the total pensioner capital, approved a one-time pension supplement, and 53 funds permanently increased current pensions. The supervisory authority's survey covers a total of around 1,300 pension funds.

A permanent pension increase is not necessarily better for those affected – because, given the pension fund's financial flexibility, a permanent increase will be much lower in percentage terms than a one-time bonus. The one-time bonuses approved in 2024 totaled 1.9 percent of the total pension sum in the second pillar, while the permanent supplements accounted for 0.3 percent.

"The legislature essentially provides for permanent increases, but retirees prefer a one-time increase because then the amount seems higher," says Stephan Wyss, a pension fund expert at the Zurich-based consulting firm Prevanto. He adds: "Retirees are, on average, about 74 years old. Younger retirees are better off with a permanent increase, while older retirees are better off with a one-time increase."

According to current law, pension funds should adjust retirement pensions to inflation "according to the funds' financial capabilities." The political left is demanding mandatory, regular adjustment of pension fund pensions to inflation, similar to the AHV (Old Age and Survivors' Insurance). A parliamentary motion on this is currently pending before the Council of States' Social Affairs Committee.

But this is primarily a case of shadow boxing. The calculation of annual pensions for new retirees via the conversion rate is based on assumptions about life expectancy and investment returns. These return assumptions already implicitly include a kind of inflation adjustment. On average, all current pensions likely include an interest rate guarantee for retirees' retirement capital of over 3 percent—which is significantly higher than inflation expectations.

Over the past twenty years, conversion rates for new retirees have declined significantly due to the ongoing increase in life expectancy and the downward trend in interest rates and inflation. In 2024, the average conversion rate for new retirees was 5.3 percent. This corresponds to approximately a guaranteed interest rate of 2.5 percent on retirees' retirement savings. This is also still above inflation expectations.

Of course, one could also demand regular official inflation adjustments from pension funds. But then the initial pensions would simply have to be correspondingly lower, because the money for the pension supplements doesn't just fall from the sky. "Assuming an average inflation rate of 1 to 1.5 percent per year, the conversion rate would have to fall by about 0.6 to 0.9 percentage points to finance inflation adjustment," says pension fund expert Stephan Wyss. Roughly speaking, this would mean that initial pensions would have to fall by about 10 to 15 percent.

Thanks to the strong stock market years of 2023 and 2024, pension funds have significantly increased their reserves. The common metric for this is the funding ratio. This rose on average from 110.3 percent to 114.7 percent in 2024. This means that for every 100 francs of future liabilities, the funds have assets of 114.70 francs. Are reserves of 14.7 percent reasonable, too much, or too little? That depends on the risks of the investments. The more heavily a pension fund is invested in volatile assets such as equities and real estate, the higher the reserves should be—but also the higher the average long-term return expectation.

According to the funds' own assessment, the buffers are not yet large enough in some cases. The average target value for pension funds is 17.6 percent. Such target values ​​are typically based on model calculations along the following lines: Given the known volatility of the investment portfolio, the fund should have a 95 percent probability of not experiencing a shortfall within a year. In practice, the funds have considerable leeway – for example, in determining the degree of certainty (95 percent probability, 97.5 percent, or even higher?) and the modeled period (e.g., one year or two years?).

In a stress scenario envisioned by the supervisory authority, around 40 percent of pension funds would experience a funding deficit: their liabilities would no longer be fully covered by assets. Capital-weighted, as much as 57 percent of the pension fund system would be underfunded. The stress scenario includes, among other things, price drops for equities of 20 percent, for real estate of 15 percent, for bonds of 10 percent, and for foreign currencies of 5 percent. This would be far from an extreme scenario; it is reportedly based on the situation in 2022.

In the event of a shortfall in funding, affected pension funds must adopt restructuring measures that bring the funding ratio back to at least 100 percent within a reasonable timeframe (e.g., within three to seven years). The supervisors' stress test assumes restructuring contributions of 5 percent of wages each year for seven years, as well as a cap on the interest on employees' savings capital of 1 percent per year. It is also assumed that the investment return during this restructuring period exactly matches the pension fund's target return. In this scenario, with fairly substantial restructuring contributions, approximately 4 percent of the funds would still be underfunded after the seven-year period, and the average funding ratio of the pension institutions would be roughly the same as at the end of 2024.

The moral of the story: Current pension fund reserves may melt away quickly, but they provide a significant cushion against future storms.