Pension Risk Study 2024
ZURICH, August 28, 2024 – Despite an improving capital market environment in 2023, the average coverage ratio for funded pension liabilities according to IFRS and US-GAAP decreased by around 3% compared to last year, from 107% to 104%. This is mainly due to a higher increase in liabilities compared to assets, driven by lower interest rates. The financial markets showed a positive trend throughout 2023, with positive returns compared to 2022, when returns were negative. These conclusions are drawn from the WTW's latest study on the coverage ratios of SLI companies in Switzerland.
“Occupational pensions are a key benefit in Switzerland and abroad – from an employee perspective, pensions often are the most important benefit. Hence, financial stability of pension plans is essential. For more than a decade, we have been monitoring the market movements year after year and examining the impact they have on pension liabilities of Swiss companies.” explains Stephan Wildner, Head of Switzerland at WTW in Zurich.
In comparison to the previous year's figures, the pension liabilities of the SLI companies considered in this study increased by around CHF 5 billion (3,4%) in 2023. Over the same period, plan assets decreased by around CHF 1 billion (-0.6%). The average cover ratio of all pension obligations (funded and unfunded plans) decreased significantly, from 99% to 96% between 2022 and 2023.
Following a year 2023 with relatively stable financial markets, this situation of stability is maintained in the first half of 2024. The initial sharp increase in inflation has been reversed, thanks to the measures taken by the central banks, thus strengthening the real economy. Christian Heiniger, pension fund expert and Senior Director at WTW in Zurich, points out that: " We are indeed seeing a turnaround with respect to interest rates. The Swiss National Bank (SNB) has already decreased the interest rate in two steps from 1.75% to 1.25% in response to the low inflation rates and to the increasingly complex economic environment."
The SNB is in a comfortable position to further decrease the interest rates, thanks to the low inflation rate. This measure would support long-term positions in the Swiss bond market, but would increase pension obligations. Pension funds should proactively prepare themselves for this scenario to avoid a deterioration of their coverage ratio.
The SNB’s decision to cut interest rates in response to the inflation rates and economic environment has a direct impact on pension funds mainly pension liabilities. For instance. for a typical pension liability duration of 15 years, a decrease in the discount rate of around 25 basis points translates into a 3% increase in liabilities. Additionally, lower interest rates have a direct impact on investment returns especially on fixed income securities (bonds). Therefore, pension funds have to be proactive to face this decrease in interest rates. One solution, for instance, could be to adapt their investment strategy.
So far, we have seen a readjustment of balance sheets. Since the start of the year 2024, the discount rate fluctuates between 1.3% and 1.5%. On the other hand, inflation has been gradually decreasing since January 2023. This fall in inflation rate has also been observed at the beginning of 2024, with a rate of 1.4% in May 2024. Experts predict a continuous decrease of the inflation rate throughout 2024, with an estimated rate of 1.2% for the whole year. It is worth mentioning that for the valuation of pension liabilities, inflation is considered when setting the actuarial assumptions on salary and pension increases.
The decelerated effect in the improvement in life expectancy observed in various countries has a positive impact on the financial stability of pension funds, however the trend towards an increase in the proportion of pensioners adds a considerable weight to the financial situation of pension funds.
Christian Heiniger underlines that: "It is important to take measures to decrease the costs of pension funds, in order to be proactive in a flexible and autonomous manner with regards to unexpected crises. Quantitative risk management as part of Asset Liability Studies can help increase the expected return on assets while maintaining the same level of risk by choosing the optimal risk-adjusted investment strategy needed to cover these liabilities. The latter creates better conditions for both employees and employers to meet the challenges they may face in the future."
The average coverage ratio for American companies, summarised in the WTW Pension 100 Index, has experienced a slight increase from 98% to 100% between 2022 and 2023. Whereas Swiss plans and German plans have seen a slight decrease in their coverage ratio from 99% to 96% and 80% to 79%, respectively, between 2022 and 2023.
