What is the funding ratio of pension funds?
One of the most important and well-known figures for rating a pension fund is its funding ratio; this mirrors the ratio between its assets and its payment obligations towards current employees (currently active contributors) as well as retirees. It therefore reflects the ratio of assets to the respective pension fund's payment obligations.
The basic rule is that the higher the funding ratio, the better. A general guide is that 100 percent must be reached or exceeded. But it's not quite that simple.
What is surplus coverage?
If a pension fund has more assets than payment obligations, the funding ratio is therefore greater than 100 percent, i.e. there are surplus funds. This means that the pension fund has set aside reserves and can distribute future profits, particularly investment profits, quicker to insured members, e.g. in the form of higher interest.
What is underfunding?
The opposite applies when a pension fund is underfunded: in this case, the pension fund has more payment obligations than assets, so the funding ratio is less than 100 percent. The pension fund must analyze why it is underfunded and take remedial steps if the underfunding has a structural cause and it is not possible without measures to return to a funding ratio of (at least) 100 per cent in the medium term. Foundations with a fully insured plan cannot be underfunded. This is because pension fund assets and payment obligations are fully outsourced to an insurance company which bears all the risks.
However, to be able to compare the respective funding ratio of pension funds, you first have to know how it is calculated.
How is a pension institution's funding ratio calculated?
A pension institution's funding ratio is calculated by dividing total assets by total payment obligations.
Assets here comprise all pension fund assets (e.g. credits in accounts, equities, bonds, real estate, alternative investments) at current market value.
In turn, a pension institution's payment obligations cover
- the retirement assets of insured contributors
- the actuarial reserves of current pensions
- technical provisions
1.) Retirement capital of current employees
Thecurrently insured employees have a claim against their pension fund for their saved retirement assets (also known as vested benefits) which must be paid out when required (e.g. if they change pension funds, for example, due to a change of employer, withdrawal as part of purchasing a home or if the person in question moves abroad).
2.) Actuarial reserves of retirees
The actuarial reserves of current pensions correspond to the total value of expected future pension payments that the pension fund must make.
3.) Technical provisions
Technical provisions are financial reserves for all additional payment obligations that are foreseeable today, i.e. that the pension fund calculates for the future. For example, because actuarial reserves of current pensions have to be revalued and increased due to falling interest rates. Or because the retirement assets saved by insureds at the time of retirement are insufficient to fund their pension, thus giving rise toretirement losses.
