Return Requirements of Pension Funds
The key assumption when calculating the new technical provision generated in connection with pension accrual, that is, in the discounting of future funded pensions, is a nominal discount rate of three per cent. The technical provision is adjusted annually by at least this discount rate of three per cent.
The discount rate has been set at a fairly low level. Thus, with the exception of a few unexceptional years in investments, the discount rate has been achieved most of the time.
As a result of the low discount rate, investments could generate large surpluses in several years if no additional measures were taken. The funded old-age pension are increased annually to solve the problem of fluctuating investment returns. The increases can be targeted exclusively at persons of a certain age group. Currently, the increases are targeted at those who have turned 55 years. The targeting results in a more even development in earnings-related pension contributions.
The size of these increases is determined by the adjustment factor. It is defined on the basis of the average solvency of all pension providers.
A collective equity-linked buffer fund acts as a buffer against fluctuations in share returns. The buffer fund may be either positive or negative. At the most, the equity-linked buffer fund is one per cent and, at the least, -20 per cent of the technical provisions. On the basis of pension providers’ realised average share returns, this component of the technical provisions is either increased or reduced.
Assets exceeding the upper limit (1%) are transferred to the old-age pension liability on an individual level by increasing the size of the funded pension components. Falling below the lower limit (-20%) is prevented by dissolving the pension providers’ solvency margin.
If the average return of shares drops drastically, a negative buffer fund reduces the total technical provisions and the pension provider can more easily meet the requirement for a sufficient solvency margin. In other words, the equity-linked buffer fund is a mechanism that equalizes the equity risk.
Each pension provider must adjust its technical provision with a three-per-cent discount rate, the adjustment factor and a change in the equity-linked buffer fund.