The conversion rate, with which your retirement assets are converted into a lifelong retirement pension at retirement, is a key figure in the world of pension funds. The higher the conversion rate, the higher the monthly retirement pension you receive from your accumulated retirement assets.
The pension fund sets the conversion rate so that it can finance the promised retirement and survivors’ benefits in the long term, without the pension fund making a profit or a loss.
Since the sum of the pension payments expected over the lifespan is as a rule higher than the retirement assets available at retirement, the pension fund has to invest the accumulated assets with a focus on returns. These capital returns help to keep the lifelong pension guarantee.
The level of the conversion rate is mainly influenced by two factors: by life expectancy and by the interest credited to the available retirement assets.
- Life expectancy determines how long the pension fund pays a retirement pension on average. The higher the life expectancy, the lower the pension-forming conversion rate has to be set, so that the available assets last until death and the pensions are financed in the long term.
- The interest depends on the income the pension fund achieves by investing the accumulated retirement assets. The higher these returns, the more the invested retirement assets grow. This makes it possible to finance higher pensions, which has a positive effect on the conversion rate.
When we vote on the level of the conversion rate, it is easy to draw the false conclusion that its level can be set freely. In fact, the conversion rate is substantially influenced by two factors:
- Life expectancy is a demographic variable, connected in particular with medical progress.
- The interest is an economic variable, derived in the long term from inflation, economic growth and developments on the capital markets.
Over the past 40 years, life expectancy has risen continuously. At the same time, the interest – illustrated in simplified form by the return on a 10-year Swiss government bond – has fallen markedly. Because of these changes, pensions have to be paid out for longer while lower risk-free investment income can be earned. This inevitably results in a continuous lowering of the conversion rate. If this reality is ignored in politics, the pressure to adapt on occupational pension provision increases.
The pension funds have responded to these upheavals and the related financing problems in the past with a combination of measures:
- Retirement losses and redistribution
Many pension funds recorded so-called retirement losses on newly granted retirement pensions. This means that the pensions promised were higher than the available funds and the expected income allowed in the long term. This deficit was partly offset by crediting active insured persons with lower interest on their retirement assets. As a result, a redistribution took place from the active insured persons to those drawing a pension. - More investment risk
In order to achieve higher income, many pension funds adjusted their investment strategy and chose a larger share of riskier investments. Higher return opportunities, however, also come with higher risks. If investment results turn out worse than expected, restructuring measures may become necessary, to be borne by employers and employees. - Lowering the conversion rates
In the supplementary area, pension funds can set the conversion rate themselves. Many pension funds have therefore lowered this rate in recent years. Many so-called «pension funds close to the statutory minimum» – that is, pension funds with benefits near the legal minimum – were and are nevertheless forced to increase their savings contributions. In this way they gain the financial leeway in the supplementary area needed to finance the pensions in the long term.