Cost-benefit ratio of a pension fund: Benefits

The core function of a pension fund is to generate the highest possible retirement benefit from the savings contributions paid in. The two key factors in this process are the annual interest rate applied to employees’ retirement savings and the conversion rate used to convert the accumulated savings into a guaranteed lifelong pension upon retirement.

These two key factors are illustrated in this week’s chart. For the interest rate on retirement savings, the average value over the last five years (2020–2024) was used.

You want to be insured with a pension fund offering high benefits. Referring to the chart of the week, this means choosing a pension fund located in the upper right area – one that offers both above-average interest on retirement savings and an above-average conversion rate.

Another important aspect when evaluating benefits is fairness in the benefit structure of a pension fund. A pension fund located in the bottom right of the chart has a high conversion rate but offers below-average interest on retirement savings. This is good for retirees but less favorable for active members.

We consider a benefit structure to be fair when active members receive, on average, at least the same interest benefit as retirees. The compensation for active members may even be slightly higher, since they – together with their employers – bear the risk of having to recapitalize the pension fund in case of unfavorable developments in the financial markets.

To compare the interest benefits of active members and retirees, the guaranteed interest rate must be derived from the conversion rate, as described in Economico Flash 5. A conversion rate of 5% implies a lifelong interest rate guarantee of around 2%, while a conversion rate of 6% implies a guarantee of 3.6%.

If the guaranteed interest rate is calculated for different conversion rates, the red line shown in the chart of the week emerges. Pension funds located on this line have granted an average interest rate on retirement savings over the past five years that exactly matches the guaranteed interest rate implied by the current conversion rate.

Pension funds located within the red-hatched triangle have not reached this guaranteed level for active members. These funds therefore have a so-called redistribution problem: new retirees are overcompensated compared with active members, which should be avoided in the long term.