Threshold Portfolio Return for Swiss Pension Funds Based on Nested Stochastic Modelling
According to the FRP5 Guidelines of the Swiss Chamber of pension fund experts (SKPE) the threshold portfolio return corresponds to the annual portfolio return which the pension fund requires to keep the funding ratio constant. The difference between the expected return on assets and the threshold portfolio return plays a key role in determining whether the current benefits can be financed and in establishing and assessing recovery measures in cases of underfunding. The future threshold portfolio return depends mostly on interest credits, reserving and benefit policies and does not depend on the investment strategy. In our forecasting approach, the future threshold portfolio return over different periods is determined based on the nested stochastic modelling for pension fund liabilities whereas the future discount rate is directly linked to the stochastic 10-year-yield of Swiss government bonds (based on the revised FRP4 SKPE-Guidelines). This approach allows a realistic modelling of the pension fund development as well as its benefit and reserving policies. The distribution of the future threshold portfolio return helps to define a suitable investment strategy. For Swiss pension funds the threshold portfolio return has become one of the most important metrics used in risk management and has a significant impact on the investment strategy.