86 very sensitive to changes in the MIR in the short run, the present value of annuities is extremely sensitive to changes in the technical interest rate. The reason is that the MIR is merely applied on accumulated capital and does not affect future benefits to be paid. Thus, in the short run there are no compound interest effects.<sup>78</sup> Recall that the MIR is set by the Swiss Federal Council, and is not therefore directly influenced by pension funds (c.f. Section 3.2.2), but they can decide if their performance is better and – under certain conditions – if it is worse.

**Table** **<u>35  Aggregated Liabilities of all Pension Funds</u>**

|Liabilities(in M CHF)|2002|in %|
|---|---|---|
|Deposits and Borrowed Funds|11,315|2.72%|
|Mortgages|1,443|0.35%|
|Funding Status (Schwankungsreserven)|16,805|4.03%|
|Reserves of employer|3,160|0.76%|
|Fixed and non-fixed Capital|383,795|92.14%|
|Total Liabilities|416,518|100%|

Source: Bundesamt für Statistik (2004b), p66 The technical interest rate discounts all future cash flows and enters via compound interest rate effects into the calculation of present values of annuities. Hence, these positions are highly sensitive to the choice of the exact discount factor. Responsible for the use of the technical rate is the so–called _technical expert_ . In accordance with guidelines for experts in retirement pension insurance the technical interest rate should be a reasonable amount of basis points below long run market returns and take into account specific characteristics of the fund.<sup>79</sup> It is advisable to use a technical interest rate that is quite low. As a direct consequence, the present value of future cash flows is larger. Using a lower technical interest rate comes at the cost of a less favorable looking balance sheet (in the short run).<sup>80</sup> Common practice is to use a rate of 3.5 percent. High values of the technical interest rate are only sustainable when assuming a recovery of financial market returns and/or international diversification. So far, there have been no moves to adopt more objective market indicators, such as the zero-coupon yield curve on AA corporate bonds, to value future (actuarial) liabilities.

The _asset side_ of the balance sheet, consisting of investments in securities (c.f. Figure 22 and Table 36 for the valuation rules), is directly affected by changes in market returns (which are exogenous for pension funds), whereas the liability side is mainly affected by the MIR and the technical interest rate, which both do not directly depend on market interest rates. _Asset Management_ has therefore two particular objectives: First, the management of assets in such a way that they meet the contractual and statutory (e.g., MIR

> 78 Obviously, the effect on an individual balance can be considerable, especially in the case of older members as they have already accumulated a relatively high credit balance.

> 79 Keel and Frauendorfer (2003) examine the impact of the technical interest rate on the ability to take risks. 80 As an Example: The pension fund of the City of Solothurn reduced the technical interest rate from 4.5% to 4% in the financial year 2004. As at 01.01.04, the resulting funding ratio was 78.7 percent (with a rate of 4 percent). In contrast, by still assuming a rate of 4.5%, the funding ratio would be 83.8 percent, i.e., due to increased liabilities the underfunding grew by 5 percentage points.