Closing the Pension Gap for the Next Generation

Closing the Pension Gap for the Next Generation
Source: Own illustration

Context

Switzerland's first-pillar pension system (AHV/AVS), primarily funded through a pay-as-you-go (PAYG) mechanism, faces considerable financial pressures driven by significant demographic shifts. Notably, the country's population is aging, with life expectancy steadily increasing, while birth rates continue to decline. These demographic trends are worsening the imbalance between active contributors and pension recipients, challenging the sustainability of the current financing structure. Moreover, the baby-boomer generation's retirement further intensifies these pressures, posing a risk to intergenerational equity and social justice, and potentially causing fiscal instability in the future.

Problem Statement

The current PAYG structure of the first pillar relies heavily on contributions from the working population to fund pensions for retirees. However, due to demographic aging and declining birth rates, this model is increasingly strained. The ratio of contributors to beneficiaries is declining, leading to significant projected shortfalls. Without comprehensive reforms or supplementary funding strategies, the pension system is at risk of becoming unsustainable, placing a growing financial burden on future generations and undermining the system’s ability to provide adequate retirement security.

Research Question

This thesis investigates an innovative solution by examining the potential of introducing a state-funded, capital-based investment initiated at birth for each newborn child. The central research question is: How much would the Swiss government need to invest per newborn in 2025 to fully cover the projected AHV/AVS pension funding gap by 2090?

Methodology

The study employs a rigorous quantitative approach integrating long-term financial market simulations, demographic projections, and detailed fiscal modeling. Historical performance data, including returns and volatility from the Swiss equity and bond markets, were extensively analyzed. Monte Carlo simulation techniques were utilized to project numerous possible outcomes for the investments over a 65-year horizon, thereby accounting for the inherent uncertainties in financial markets. Furthermore, regression analysis was conducted to quantify the relationship between market volatility and long-term investment risk. Demographic projections extending to 2090 incorporated critical variables such as population size, age distribution, fertility rates, life expectancy, migration patterns, and labor force participation rates, ensuring a comprehensive analysis of future demographic dynamics.

Results

The research developed three distinct scenarios – Low (optimistic), Reference, and High (pessimistic) – each characterized by varying assumptions regarding financial returns, inflation, demographic growth, and dependency ratios. The projected pension funding gap in the year 2090 under these scenarios ranged significantly from CHF 17.17 billion (Low scenario) to CHF 46.22 billion (High scenario). Accordingly, the investment required per newborn in 2025 to close this gap varied widely, from CHF 627 in the optimistic scenario to CHF 5'600 in the pessimistic scenario. The Reference scenario, considered the most balanced and realistic, estimated a required investment of CHF 2'018 per newborn. The simulations highlighted the strong robustness and reliability of equity-based investments over extended horizons, with no scenario resulting in capital losses, and a majority (over 55%) exceeding deterministic targets. Nonetheless, the results underscored the substantial influence of market volatility, emphasizing the necessity of disciplined, well-governed, and transparent investment management practices to achieve predictable outcomes.

Conclusion / Discussion

The findings suggest that early-life, state-funded investment strategies offer a promising complementary approach to securing the future sustainability of the Swiss pension system. By leveraging compound interest over extensive periods, even relatively modest initial investments could substantially alleviate future fiscal pressures. This strategy promotes intergenerational fairness by reducing the financial burden on younger and future generations, while simultaneously enhancing the predictability of retirement financing.

However, successful implementation would require careful consideration of political feasibility, governance frameworks, and investment strategies. Transparency, strategic foresight, and continuity in policy implementation emerge as critical components. Additionally, the integration of this investment-based approach into Switzerland’s broader pension and fiscal policy framework is crucial to maximize effectiveness and ensure political and public acceptance. Overall, the research underscores the viability and scalability of birth-based capital investment mechanisms, contributing significantly to academic discourse on sustainable pension funding and providing actionable insights for policymakers and stakeholders aiming to strengthen the resilience of Switzerland's pension system.