Pension Funds

Pension funds are pools of money set aside to pay retirement income to workers. They are built up from contributions by employers, employees or both, and invested until benefits fall due. They are run by companies, national and local governments, unions and industry bodies, and together they are among the largest investors in the world's stock, bond, property and infrastructure markets, measured by assets under management.

A pension fund is different from a state pay-as-you-go system such as US Social Security, in which today's payroll taxes pay today's retirees, and from a sovereign wealth fund, which invests national wealth on behalf of a government. Norway's Government Pension Fund Global, despite its name, is a sovereign wealth fund financed by oil and gas revenue rather than by workers' contributions. Pension funds are also distinct from insurers that sell annuities, although the two often trade risk with each other.

Imagine a group of colleagues who each put a slice of every pay cheque into a shared savings jar, with their employer adding a bit more. Someone is hired to look after the jar and invest the money so that it grows over the decades. When each person retires, the jar either pays them an income for the rest of their life or hands them their share to live on.

The difficulty is that the jar has to last a very long time. Its managers must estimate how long members will live, what investments will earn and how prices will change over thirty or forty years. If they are too cautious, the money grows slowly and contributions have to rise. If they take too much risk, a market crash can leave the jar short just when people need it.

There are two main designs. In a defined benefit (DB) plan the employer promises a set income, usually based on salary and years of service, and bears the risk that investments fall short. In a defined contribution (DC) plan the contributions are fixed and each member has an individual account; the eventual income depends on how much was paid in and how the investments performed, so the member carries the risk. Many private employers in the United States and the United Kingdom have closed DB plans to new members and moved to DC arrangements such as the US 401(k), named after a section of the tax code added by the Revenue Act of 1978. Hybrid and collective designs, used in the Netherlands and elsewhere, share risk between employers and members.

A DB fund's health is measured by its funded ratio: assets divided by the present value of the benefits it has promised. Future payments are converted into today's money with a discount rate, usually based on government or high-grade corporate bond yields, which links pension accounting closely to the risk-free rate. For a single payment:

• $\text{PV}$ is the present value of the promised payment.
• $B$ is the benefit due in the future.
• $r$ is the annual discount rate, written as a decimal.
• $t$ is the number of years until the payment is due.

A fund that owes 100,000 dollars in 20 years must hold $100{,}000 \div 1.04^{20} \approx 45{,}600$ dollars today if the discount rate is 4 percent. At 2 percent the figure rises to about 67,300 dollars. Falling interest rates therefore make pension liabilities larger, which is why many DB funds hedge with instruments such as the interest rate swap.

Because their liabilities stretch decades ahead, pension funds can hold assets for a long time. Typical portfolios mix shares, bonds, property and infrastructure, and many funds have moved into private equity, private credit and timberland in search of returns that are less tied to listed markets. Japan's Government Pension Investment Fund (GPIF), which manages reserves for the national pension system, is generally described as the largest, with about ¥293.6 trillion in assets at the end of March 2026. The California Public Employees' Retirement System (CalPERS), the largest US public pension fund, reported preliminary assets of about 637 billion dollars on 30 June 2026.

Many UK DB schemes use liability-driven investment (LDI), which hedges interest-rate risk with derivatives and repurchase agreements, often with leverage. After the government's mini-budget of 23 September 2022, yields on long-dated gilts jumped and LDI funds faced large collateral demands, much like a margin call. Schemes sold gilts to raise cash, pushing yields higher still. On 28 September the Bank of England began temporary purchases of long-dated gilts, which ran until 14 October, to restore orderly trading. The episode showed how funds designed to be safe could turn a market shock into a liquidity crisis.

In the United States, private-sector plans are governed by the Employee Retirement Income Security Act of 1974 (ERISA), and the Pension Benefit Guaranty Corporation insures DB benefits, up to a limit, if a sponsor fails. Public plans such as CalPERS fall under state law. In the UK, the Pensions Regulator oversees workplace schemes, the Pension Protection Fund covers members of failed DB schemes, and since 2012 employers have had to enrol eligible workers automatically into a workplace pension.

• Pension Benefit Guaranty Corporation
• The Pensions Regulator
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