1e pension plans are facing reform. Will this hinder their continued popularity?
What are 1e pension plans?
Swiss pensions are provided under a three pillar system of state (first pillar), occupational (second pillar) and private (third pillar) pension provision.
The 1e pension plans fall under the second pillar of occupation pension plans.
1e refers to article 1e of the Ordinance on Occupational Retirement, Survivors’ and Disability Pension Plans. 1e plans offer up to 10 investment strategies to employees whose annual salaries exceed a certain level, at present CHF126,900.
A referendum last September blocked Swiss pension reform, and instead it has been decided to split the reform process into two. It is hoped that the state pension will be reformed quickly. The second pillar will then be discussed by employer and employee organisations.
However, 1e pension plans – which allow insured employees to choose between different investment strategies (see box) – develop apace. This article considers the impact on 1e plans of new regulations for such arrangements. They will be examined in the context of IAS19 and US GAAP.
We refer to the new article 19a of the law governing vested benefits (FZG/LFLP), effective from October 2017. Under this rule, Swiss 1e pension plans are no longer required to provide the protection afforded under Article 17 for investment losses (irrespective of the chosen level of investment risk) if they pursue a low-risk investment strategy.
Sponsors may choose to implement 1e for annual salaries of not less than CHF126,900 (€106,000). Implementing them at more than CHF126,900 will dissipate the IAS 19/US GAAP impact of moving to this type of arrangements, with no option to implement 1e for salaries less than CHF126,900.
The associated IAS 19/US GAAP impact of the new ordinance is of interest to employers disclosing in accordance with the previously mentioned international accounting standards. This refers to the impact that the recent issuance of article 19a has on the balance sheet and also the recording of pension costs for such companies. The previously mentioned balance sheets are determined with reference to the funded status on a defined benefit obligation (DBO) liability basis and projected benefit obligation (PBO) liability basis in accordance with IAS 19 and US GAAP.
Second pillar provision is predominantly provided to employees on a cash balance basis. Members’ retirement benefits are based on their accumulated balances on retirement. Cash balance plans are typically accounted for on a defined benefit (DB) basis in Switzerland rather than defined contribution (DC) because of the underlying guarantees and the right to receive a lifelong pension at retirement. We envisage that, with the new ordinance, employers should be able to account for their 1e pension plans on a DC basis pursuant to auditor approval provided certain criteria are fulfilled (1e plan only):
• Retirement benefits payable under the Swiss 1e pension plan should be offered in a capital lump sum rather than in the form of a pension. Here, longevity risk is eliminated from the employers’ perspective.
• Furthermore, the risks associated with the benefits payable on death and disability under the Swiss 1e pension plan should be covered by a congruent insurance contract.
• The positive and negative returns on assets of the chosen investment strategy are credited to the members’ individual account.
While it is likely that the impact of moving to a 1e pension plan on the IAS 19/US GAAP balance sheet will be positive, the effect and timing for a company should be carefully considered in detail. For example, companies reporting under US GAAP may be exposed to one-time settlement charges. These depend on the extent to which assets are moved from a pension plan already covering salaries of more than CHF126,900 to a 1e pension plan should there be unrecognised losses prior to the move.
Companies should also review the extent to which pension expense and employer contributions are envisaged to develop before and after the change. The actual amount of employer contributions that should be recorded after the move under a 1e pension plan may not necessarily be less than the pension expense that the company records before the move for salaries of over CHF126,900. The pension expense before the move depends on the specifics of the plan already covering salaries exceeding CHF126,900, demographics and the assumptions and methods employed.
“While it is likely that the impact of moving to a 1e pension plan on the IAS 19/US GAAP balance sheet will be positive, the effect and timing for a company should be carefully considered in detail”
Actual IAS 19/US GAAP impacts will depend on circumstances. One organisation may employ well-paid individuals while another organisation may not remunerate employees to such an extent. Well-paid individuals will accrue higher 1e benefits than less well paid individuals.
Particular parts of the business of a company in Switzerland may be more open to implementing a 1e pension plan than other parts. For example, owing to the salary structure, a global or European headquarter entity in Switzerland may be affected more than the domestic business of a multinational company. An organisation with greater exposure to active liabilities may be more impacted than another organisation with inactive liabilities.
The new ordinance may pave the way for DC accounting. However, it is important to note that it does not set out how the vested benefits already earned in respect of salaries above CHF126,900 should, or can, be transferred to the 1e pension plan from the previous plan sponsored by the employer in respect of such salaries, if any. The transfer of such vested benefits is important, and transfers to 1e plans remain to be scrutinised under Swiss law. There is a lack of certainty, pursuant to dialogue with the relevant authorities among others, in respect of the extent to which partial liquidations are triggered for such transfers from an overmandatory plan and to what extent such transfers are allowed. Furthermore, the materiality of the IAS 19/US GAAP impact will depend on the assets and liabilities transferred in respect of salaries insured in the 1e plan.
“We envisage that employers will continue to express an interest, not least given the issuance of the new ordinance. Some employers may prefer to take advantage of implementing a 1e pension plan earlier rather than later”
A shift to DC accounting in 1e pension plans is likely, assuming that the criteria for such a move are met. However, we advise that companies should seek the approval of auditors. These should include, but not be limited to, any one-time effects owing to the change (plan change/settlements). We envisage that readers of company accounts will be interested in the changes in approach including narrative descriptions and associated impacts. The disclosure of more competitive figures should not be a barrier to investment.
As set out in Aon’s Global Pension Risk survey, about 15% of Swiss companies are considering 1e arrangements. We envisage that employers will continue to express an interest, not least given the issuance of the new ordinance. Some employers may prefer to take advantage of implementing a 1e pension plan earlier rather than later, although the pace of change is debatable. Some employers may prefer to consider changing at a different pace given moves afoot once more by the Swiss government to reform pensions. Much discussion also continues regarding the parameterisation of pension plans in the context of a low interest rate environment. An example here is the rates at which retirement account balances are converted to a pension on retirement (conversion rates).
While the share of 1e occupational benefits institutions is not significant, according to statistics published by the Occupational Pension Supervisory Commission (OAK), we expect this to be an area of growth. Administrative charges levied by 1e providers, also the time horizon to implement, will have their role to play in the extent and pace at which the market evolves.
The communication of pension changes involves time. The time horizon will also depend on the complexity of the change. A time horizon of not less than about one to two years is envisaged for a move from a traditional pension plan (for example, company-sponsored fully autonomous plan) already covering salaries of more than CHF126,900 to a 1e pension plan. That is not least because the views of bespoke stakeholders in the change will need to be considered. This includes the pension fund manager and the board of trustees of the pension fund.
Iain Richardson is senior actuarial consultant and Willi Thunherr is CEO at Aon Hewitt Switzerland
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