As solvency levels fall Swiss pension funds are caught between conflicting pressures, Emma Oakman finds

As funding levels deteriorate, Swiss Pensionskassen are caught between the conflicting pressures of lower risk tolerance and a need to generate sufficient returns to cover liabilities and replenish reserves.

Nowhere is this more pronounced than for public schemes, which face growing pressure to reach fully funded status. With tough markets continuing to erode performance, the prospect of recapitalisations is proving unpopular and schemes' asset allocation strategies are coming into question.

At the end of 2007, the average funding ratio of private and public pension schemes was 112.6% and 98.8% respectively, according to the latest figures from the annual Pensionskassen survey by Swisscanto, the operational asset manager of Swiss cantonal banks.

"Based on the asset allocation of the average fund as per our 2008 pension fund survey, performance for the year to the end of August is likely to be around -4%," says Peter Bänziger, (pictured left) head of asset management and institutional clients at Swisscanto. "Considering the current minimum guaranteed rate of 2.75%, schemes must deliver annually, funding ratios are already about 6% lower."

While the majority of private schemes are expected to maintain surpluses, Bänziger estimates that roughly 60% of public schemes will have funding ratios below 100% during 2008. These schemes, which are backed by taxpayers, pay pensions to public sector workers in cantons or municipalities.

Sven Ebeling, Mercer's head of investment consulting in Switzerland, says: "There is currently no regulatory requirement for public schemes to be fully funded and some have ratios as low as 40%."

As the credit crunch continues to bite, pressure is mounting for shortfalls to be addressed. By early October, the Federal Council, the cabinet, is expected to have sent to parliament a document calling for public schemes to be fully financed.

"The document's message is that, after a certain period, it will no longer be acceptable for underfunded public schemes to have guarantees," says Jean-Marc Maran, head of the funding and system development section for occupational benefit plans. "Several cantons will therefore have to find a solution to the problem."

The trend is already towards plugging any significant holes, Bänziger says. A number of cantons put the proceeds from large-scale gold sales by the Swiss National Bank towards funding pension schemes. "But, it varies from canton to canton," he adds.

Even for those who have made efforts to bolster schemes, the results have not always lasted. "Timing recapitalisations is crucial," Bänziger says. "Some of those schemes where shortfalls were funded are back below 100% as a result of the poor market conditions. Faced with this prospect, other cantons may be reluctant to finance schemes during the current downturn. The question cantons and cities are faced with is how they should finance these holes and when."

He believes the most likely solution will be for cantons to issue debt, effectively transferring hidden pension debt into public debt.

But it is not just the cantons that are faced with tough funding decisions. A consultation is already underway over an up to CHF3.2bn (€2bn) federal government recapitalisation of SBB-Pensionskasse (SBB PK), a public scheme for railway workers. At the end of December 2007, SBB PK's coverage ratio was 92.4% despite increased employee contributions and financing of nearly CHF1.5bn from SBB.

However, this is rousing considerable debate as other schemes have called for similar treatment.

ASCOOP, a private scheme encompassing 150 privately owned transport companies with a funding ratio at the end of 2007 of 80%, has suggested that recapitalising SBB PK would unfairly disadvantage its active members and creates a competitive bias.

ASCOOP already has a refinancing programme in place, with employees paying 1.5% of a salary  into the fund on top of their normal contributions. Despite having no direct state connection, the government is considering awarding subsidies in this case as it holds shares in a number of ASCOOP's member companies.

Increased pressure on public finances is an unattractive prospect for the federal finance ministry (FDF), which is already calling for urgent pension reform to prevent national debt from trebling. Without speedy reform, the FDF estimates that Swiss national borrowing would hit 130% of GDP by 2050 as a result of changing demographics. The figure is currently just under 50%.

However, Ebeling believes that regulatory intervention is unlikely. "After the 2000-2002 crisis, the law was changed in response to decreased coverage ratios," he says. "Rules were laid out to determine who should contribute to what extent to finally re-establish full funding. As a result, measures to deal with shortfalls are largely already in place and a similar reaction is unlikely this time. The debate will probably focus more on the asset allocation side to ensure better downside protection."

But lower funding ratios also create an asset allocation dilemma by reducing schemes' ability to take risk, says Bänziger: "This requires them to cut back on risk assets such as equity, which limits their chances of improving their financial positions in the longer term. However, our long-term survey shows that pension funds kept their asset allocations relatively stable through bull and bear markets."

Daniel Gloor, head of asset management at BVK, the Pensionskasse for the canton of Zurich's civil servants, says: "The discussions are always the same. If the fund doesn't achieve its long-term performance target, there are only two options: reduce risk or look for funding solutions.

"Increasing contributions is very difficult on a political level. On the other hand, reducing the risk level in the portfolio means the fund would not be able to achieve the minimum performance required to maintain the funding ratio in the long run and it would therefore
deteriorate."

This impact has already been seen at ASCOOP which, because of its financial situation (a funding ratio of 80.42% and no reserves), is not able to take risks in the investment portfolio. With a risk-free investment strategy, however, the 5% annual return required to recapitalise the scheme cannot be achieved.

Many schemes are resisting pressure to change their asset allocation. The Bernische Pensionskasse (BPK) is not planning a change in strategy despite its coverage ratio dropping nearly 10% to 95.1% at the end of 2007 at the end of June after a first-half performance of -7.4%. According to Hans-Peter Wiedmer, CFO in charge of asset management for the BPK: "We see no reason to change the strategy or take corrective action in the pension plan based on recent market volatility. We are not happy with how things are, but we believe in our strategy and the portfolio is reacting how we expected it to based on our asset-liability modelling. Over the long term we are confident we can realise the required 4% return."

By 12 August, the BPK's funding ratio had improved to 97.4% on the back of positive equity market developments.

"People often believe that by changing the strategic asset allocation, funds can do better at avoiding tumbling coverage ratios," says Gloor.

"This is a misunderstanding, but it is not always easy to convince them of the contrary. Every five years the same discussion comes up when funding ratios go below 90% and politicians panic. Changing the asset allocation is not a realistic option though. Other crises have proved that in the end tactical changes in asset allocation are no use. There is a lot of uncertainty about where the markets are going, and changing strategy means a chance of missing the recovery."

PKZH, the scheme for the city of Zurich, confirmed in July that, despite a 14% drop in its funding level to 116% at the end of December, it would not be making any short-term decisions as a result of the credit crisis. However, if its funding ratio dropped below 112%,
it would decrease its equity exposure because of the reduced ability to absorb risk.

However, PKZH is suspending a rebalancing in its portfolio as a result of lower reserves. The fund is currently 5% under its strategic equity allocation of 40%.

Bänziger says this is not unusual. "As a result of reduced coverage ratios, many funds have put their asset allocation plans on hold," he says. "Given the current market environment, some are putting off building their exposure to alternatives and real estate. Mainly, funds are holding liquid assets and there has been a massive increase in money market investment."

However, Ebeling believes the general decrease in coverage ratios will drive an increase in allocations to foreign assets and alternatives. "Over the longer term, the capital preservation benefits of diversifying into more geographies and asset classes will push more schemes down this route."