There is active debate in Switzerland at the moment about the possibility that the conversion rate, which sets the minimum level of the annuity at retirement, will be lowered again. As early as 2003 the government, along with introducing other new operating rules for pension funds, proposed to reduce the rate step by step from 7.2% to 6.8% by 2015. Life insurance companies, however, consider that the proposed reduction does not go far enough and are lobbying for a rate of 6% or even lower. It is perhaps because of this pressure that the government has revised its view and is now in favour of reducing the conversion rate to 6.4% by 2011. The whole exercise seems now to depend on political bargaining rather than calculations based on reliable figures.

The regulatory framework of the occupational benefit plan is described in the law on occupational pension schemes. To calculate the annuity applicable at the time of retirement, the capital accrued in an individual’s fund is multiplied by the conversion rate (expressed as a percentage). The conversion rate for the mandatory section and the one for the non-mandatory section may differ. To make things even more complicated, insurance company Winterthur had in 2004 lowered the conversion rates for non compulsory insurance, attracting harsh criticism. However, other insurance companies followed what became known as the Winterthur Model. The main reasons insurers gave for the reductions - beside the crash on equity markets from 2000 until 2002 - were that life expectancy had increased and capital market returns (especially bond yields as a risk free rate) were low. As a consequence, in the non-mandatory section insurance companies cut the conversion rate to 5.4% for women and 5.8% for men.

The effect of a cut in the conversion rate from 7.2% to 6.4% is substantial: yearly income from CHF100,000 (€62,935) saved in an occupational fund scheme will
fall from CHF7,200 to CHF6,400. Together with the cut of the guaranteed minimum interest rate since 2003, this could equate to an overall cut of 30% in pension fund income for younger employees, says Giulio Vitarelli, managing director of independent advisers VZ-Vermögenszentrum.

Given the reductions involved, a massive reaction from the public and also from the trade unions might have been expected. But so far the unions have been astonishingly quiet. Only four years ago, plans for a reduction of the minimum interest rate that is applied to saving in DB plans to 3% from 4% led to protest all over the country. The word ‘Rentenklau’ (theft of pensions) was coined and figured in the headlines of every Swiss newspaper for nearly a year. Rentenklau even became “Swiss German word of the year” in 2003 and proved a popular slogan among the Swiss labour unions in their fight to prevent cuts in pension benefits; the colloquial word ‘Klau’ derives from the verb klauen, “to steal”. Following the crash of equity markets, the government reduced the minimum guaranteed interest rate to 3.25% from 4% in 2003. It now stands at 2.5% after having hit an all-time low of 2.25% for 2004.

The latest development came in
November 2005 when the government planned faster and bigger changes to the minimum conversion rate in occupational benefits than that set down in the first revision of the BVG, decided in 2003. The conversion rate would now gradually be lowered to 6.4% by 2011 and be reviewed for the first time in 2009. The draft underwent a “consultation procedure” until the end of April 2006. The government released the results of this at the end of June. This confirmed the view that the conversion rate should be reduced faster than decided before.

The conversion rate is determined by parliament through legislation. It is therefore likely that trade unions will begin to fight hard against any new reduction of the conversion rate. This will obviously catch the attention of the Swiss media. A prelude to more heated arguments could be observed at a conference on Swiss pensions in Berne in July organised by AG für Wirtschaftspublikationen, where the final proposals of the government on the conversion rate were presented and then discussed by politicians.

“The government is pessimistic about financial markets” said Christine Egerszegi-Obrist, first vice-president of the Nationalrat, the Swiss lower house of parliament. She added: “We have to study the topic carefully, as it really is a sensible one and middle and lower incomes are particularly affected. Politicians have to do their homework first and should not act in a hurry, as the conversion rate is too important an issue.”

Hugo Fasel, a member of the Nationalrat and also president of the Travail Suisse trade union, added his concerns. “What has changed in this long-term business that we need to adjust the conversion rate?” he asked. “If pension funds are not in a long-term business, who is? Sure we don’t know what will be happening in the future but we should forget about daily ups and downs, which are inherent in the financial markets.” He added: “Also our experts’ forecasts are very unsure as they do not have a crystal ball.”

There are, though, real problems for Swiss occupational pension funds. In the ‘Concluding Statement of the IMF Mission’ in March 2006 the International Monetary Fund noted: “Published data are likely to understate the underfunding [of the Swiss pension funds) because future liabilities are discounted with an average technical interest rate of around 4%, while the long-run market interest rates are barely above 2%. Moreover, life expectancy appears underestimated as well.”

Key factors for calculating the conversion rate are indeed the average life expectancy and the expected future returns of the savings. As nobody knows anything about future returns, the discussion is based on vague ideas or on past returns. Even worse: as insurers only want to take into account risk-free returns (eg Swiss government bonds with long-term yields at around 2%), the discussion about the “corrrect” conversion rate is likely to be endless.

Expected future returns proved to be an important topic at the AWP-Conference. “Short-time volatility on the financial markets shouldn’t be taken into account and considered as a base for long-term decisions such as the conversion rate,” said Herbert Brändli, managing director of B+B Vorsorge. “If you are a long-term investor in the pension fund business, there is no need to lower the conversion rate.” In recent years, increases in life expectancy and low bond yields have rendered the conversion rate increasingly unrealistic and too high in the view of the government. It has therefore drawn attention to expected lower returns as one important key reason for further reducing the conversion rate.

Peter Hunziker is a freelance journalist