Dilemma of market gains
Emma Cusworth assesses the funding levels of Swiss pension funds
Swiss pension funding levels have deteriorated significantly over the past year, with around 60% facing shortfalls. Recent stockmarket gains have provided some relief, but with reserves mostly gone, Pensionskassen cannot afford to relax.
Market improvements could also spite funds as crucial decisions regarding minimum interest and benefit conversion rates remain open. Should the funding equilibrium continue to improve this year, pressure for these further cuts to liabilities would decrease. At the same time many schemes could delay taking decisive recapitalisation action, threatening the long-term security of the Swiss pension system.
According to figures from Swisscanto, the average coverage ratio for private sector schemes fell 13 percentage points during 2008 to 96.4%. The picture was considerably worse for public schemes, whose average funding fell 15.1 percentage points to 84.9%.
The Swiss Federal Social Insurance Office's (FSIO) figures revealed 60% of second pillar schemes were in deficit by the end of 2008 and a further 7% fell into deficit by the end of March.
During the first quarter of 2009, the Credit Suisse Swiss Pension Fund index fell 1.58%. After a relatively stable January (-0.33%), there was a marked decline of -2.76% in February, but March produced a 1.54% gain, recouping around half of losses.
The gap between the index and the minimum legal interest rate, set at 2% from 1 January, increased 2% during the period. To close the gap by the end of 2009 would require a 24% rise in the index, twice the level recorded in the excellent stockmarket year of 2005.
The second quarter brought some relief, pushing the index into positive territory for the year-to-date. By 30 June 2009, the index was up 3.2% following a 4.86% second-quarter gain. The gap between the index and the minimum legal interest rate narrowed, but still required a 15% jump to close this year.
Mercer estimates that average funding levels improved approximately 8 percentage points during 2009 to the end of July. "Funds that were only slightly underfunded managed to re-establish full funding and most of those with substantial deficits, below 90%, managed to improve ratios back into the high 90s," says Sven Ebeling, Mercer's head of investment consulting in Switzerland.
Experts have warned against over-optimism, however. Analysis by Watson Wyatt on behalf of Switzerland's pension fund association, ASIP, showed a median return of 3.5% for the first half based on member schemes' asset allocation. "Despite this slight improvement, Pensionskassen will generally still not reach their required target return for the last five years," says ASIP director Hanspeter Konrad.
"The positive market performance for the first half has stopped the decline in funding ratios, for now, and will work to support recapitalisation measures implemented by Pensionskassen," he adds. "However, it is still too early to call an end to the difficult financial position faced by many schemes. Future market improvements are urgently needed to rebuild volatility reserves."
Earlier this year the government called for Pensionskassen to implement rapid recapitalisation measures, warning that delays meant greater future pain and relying on market improvement alone would be imprudent.
The extent of underfunding remains a crucial factor in determining the need for recapitalisation. For those with small deficits of up to 5%, measures are not necessarily essential, but, Swisscanto says, boards would still be wise to discuss and prepare measures in case things deteriorate.
Pensionskassen with funding below 90% are required to address shortfalls according to the practice established by the supervisory offices.
As a result, the emphasis remains on public schemes, whose average funding level of 87.4% by 30 June was still significantly worse than private sector schemes (98.9%). Swisscanto estimated that 82% of public schemes were in deficit by the end of June compared with 48% of private schemes.
Public schemes were generally in worse shape before the crisis began, in part because they are typically backed by the tax payer and assumed to exist forever, thereby lessening the need for fast recapitalisation. Private schemes are required to regain full funding in five to seven years, versus around 40 years for public schemes. Funding levels deteriorated to a greater degree as a result, with many more public than private schemes falling below 90%.
A bill is currently pending, which will impose 100% funding for public schemes within a set timeframe, yet to be announced, but likely to remain around 40 years. The bill is expected to be passed by parliament within the next year.
"This makes inertia less possible, especially regarding liabilities and benefits," Graziano Lusenti of Lusenti Partners believes, "as it will force them [public schemes] to take decisions they previously avoided."
Many public schemes have already implemented measures, including the cantonal Schaffhausen Pensionskassen (SPK). Following losses of SFR138m (€91m) in 2008, the coverage ratio fell 10.46 percentage points to 86.89%. Since 1 January 2009, active members have been paying an extra 1% in contributions, while the canton's premiums increased 1.5%. SPK also announced it will reduce the interest rate paid to active employees from 2.75% in 2008 to the minimum legal rate.
Many Pensionskassen are, however, still in the analysis phase and, as markets improve, face less pressure to act. "The supervisory authorities are also taking a less aggressive approach," Lusenti says. "There is a danger many Pensionskassen will delay making unpopular decisions."
Those that have taken deficit correction measures already, which Mercer estimated at approximately 18% of private schemes and 60% of public schemes, will most likely continue until the end of the year due to the annual reporting cycle.
For defined benefit schemes, the most popular measures include increased employer contributions and withholding pension increases while the deficit remains. In the more extreme cases, benefits can be adjusted.
For cash-balance schemes (subject to the minimum legal interest rate on capital), interest rates are usually reduced to the minimum legal rate, or even zero, and pension increases are withheld.
More schemes had been expected to follow SPK's lead in lowering the level of interest paid for 2009. While the government decides the minimum legal rate in advance, actual levels, set retrospectively, have not been announced by most Pensionskassen. However, recent market improvements could make cuts difficult for boards to justify.
Hopes of a cut in the minimum legal interest rate next year are also threatened by market developments in the coming months. "A reduction seems unlikely at the moment given the market recovery under way. As always, political factors will also be critical in deciding the minimum legal rate," Ebeling says.
Case Study: Pensionskasse SBB
With over SFR13bn in assets, Pensionskasse SBB (PKSBB) is one of Switzerland's largest schemes, representing 57,000 rail and transport workers. During 2008, PKSBB returned -11.48%, decreasing the coverage ratio to 79.2%, leaving a SFR3bn (€2bn) deficit.
During the first quarter of 2009, performance of -1.7% added SFR250m to PKSBB's shortfall.
Even though PKSBB became a private foundation in 1999, the government is planning to inject another SFR1.148bn this year to plug some of the shortfall and cover the costs of sinking the technical interest rate (Rechnungszins) from 4% to 3.5%.
This injection alone will not erase the deficit and SBB and its employees are also expected to play a considerable part in recapitalising the fund. PKSBB will pay 0% interest on capital this year and a decision on the interest rate paid on benefits, 2.75% in 2008, is due by the end of December.
In 2007, the government injected SFR1.5bn into PKSBB and employees had been paying additional contributions until that time. The decision to provide funding to PKSBB has angered political parties, including the FDP and the SVP, business associations and half of Swiss cantons.
The government has also so far abstained from assisting in the recapitalisation of ASCOOP, the Pensionskasse for 130 privately-owned transport companies with 15,000 members. ASCOOP believes government assistance for PKSBB unfairly disadvantages its active members and creates a competitive bias.
Many member-companies have already left ASCOOP, which is 73.57% funded. Firstbahn in Grindelwald is the latest to announce its intention to leave.
ASCOOP employees are paying 1.5% in additional contributions and member-companies had agreed to recapitalise the fund to 81% this year, but many have since abandoned the plan as falling stock markets left insufficient liquidity. The government is considering awarding subsidies in this case as it holds shares in a number of ASCOOP's member companies.