Regulators across Europe are forcing pension funds to fund every last cent of their liabilities - and more. Until now, Swiss public pension funds that enjoy a government guarantee have had the luxury of choice. However, a new law is set to take that freedom away

As things stand, the law allows Swiss public schemes with a financial guarantee to remain partly funded under certain circumstances. Now the government, the Federal Council, wants to see all local and federal authority pension schemes at a 100% funding level by 2038.

Once the law is passed, those public pension schemes that are fully or over-funded must not drop below the 100% mark and all others will have 30 years to reach full-funding level. However, those that do remain partially funded will face much stricter conditions than before, the government has said.

City of Basel Pension Fund CEO Dieter Stohler says it is the local authorities that will really feel the heat if the new proposal goes through in its current form. "It will put pressure on some pension funds, but more on the local authorities," he says. "It is the general public and not the pension funds that will be hit, because it will cost a lot to find the money if this [becomes law]. But we are not sure that it will."

Stohler is also president of the commission of public pension funds, a body under the umbrella of the Swiss pension fund association (ASIP).

Cantons, politicians and interested parties have until 15 October to file comments on the proposal; after that, the bill will go to parliament.

Already, objections have been loud. An expert commission that reported to the Federal Council earlier this year said a requirement that all public schemes become fully funded would place an "unbearable financial burden" on the authorities.

In 2006, public pension funds were CHF10.6bn (€6.4bn) short of full-funding status, with 43% of all public schemes underfunded.

"There is great resistance to the 30-year stipulation," says Stohler. "The law should continue to allow partial funding with a pay-as-you-go element so that the pension funds themselves can decide which model they want to adopt. It is not right that there should be this 30-year limit imposed on all cantons.

"There should be a mixture of different financing methods permitted, with some pay-as-you-go."

Many people will oppose this one-size-fits-all approach to solving the funding problems of Swiss public pension funds, says Stohler. Nevertheless, there are problems that need to be addressed through the law.

"There will have to be some sort of change because, at the moment, too much is left up to the pension funds themselves," he says. "Pension funds can do what they want, and they don't have to implement a plan."

But many public schemes have already taken steps to top up their funding. Most notably, under a new law that takes effect next July, the CHF30bn pension fund for Swiss federal employees, Publica, will switch from a defined benefit basis into a defined contribution scheme for all members.

Before this happens, the Federal Council will pay CHF12bn into the Publica fund to bring it up to full-funding levels, a spokeswoman says.

The CHF21bn Canton of Zürich employees' fund, BVK, which is currently 102% funded, will be outsourced to a foundation after January 2009 once it has reached a funding level of 110%.

BVK head of asset management Daniel Gloor says that, even though it is not underfunded, the fund has not recovered the minimum fluctuation reserves it should have according to its strategic asset allocation since the 2002 market crash.

For the 2007-2011 period, BVK's assets show a performance potential of 5.7% with a standard deviation of 7% based on its strategic asset allocation and empirical data, says Gloor. This means that the minimal fluctuation reserves should be 13.5%, which would mean a coverage ratio of 113.5%.

"The board of governors decided in May 2007 that, at the time of becoming independent, BVK must have a coverage ratio of at least 110% to avoid falling back into an underfunded status should markets fall," Gloor says. "Becoming independent means that BVK will no longer be protected by the state guarantee but rather by sufficient reserves − of at least 10%," he adds, pointing out that this proposal has yet to be discussed and accepted by the cantonal parliament. He says this will probably happen this month.

The City of Basel pension fund has firm plans for its future. "We will change to full capitalisation in 2008, with the canton making up the difference," Stohler explains. The balance payable next year will be CHF1.4bn, and the canton will recapitalise in order to raise half of this sum.

This will bring the funding level to 100% from its current 79% or so. The fund will remain a defined benefit scheme, but it will lose the funding guarantee it now has from the canton.

Meanwhile, the pension fund for the canton of Graubünden - Switzerland's largest canton by area - has already raised its funding levels and had a funding ratio of 104.9% at the end of last year, according to its managing director Hansmartin Eberle.

"It was fully financed in 2005 by capital inflows from the employers," he says. "Our fund is hardly affected by the foreseen change in the law."

But the new law will obviously put some pressure on those public pension funds that are still underfunded, says Gloor.

"However, taking the long time horizon into account, it should be possible to realise that goal either by setting up a professional long-term strategic asset allocation - a good solution - or by increasing contribution rates of employees and employers - tax payers - which would mean an easy but bad solution," he says.

But despite the opposition to it, Gloor predicts the legal proposal will end up becoming law.

"I think that there will be a good chance that this kind of law will pass the necessary political hurdles since there is a widespread understanding that not only private but also public pension funds, despite the state guarantee, should be fully funded," he explains. "Why should taxpayers pay for an inadequate asset allocation if there is also the opportunity to build up the necessary financial means on the capital markets?" He recalls that the very same discussion took place in the country 15 years ago.

Other funds around the country that enjoy plumper funding levels can afford to be sanguine about any law that demands high coverage ratios.

The City of Zürich pension fund (PKZH) is one such fund. Chief executive Ernst Welti says the fund supports the general trend of the proposed law. "Actually, we are not concerned by it because our funding ratio is about 135%, as of the end of August 2007," he says.

But things were not always as comfortable for the fund as they are today, he adds. "After Word War II, PKZH's funding ratio was a mere 55%. At that time the government and parliament of the city decided PKZH should become fully funded within 40 years. To this end, each year the employer paid an extra contribution. In the 1980s the ambitious goal was finally accomplished, and at that point PKZH started investments in equities."

So to some extent, it could be said that the fund anticipated the new law by 60 years, he remarks, adding: "In that respect, we are a good example for other public
pension funds."

However, PKZH took the decision voluntarily, rather than being forced by law, he stresses. "Our experience inclines us to think that other public funds shouldn't be forced either" Welti says. "Also, do we regard the proposed period of 30 years as slightly too restrictive? We support the central message of the proposed law but we would prefer a solution on a more optional basis and without too restricted a period of time."