The reserve fund for Swiss social security is well-equipped to deal with growing deficits
• From January 2019, Compenswiss will have a new legal status
• The rejection of the AHV2020 reform shapes the outlook
• The deficit at the old-age pension scheme is forecast to rise
• It achieved positive investment results using a diversified strategy, protected by overlays in 2017
Compenswiss, the CHF36.8bn (€30.9bn) reserve fund for Switzerland’s social security system, has endured a period of uncertainty. The outlook for the old-age and veterans’ pension scheme (AHV) – one of the three social insurance schemes managed by Compenswiss – is worsening due to adverse demographic trends. However, the other two schemes’ – disability insurance (IV) and income compensation (EO) – futures are brighter.
However, the discussions on pension reform ihave added to the uncertainty around the AHV. Had the Swiss voted for the pension reform known as Altersvorsorge 2020 in a 2017 referendum, Compenswiss would be facing net inflows. The rejection of pension reform means it continues to face outflows until a solution is found. But, Compenswiss knows what is coming and is prepared to meet the challenge.
Over the years, Compenswiss has developed an approach consisting of several elements. There is a separate risk budget for each scheme. Assets are spread over two portfolios, one consisting of cash and money market investments, and another of risky assets, on the basis of asset liability management projections. The risk management process includes four overlays, for currency, rates, equity and tail risk hedging.
Cumulated outflows, owing to the imbalance in the AHV, should be about CHF5.8bn for the next five years, according to the Swiss Federal Social Insurance Office (see figure). “That’s a big number, but it’s only 18% of the fund’s financial assets split over five years, and rather backloaded. And it doesn’t take into account any potential income from financial assets,” says Christophe Schaer, the funds’ chief investment strategist.
Strong investment results kept the fund’s balance sheet healthy for 2017. The return after hedging was 7.11% for the year. As Schaer points out, in the coming years the AHV can count in part on future repayments upon a loan made by it to the IV.
Disability scheme recovers
Last year, also saw the end of a scheduled recovery period for the disability scheme, which began in 2011. While the full repayment of the aforementioned loan will take time, the debt has been reduced from CHF14.9 to CHF10bn. Furthermore, IV delivered a positive insurance result last year. “It’s a scheme that had suffered from large deficits for a long time, until it was reformed by parliament. The end of the recovery period and reduction of the debt are a major positive development,” says Schaer. During the period, Compenswiss has gradually increased the risk budget within the fund’s portfolio.
The end of the recovery period for the IV fund also means Compenswiss will stop receiving an annual CHF1.4bn cash flow, coming from a temporary 0.4% increase on value added tax. However, says Schaer, the books of the IV fund should be balanced for years, according to forecasts from the Swiss Federal Social Insurance Office.
“The situation is such that we do have a challenge for the next decade, but at the same time there is no sense of urgency. We have a suitable investment process and we are studying possible solutions and evaluating options to further strengthen it beyond 2020,” adds Schaer.
Further improvements to the investment strategy are under discussion, but remain undisclosed so far. But as things stands, Schaer argues that the strategy is robust. He says: “It allows us to steer the fund’s risk exposure with ease. We have tools to manage the immediate challenges and of course in the longer term, bearing in mind we are in a late phase of the market cycle. For instance, the tail-risk hedging programme should help if we get bad surprises, as this very long bull market ends.”
Schaer adds: “The investment process as a whole is holistic, because it is applied to all three insurances, using potential cash outflows to determine the risk budget for each insurance. Another advantage of the current process is that it is forward-looking, since it takes into account future outflows.
“We do have a challenge for the next decade, but at the same time there is no sense of urgency”
Of course, there are some options to further strengthen the methodology, but I think we have a good basis, particularly at the moment, since the deficits are still at moderate levels.” At present, he explains, the risk budget for the funds are similar, each hovering at a 4% volatility target.
Same name, new status
From 2019, Compenswiss will benefit from a new legal status. Despite operating under the common name of Compenswiss, the three social security funds are currently legally separate.
Following the 2017 approval of the Social Security Funds Act, come next January the three funds will be part of a new individual entity. Although the three funds remain separate for accounting, they will be incorporated into Compenswiss. The organisation will become “a federal institution governed by public law, with its own legal personality and its seat in Geneva”, according to an official document.
Schaer says: “The new law gives clarity and a better, more precise definition of the institution. Previously, there was a law for each of the social insurance schemes, but there was very little actually said about the organisation of Compenswiss itself, which is the entity managing financial assets insuring the liquidity of the Social Security System. There was a broad statement of mission about the organisation.
“In the new arrangement, we will be standing as one legal entity in the market, which is a great advantage, for example when you negotiate ISDA [International Swaps and Derivatives Association] contracts. The governance, including the responsibilities of the board of directors and the executive board, are also defined in more detail.”
The details of Compenswiss’ current and future governance structure are somewhat complex. In basic terms, the new structure will consist of a board of directors, appointed directly by the Swiss Federal Council, an executive board, appointed by the board of directors and headed by a CEO, an auditor, appointed by the Swiss Federal Council at the request of the board of directors.
Currently, the executive board’s functions are carried out by a management office, while the auditor is the Federal Department of Finances. These are important differences suggesting that Compenswiss will operate more independently. The changes raise confidence in Compenswiss, despite the failed reform attempt.
The rejection of the Altersvorsorge 2020 package may have left Compenswiss, with no solutions to growing deficits in the system. However, the government has started new talks aimed at new reform proposals.
For Compenswiss – with more than 10 years of potential outflows covered by the assets of the AHV, – there is plenty of time for solutions to be found. The strong returns the fund achieved last year indicate that the current strategy is working.