Switzerland: Doing the splits
Nina Röhrbein looks at how Switzerland is dividing up the AHV/AVS Social Security Fund to avoid what has been described as ‘an unhealthy state of affairs'
The CHF26.7bn (€19bn) Swiss Federal Social Security Fund is in the process of splitting into three funds: a main old age pension fund, a disability fund and a third fund responsible for maternity and military benefit payouts.
The reason behind the split, after 63 years of running as a single fund, was that ever since the introduction of the federal disability insurance (IV) in Switzerland in 1960 its deficits had to be financed by the Federal Old Age and Survivors' Insurance AHV, or AVS in French.
"This was an unhealthy state of affairs so Parliament wanted to create its own sources of revenues and own expenses for each insurance," says Eric Breval, CEO at the AHV fund. "The opinion was that if an insurance has a structural, chronic financing problem, like the disability one, it should not be able to solve it at the expense of another insurance."
While the disability fund is a new development, the fund responsible for maternity and military payouts has existed for a number of years, albeit not as a separate entity. From 1 January 2011, additional financing for the disability fund will run for seven years, during which the fund should be in equilibrium. What will happen thereafter is an open question.
Current target medium-term asset allocation for the overall fund consists of 47% foreign currency bonds, 20% Swiss franc bonds, 10% Swiss franc loans to cantons and municipalities, 15% equities, 5% real estate and 3% commodities, with the currency risks associated with the investments hedged to 80%.
The AHV fund, which returned 13% in 2009, also has a CHF500m Active Allocation Mandate, managed internally by an investment committee headed by the CIO. "The tactical asset allocation mandate has given us the required know-how and helped us to react more quickly to market movements," says Breval. "We also set up a financial risk management and reporting unit in 2009 to help us control future market volatility."
As part of the restructuring process last year, AHV also changed its management office, leading to the creation of a five-person strong executive board (Geschäftsleitung).
The same executive board and teams will also be in charge of the central management of the new three-fund system. The three different investment strategies and asset allocations have yet to be decided but the military and maternity fund is likely to have the most dynamic asset allocation, as its financing sources will be the strongest relative to assets.
The new three-way system will be effective from 1 January 2011. Breval estimates the old age pension fund to roughly hold CHF18bn, the disability fund to have CHF5bn and the military and maternity fund to be the smallest at about CHF500m. A decision on their individual investment strategies is expected by the third quarter.
• The Swiss Federal Social Security Fund is the central manager of the funds and assets of the Federal Old Age and Survivors' Insurance (AHV), the Federal Disability Insurance (IV) and the Income Compensation Scheme (EO). AHV/AVS forms the most important part of this first pillar of the Swiss social insurance and is designed to provide an old age pension.
• AHV/AVS dates back to the year 1925, when the Swiss electorate agreed to a constitutional paper article outlining the creation of an old age and survivors' insurance system. It came into force on 1 January 1948.
• The AHV is financed by the pay-as-you-go system.
• The Swiss Federal Social Security Fund must always have a large portfolio of liquid funds and short-term investments, as money flows unevenly into and out of the social insurance schemes' income and expenses. This is due to the fact that outgoing payments mostly correlate with pension due dates, while incoming payments are much more erratic (VAT, quarterly highs of compensation offices). Furthermore, the income is not sufficient to cover the benefits and the Federal Disability Insurance (IV) and Income Compensation Scheme (EO) deficits. To avoid frequent investment changes and the attendant costs, an operating liquidity reserve of around CHF2bn is maintained.