Switzerland: The wrong conversion
Barbara Ottawa assesses March's national referendum on the mandatory conversion rate for Swiss pensions. This political victory for the few might prove detrimental to the many who will now have to pay higher contributions
On 7 March this year, 72.7% of all Swiss who went to the polls voted against lowering the minimum conversion rate to 6.4% by 2014 from the current 7% for men and 6.95% for women - a step which had previously already been agreed by both chambers of Parliament. Enough signatures had been collected to push for a referendum.
Critics of the second pillar, which include unions and left-wing parties, created the slogan "pension theft" in what many agree was a concerted attempt to make the referendum about more than just the conversion rate.
"Although life insurance companies only cover around 20% of the market for retirement provision, the opponents of the conversion rate cut portrayed the life insurance sector as profit-orientated companies in the centre of criticism," notes the pension fund association ASIP.
"The result is therefore more likely to be viewed as a protest ‘no' against insurance companies and excessive salaries and bonus payments in particular," the organisation added.
But whatever shaped public opinion, the no vote means that the conversion rate - which depends on longevity assumptions and the long-term expected return or the technical discount rate - will stay too high for some years, most experts agree.
In response to increased longevity assumptions, Parliament had already decided on an unchallenged cut in the conversion rate to 6.8% for both sexes by 2014 - but, then the crisis hit.
"As many Pensionskassen have lowered the technical discount rate from 4% to 3.5% in the wake of the crisis, the conversion rate will have to be lowered further," Othmar Simeon, CEO at Swisscanto Vorsorge, points out.
What might save the system would be a long-term average return above 5%, but over the last ten years the average performance has been 2.7%. Only over the last 25 is average performance as high as 5.7%.
"Critics might see the necessity of a lower conversion rate if market returns stay low over the next three years," Simeon notes.
What will most likely be seen over the next few years - but perhaps not associated with the outcome of the referendum - are higher contribution levels in smaller Pensionskassen.
"It could happen now that some Pensionskassen start levying higher contributions, parts of which will not go directly towards a person's pension account, but will be used for redistribution purposes," confirms Anton Streit, head of the pension department in the Swiss social ministry BSV.
The creation of a pay-as-you-go system by stealth within the second pillar by maintaining a conversion rate that is too high was also one of the major concerns raised by ASIP.
"There will be Pensionskassen that will have to redistribute funds between active members and pensioners, for example by giving active members a lower interest at the end of the year," says Simeon.
As far back as 2005 the Swiss interior ministry noted in a report that a too-high conversion rate is a burden on single people and those with lower incomes as they statistically have a lower life expectancy and are therefore paying more into the system than they are eventually getting out.
But that problem is limited to smaller funds, mainly those covering SMEs, as they often only cover the legal minimum for occupational retirement provision while larger funds mostly enjoy additional pension contributions from employers who can afford to be more generous.
And the legal minimum interest and conversion rates do not have to be applied to these so-called ‘above-mandatory' assets, which means that these ‘enveloping Pensionskassen', as they are referred to, can shift some money from one part of the fund to the other to fill any pension gaps.
"Generally speaking, larger funds which manage more than the legally mandatory pension provision do have more leeway not only when it comes to the conversion rate but also in terms of recovery measures," Streit explains.
According to calculations of Swisscanto, the average actual conversion rate in the second pillar - when including ‘above mandatory' assets - currently stands at 6.74% for people aged 65 with some funds having gone as low as 6.3%.
So in fact, as ASIP points out, it is not a lower conversion rate which is tantamount to pension theft but a rate that is too high as this draws money from the active members while pensioners' assets remain untouchable by law in Switzerland.
Looking back at former debates surrounding the conversion rate shows that the referendum might never had to have taken place had, for example, the first revision of the BVG law which created the mandatory second pillar in 1985, taken place a few years earlier.
"In the discussion on the first major BVG amendment [which started in the late 1990s] suggestions were to cut the conversion rate to 6.65% over 13 years - a period which would be almost over by now," Streit notes.
But while the 1990s brought a major increase in the longevity tables, the tables were corrected downwards again after the turn of the century and for the BVG revision in 2004 a cut in the conversion rate to 6.8% over the following 10 years was decided.
For critics like Herbert Brändli, head of the multi-employer fund Profond, and known for controversial statements, a conversion rate cut is just an excuse for Pensionskassen not to "clean up their act" and strive for efficiency and higher returns.
"For this we need less regulation and the possibility to invest the pension assets according to adequate time and target return horizons," says Brändli.
According to him, the benefit level in the second pillar has decreased by 30% over the last 25 years because of lower minimum rates.
He adds that while some insurers are guilty of the misconduct there are "many independent Pensionskassen which are efficient and do not have to outsource business to inefficient providers".
Streit points out that in 1985 there had already been a provision in the BVG to allow for differences between life insurers and other pension funds:. Insurance companies were allowed to lower the conversion rate with permission from the government if profits were in turn cleanly shared with members.
"But no insurer made use of that clause and it was scrapped - at the time returns were still high so the problem was not imminent and the first company to have asked for a lowering of the conversion rate might not have had a good position in the market," says Streit.
In order to bolster faith in the system and the second pillar itself, the government is pushing its planned reform of the supervision and governance of Pensionskassen.
Furthermore, the social ministry is preparing a comprehensive report on the second pillar for next year covering the conversion rate, the level of benefits, administration fees and other issues.
However, Streit emphasises that any suggestions made on the conversion rate will not automatically lead to a further reduction.
The final decision will always be a political one and will lie with Parliament - another point that the pension industry has criticised for some time.