Positive voting opportunity
The Swiss vote on pensions in 2010 presents an excellent chance to make the case for a good second pillar, argues André Tapernoux
One particularity of the Swiss political system is that people vote regularly, whether it is about complex contracts with the European Union or a law about wearing seatbelts in private vehicles. So it is no surprise that sooner or later the Swiss will vote on pensions, as will be the case in early 2010. Unions and some political parties collected a sufficient number of signatures to prompt a vote on a proposed further cut in mandatory minimum pensions, which is unnecessary in their view. Insurance companies and a majority of actuaries, on the other hand, have been urging parliament to make this cut even earlier, as they fear that artificially high pensions undermine the stability of the pension system.
In order to understand the background to the vote, one has to look back at history: Switzerland introduced its cash balance type pension mandatory plan in 1985, at a time when interest rates were relatively high. The law requires companies and employees to save for a minimum level of pension cover. This usually takes the form of age-dependent minimum savings credits, which grow with at least a minimum interest rate (the interest guarantee) and are converted to annuities at retirement using a fixed rate (the conversion rate guarantee). Calculations for the guarantees were originally based on conservative assumptions, such as an interest rate of 4%, which was well below a risk-free rate at that time. The idea was to guarantee the 4% and usually a conversion rate of 7.2% for a long time. This would lead to both predictability and a stable pension system.
The government was given the power to change both guarantees but never did so until 2002. Then, as a result of poor asset performance and generally much lower interest rates, many pension funds had serious financial problems in meeting the fixed guarantees. At that point the guarantees offered returns well above risk-free rates, even if not taking account of the increasing life expectancy.
After reducing the interest rate guarantee, the government and the insurance industry were heavily criticised by the unions and left wing parties for so-called ‘pension theft'.This opposition did not prevent the enforcement, but had an indirect effect: the government, now much more cautious, proposed a more comprehensive revision of the pension law (BVG), including a reduction in the conversion rate, but left the final decision for implementation with parliament. Parliament, still nervous as a result of a pension theft campaign and as a result of a temporary improvement of the financial situation, decided that a cut was necessary, but that rates should be reduced to 6.8% by 2014 instead of the proposed larger reduction to 6.65% by 2012.
After this, however, market interest rates fell further and life expectancies increased, to an extend that actuarial calculations now show that the 6.8% conversion rate is approximately based on a 4.9% interest rate, some 2.5% above the risk-free rate, for a person retiring in 2015. In the light of these developments, parliament decided to reduce the conversion rate further to 6.4% within a five-year period by again amending the law.
Unions and some political parties are strongly opposed to this further cut as, in their eyes, it would only increase profits of life insurance companies. Proponents of the amendment argue that insurance companies already lose money on the high conversion rates.
Actually, in their view, active members are currently paying for high pensions, thus cross-subsidising pensioners, which is in contradiction with their idea of a fair pension system, where everyone accumulates money to finance their individual pensions.
The vote on this amendment will be in early 2010. If it is rejected, future reductions to pension benefits will become very difficult and pension funds will have to find alternative ways to fund the high guarantees. This could, for example, include the addition of a ‘conversion rate premium' to the contributions, which would cover the difference between an actuarial rate and the mandatory value.
But even if approved, the measure could turn out to be insufficient, if interest rates stay low in the longer term. From a financial viewpoint, it would be preferable to come away from fixed rates and find more intelligent ways to redistribute surplus.
However, as the past shows, even the best system only works if people understand and support it. In that sense, the vote on pensions could be a good opportunity to explain and communicate the advantages of a good second pillar. This may prove to be far more important than the decision itself.
André Tapernoux is a senior consultant at Mercer in Zurich