Early last month the Swiss government announced that the minimum guaranteed rate pension funds must deliver would be lifted to 2.75% from 2.5% on
The rate has fallen in recent years, sharpening a long-standing debate that has polarised opinion among employers and trade unions. The unions resisted the cuts and have been vociferous in their calls for the level to be restored while pension funds have said that they could not pay more. But economists have pointed out that falls in inflation over the period have meant there has been no impact on pensions.
However, the federal agency for social insurance (BSV), which is part of the interior ministry, decided that the rate should be raised.
It justified the decision by saying that pension schemes were earning more through the financial markets, with the average yield on seven-year government debt having risen to 2.6% - or just under the future minimum rate.
But the BSV's decision came as the markets were heading south following the global impact of the US sub-prime crisis.
"It had previously been cut in response to the bear markets from March 2000 to March 2003," recalls Graziano Lusenti, chief executive of consultancy Lusenti Partners. "So it hadn't been raised for almost 15 years and it would have been fine to raise the rate to 2.75% one year ago. But I don't really understand the rationale in doing that now just after two months of a very rough market and just ahead of a period of uncertainty. Political time lags mean this kind of decision is never in tune with the market. So it's more of a problem than a solution."
Werner Enz, pensions expert at authoritative Swiss newspaper Neue Zürcher Zeitung, agrees: "They looked at the seven-year rolling average on government paper, then had a little look at the stock market and maybe at the Swiss property market, which is roughly one-tenth to one-sixth of all the assets, and said ‘OK, it's quite a nice climate so we can raise the guarantee'. But the move is counterproductive. It is conventional wisdom in modern finance that having to cover a guarantee over a certain time period forces you to invest in certain categories of assets with low yields. So while apparently guaranteeing a higher return the government is effectively taking away opportunities from the portfolio managers to do a better job in the market."
"The general rule of thumb is that the higher the guarantee the more conservative an investment strategy becomes but having said that there will still be some differences between the pension funds because some will have a lot of reserves and some won't," says Andre Haubensack, director of sales in New Star AM's Zürich office. "We find that those at the lower end of the scale will be forced to be more conservative and this runs counter to the interests of their members because over the long term they potentially will have a lower yield because of the lower risk level.
So will an increase of 25 bps make much of a difference?
"This is only relevant for Swiss-style DC pension funds, the majority of funds in number but rather small in assets under management," says Hansjörg Herzog, chief operating officer, institutional distribution Europe at Credit Suisse Asset Management. "It has no impact on DB plans because there it is the sponsors' problem, they have anyway to guarantee the benefits and it's their decision what interest rate they want to use."
"The discussion went on in an advisory committee and the debate was whether to increase the rate between a quarter and a half per cent," says Theodor Keller, senior pensions consultant at Hewitt. "The insurance companies opted for no increase at all because they invest in a very conservative way, with only 5-10% of their portfolio in equity, and so it's hard for them to reach 2.75%. But the trade unions want as big an increase as possible because they argue that we have had very good investment returns. So I would say that a quarter per cent increase is quite small and will have almost no impact on the financial situation of autonomous pension funds."
"It's important not to overstate the implications of the increase," agrees Lusenti. "Many pension schemes have a benefit structure that goes much further than the minimum standards, and in addition many funds use a technical rate to make the projections of their future liabilities at a higher rate, mostly 3.5-4% and sometimes 4.5%.
"So the minimum rate is mainly significant for the pension schemes of small companies and to foundations run by life insurance companies - that is to one-third or 40% of the people insured in pension schemes in Switzerland. But for most large autonomous pension funds and large private sector pension funds it is not key because they already work with a different technical rate, and they haven't changed that rate since the beginning of the
"It will only be relevant to people who are covered for their occupational scheme by insurance companies," says Jean-Pierre Steiner, CEO Nestlé Fonds de Pension, one of Switzerland's largest private sector pension funds. "Independent pension funds, public and private, generally grant more than that anyway, so it is not really relevant and will not lead to any change in strategy or asset allocation. But the fact is that insurers tend to keep too much of the profit made on assets for themselves rather than crediting back to the various beneficiaries under the contract they have."
"In fact the 25 bps increase will have no direct impact on the asset management industry," says Herzog. "Trade unions and the Socialist Party were asking for more, for 3% or even 3.25%, while the employer side and the insurance industry wanted no change in the rate. In fact the question is much more relevant for the insurers who offer a fully outsourced solution for smaller pension funds. For the asset managers and banks this is not really significant; usually we don't see any impact on mandates we can offer to our pension fund clients."
"The government wants to have this tool and to show it is powerful," says Enz. "But if it wanted to make a real contribution to ensuring that this sort of long-term saving can be done in a smoother and more professional way it should get rid of this guarantee. It's foolish to make a benchmark for 2008 on the basis of 2007. Perhaps you should define this type of interest rate at the end of the year in which it is to be implemented, not before that year."
"The minimum return requirement should not be politically driven," says Steiner. "When I was on the board of [the Swiss Pension Fund Association] ASIP we tried to develop and propose other methodologies that could be based more on market data, market levels, or whatever - for example, link it to the prevailing bond yield on the market rather than taking various factors into account like the past equity returns and a decision by the political body - to fix it. But they were never accepted."
However, before last month's decision to increase it, the rate was no longer a key issue.
"A much more important question for the medium and long term is what will be the conversion rate of the pension payouts for retirees," says Herzog.
"The guaranteed minimum interest rate is less problematic than the difference between the treatment of pensioners and the active insured," says Christoph Ryter, president of ASIP. "At the moment of retirement the savings account is transferred into a life-long pension at a fixed conversion rate, which sets out a pension fund's commitment to the pension level a member will receive on a life-long basis. And this conversion rate is also a topic that is very often and loudly discussed between politicians. For a long period in the past the conversion rate was 7.2%. It was reduced due to an increase in life expectancy and discussions are now underway on whether it should be increased further."
"There was a common understanding that the conversion rate had to be reduced because of the impact of growing life expectancy," says Enz. "But this summer, with the approach of the October general election, the politicians decided there was no necessity to lower it. So you have the feeling that before an elections life expectancy is no longer increasing but after the poll we will see that life expectancy will have to grow a little faster to catch up with reality. It's really nonsense."
"ASIP's view is that it is important to base this discussion on pragmatic issues rather than political expediency," says Ryter. "It is important that we have rules and that life expectancy is not a subject for political discussion but a prognosis based on contemporary knowledge."