Switzerland: Huge challenge to pass pension reform package
The final draft of the first and second-pillar reform package has been published but it could prove impossible to get through parliament in its present form
Regulation in summary
• The Swiss parliament is discussing a major reform covering the first and second pillars, the Altersvorsorge 2020 package.
• The project is so broad it has drawn criticism from all sides, despite widespread agreement on the need for reform.
• Ensuring the sustainability of the system is key but there is disagreement on how to do that.
• Proposal includes reducing the mandatory conversion rate for annuities, raising VAT and broadening the coverage of the second pillar.
Switzerland is bracing itself for a heated debate on the Altersvorsorge 2020 package, the planned reform of the first and second-pillar pension systems to transform the country’s retirement system.
Given the broad scope of the reforms, experts predict that the parliamentary vote will be close, and that this will influence the outcome of the popular vote.
Christophe Steiger, principal at Mercer in Nyon, says: “The reform project is coherent, and will take the country’s pension system forward for the next decade. But it is so complex that it is difficult to see how it will get through parliament intact.”
This makes a negative vote in the referendum more likely, even though there is broad agreement on the need for reform. The final version of the reform package was published in November last year, but the timetable for parliamentary discussion is not fixed. It could be some time before a final decision is reached and the matter is passed on to the people.
Meanwhile, bodies such as ASIP, the Swiss pension fund association, are campaigning to make sure all Swiss citizens are aware of the importance of bringing the reform to fruition.
In the final draft, the government made significant amendments to the original project to effect a compromise with the various parties. The broad aim is to make the first pillar more sustainable, while increasing the coverage of the second pillar.
Lawmakers want to increase the minimum retirement age from 58 to 62 and move the statutory retirement age to 65 for both sexes. While this has drawn some criticism, the most urgent matter is finding additional sources of funding for the first pillar.
Switzerland has increasingly relied on immigration to finance the system, with contributions from incoming workers supporting the ageing population, but there is recognition that this trend is unsustainable.
One proposed solution is a 1.5% increase in VAT to fund the AHV/AVS first-pillar system. This would allow the government to raise funds for the pay-as-you-go system while keeping the money fungible, meaning the additional financing is not ring-fenced for the AHV/AVS.
Another key measure is to lower the minimum conversion rate in the second pillar from 6.8% to 6%. This will be a tricky sell, since in 2010 the Swiss voted against a cut to 6.4%. But the current conversion rate is clearly incompatible with life expectancy at retirement and expected returns on investments today.
To counteract this, the government proposes scrapping the Koordinationsabzug, a measure to harmonise employer contributions to the first and second pillar. The Koordinationsabzug consists of a salary threshold above which the employer is required to contribute to the employee’s Pensionskasse – if the employee’s salary is below that threshold, the employer only contributes to the first-pillar pension. Once the Koordinationsabzug is removed, employers will have to pay into Pensionskassen for each employee, according to salary levels.
This way, lawmakers hope that more workers will enter the second-pillar system, as the measure would ensure contributions for part-time workers, most of whom are not covered by the second pillar.
More importantly, if every worker has a right to second-pillar contributions, current benefit levels are more likely to be maintained in the future, even when the weight of the first-pillar element is reduced.
But regardless of what new sources of pension fund funding are chosen, there is a need to restructure the method of valuing pension fund liabilities. Some schemes can withstand the high conversion rate for mandatory annuities of 6.8%, as employers pay high contribution rates.
However, at the beginning of each year, the government sets the minimum return each pension fund has to guarantee on the mandatory part of their assets – the Mindestzins. This is separate from the technical discount rate for liabilities, also set by the government, which determines the target return that pension funds must achieve each year.
However, it has been proposed to set the Mindestzins at end of the year, basing it on market conditions rather than forecasts. Pension funds argue that this clashes with their need to set a target return for the year in advance.
Pension fund stakeholders disagree on this and other technical questions, such as how pensions are financed in the transitional period while the reform is implemented. In the meantime, Swiss pension funds are left with difficult asset allocation choices.
Due to ultra-low interest rates, pension funds have seen their liabilities increase significantly this year, by about 4%, while returns started to come under pressure during the summer.
Market volatility, prompted by the Swiss National Bank’s surprise decision to abandon the peg with the euro, plus negative short-term rates and negative rates on cash deposits, have all added to their headaches.
In response to this environment, funds are reviewing their strategic asset allocation. But the regulator’s recent reclassification of several fixed-income assets as alternatives complicates matters.
For instance, some real estate investments now fall into the alternative category, which is capped at 15% in portfolios. Some funds might be told to divest from this traditionally well-performing market at the wrong time, or simply face additional limits to diversification.
Meanwhile, schemes are finally becoming accustomed to reporting total expense ratios (TER), a major regulatory change enforced in 2013, which has got trustee boards to think hard about costs. They have implemented the change smoothly and this has shifted fee negotiations with asset managers in favour of pension funds.