Swiss defined benefit pension funds are struggling to stay on an even keel in today’s low-interest-rate environment, a survey of key assumptions used by 92 Swiss pension foundations by advisers KPMG has found.
The firms under scrutiny were reporting under either IFRS or US GAAP at the 2014 year-end.
Among the 92 sponsors, many saw their pension balance sheet positions worsen significantly over the course of 2014.
The main cause of this was a dramatic slump in discount rates, with this year’s median being 110 basis points lower than last year’s.
Graham Middleton, a Switzerland-based partner at KPMG, said: “The root problem here is that the Swiss pension system will struggle if this low-interest environment continues for a period. People are looking at every lever that exists.
“But, addressing the underlying impact of continual low yields and longevity improvements, through legislative changes, is something that will need to be taken up first at a federal government level.”
The effect of the lower discount rate was, however, offset, at least partially, by strong asset performance.
According to the Credit Suisse Schweizer Pensionskassen Index, assets held by autonomous foundations on average returned approximately 7-8% – some 5 percentage points above discount-rate averages.
The KMPG experts behind the report also warn that the next wave of annual reports from Swiss companies could contain yet more bad news.
Middleton said: “Most companies take the calendar year-end for annual reporting purposes. This means we will have very few companies reporting the effects of the January currency event before the New Year.
“Nonetheless, during July and August, we can expect to see some companies posting results based on the June position.
“What is significant here is that we will potentially be seeing companies using discount rates of less than 1% outside Japan for the first time. If that continues into next year, our survey will make for interesting reading.”
One of the main drivers behind the depressed yields is the decision by the Swiss national bank to scrap its cap on the Swiss franc’s exchange rate against the euro.
The move prompted a collapse in the single currency against the franc and a fall in Swiss equities, and helped to depress European sovereign debt yields further.
Aon Hewitt partner Olivier Vaccaro told IPE he agreed with the KPMG findings.
“At the end of the year, depending on duration, we had discount rates of 10-year duration of 0.87%, for 15 years we had 1.12% and for 20 years we had 1.25%,” he said.
Vaccaro said the range at year-end among Aon Hewitt clients was 1.1-1.2%, depending on duration.
He added: “So far this year, we have seen further falls since the start of the year, and so we are currently looking at 0.54% over 10 years, 0.69% over 15 years and 0.76% over 20 years.
“That adds up to a fall in the range of between 35 and 50bps since the end of last year. We are looking at something like a 7-8% increase in DB liabilities. This will have an impact on the P&L position, mainly due to the increase in the service cost.”
KPMG also noted that companies have taken a number of steps to mitigate the impact of falling bond yields by:
- discounting on the basis of AA-rated bonds only, instead of a mix of AA and AAA
- using synthetic bond yields – specifically those reached using currency swaps – in place of real-world yields
- looking to non-CHF denominated bond markets
The auditor said that, by its understanding of acceptable practice under IAS 19, the use of synthetic yields is “not appropriate” and that relying on non-Swiss franc yields is “generally not appropriate”.
Alongside these developments, Swiss preparers have also explored the use of different discount rates to value pensioner liabilities and employee liabilities – and also to determine service cost under IAS 19.
KPMG manager Daniel Tonks said: “There are one or two companies in the Swiss market that have introduced split discount rates under IFRS, and this follows the adoption of such in the UK in recent years.
“The audit judgment is that this is generally acceptable, and the audit considerations in Switzerland follows the same thought process.
“We are talking about a relatively few number of cases where this is happening, but it is worth pointing out that it would be considered a change in methodology and has to be adopted consistently in future years.
“If discount rates stay at their current levels, I would expect more people to be considering this and other options. The fact discount rates are so low is focusing people’s minds.”
Olivier Vaccaro said the outcome of any such move would depend on the structure of the pension fund because “there is a lower sensitivity to discount rate changes among inactive members than active members”.
KPMG supports this approach as auditors and notes that, although it has little impact on a sponsor’s balance sheet position, it will help to reduce future service cost.