Switzerland: No magic formula
The minimum interest rate in the Swiss second pillar was recently cut from 2% to 1.5% for 2012, writes Barbara Ottawa. But experts believe this is still too high to be sustainable
This article, or at least one remarkably similar, was written almost ten years ago. In March 2002, IPE reported about an imminent slash of the minimum rate in the mandatory Swiss second pillar. "In the past, Swiss pension funds have relied on their investment in federal bonds to provide most, if not all, their return," wrote IPE's David White back then. He explained that "lower inflation had depressed net yields" which made it difficult to achieve necessary returns. And while "normally, the funds could rely on returns from equities to make up the shortfall" the "volatility in the capital markets over the past two years has also depressed equity performance and drastically reduced returns".
If that sounds familiar and strangely up-to-date, it is because net yields of the ten-year Swiss government bonds dropped to 1.54% on average for the first eight months in 2011 and inflation even became negative over the summer when the strong Swiss franc pressured markets. In fact, long-duration Swiss bond yields have not matched the minimum interest rate since 1997. Even comparing actual returns including other asset classes, the Credit Suisse Pension Fund index reported a 1.95% annualised performance between 2000 and June 2011 while the average BVG-minimum interest for the period is 2.85%.
Since 2002, Swiss funds have diversified their portfolios more, bringing bond exposure down from three quarters of the portfolio to a third.
What has changed significantly since then is the minimum interest rate itself, the Mindestzins (see panel), which every Pensionskasse has to grant annually on the assets of their active members: The IPE article in 2002 was entitled "End of the line for the magic 4%"; in autumn 2011 the 2% rate was reduced.
"When the law on the mandatory second pillar, the BVG, was set up in 1985 it was done based on the ‘golden rule' of 4% minimum rate correlating to 4% average wage increase," Ernst Rätzer, board member at Aon Hewitt Switzerland, explains. He is also part of the think tank Innovation Second Pillar (IZS) founded 16 years ago by chartered pension fund experts.
When the holy cow was slaughtered in 2002 with the rate cut for the first time to 3.25% for the following year, protest marches were held in Bern, the seat of the Swiss government.
In September 2011, the BVG commission (a politically appointed body of experts and other pension stakeholders) which advises the government on matters relating to the second pillar, recommended to set the minimum interest rate at 1.5% for 2012. This time, unions and left-wing politicians criticising the step as further "pension robbery". Union representatives in the commission called to keep the rate at 2% while employer groups proposed a cut and the insurance association suggested to slash it to 1% - which is indeed where the rate might be headed in future.
Just like in the last few years the Swiss Parliament followed the commission's recommendation and the minimum interest rate was set at 1.5% for 2012.
"1.5% seems very little, but given the market returns it is still too high," says Othmar Simeon, managing director at Swisscanto. Rätzer expects the rate to fall to 1% in the near future. But that is almost the bottom for the Mindestzins, as the legal framework includes guarantees on contributions and pensions after inflation.
"The minimum rate and also the conversion rate are like a corset that is tied around the second pillar and which is not adapting to the markets," notes Simeon.
"The guaranteed minimum is a political rate, not a real rate - politics and reality rarely coincide," chartered pension fund expert and consultant Claude Chuard was quoted in IPE in 2002 and today he says: "Over the last decade, I have come to realise that we have to accept that politics has a different thinking to that of experts, but because this is so politicians should explain to pension funds how to cope with the gap between the expected and the real return - and that is what is missing."
According to Chuard, "1.5% is more realistic but still too high". Instead of the government or parliament setting rates, Chuard suggests a legal framework including parameters from which every fund could then derive the necessary rates. Rätzer is also suggesting giving the funds more leeway, but the Swiss pension fund association ASIP thinks it is good to have a binding minimum standard for all pension funds.
For ASIP president Christoph Ryter "1.5% is a step in the right direction and we can live with that."
Currently, the BVG-commission and the government are basing their decision on average returns of seven-year Swiss government bonds, mean returns from various asset classes, as well as political calculations.
"We have always pledged for a formula on which the politicians will have to agree and which would then be applied for several years in a row," says Ryter.
But Ryter confesses that even within ASIP this is a difficult topic as various approaches are being discussed each year - "but rarely ever the same approaches for two years in a row".
Rätzer is also sceptical about finding a philosopher's stone for the Swiss second pillar: "In a federal commission on the BVG ten years ago, we searched for a formula for two years but it does not exist as you have to take every class and their expected returns into consideration."
The "quest" was repeated in 2005 but also failed after which the government issued a statement noting that neither the BVG-commission nor the expert could reach an agreement necessary to ensure stability in the system. It added that the current system has "quite proven itself" despite criticism.
Rätzer would rather have the rate set annually, if it has to be set at all, "but it has to be done with the notion that this is a minimum interest rate which should be kept as low as possible". Chuard sees a problem in the rate being set in advance, which has then to be applied by Pensionskassen in their annual statements. Further, he sees a discrepancy between pensions being a long-term affair and annually set parameters like the minimum interest or full-funding based on "arbitrarily chosen dates" such as 31 December.
In Switzerland, the BVG minimum standards have to be applied to contributions and savings within the mandatory requirements. Pension funds which are managing higher contributions only have to guarantee the minimum interest rate and conversion rate on the mandatory part of their savings.
According to estimates, 70% of Pensionskassen are managing Überobligatorium savings, while only 30%, mainly smaller ones, are managing the BVG-minimum.
For the latter, the minimum interest rate is more of a problem, as they really have to achieve it, while the other funds can mostly make use of the so-called Schattenrechnung (shadow calculations) if they have combined the mandatory with the above-mandatory assets which is called umhüllende Kassen (encasing funds).
Every year, it is audited whether the fund has granted the minimum interest on the BVG-minimum and for this, the above-mandatory assets can be added for which the pension fund is free to set the interest rate. In times of lower returns, these funds can then announce zero-interest years to help recovery. Simeon reports that his own fund at Swisscanto had taken a similar step after the crisis and then compensated members with higher interest the following year.
According to the government, some Pensionskassen - especially collective, multi-employer schemes, so-called Sammelstiftungen be they run autonomously or by insurers - have used this possibility of granting higher interest to attract members even if they were underfunded at that time.
Therefore, Parliament included a new regulation in the structural reform which would have prevented funds from granting interest above the minimum interest rate or other "improvements of benefits" if they do not have sufficient buffers. This makes the minimum interest rate a maximum interest rate as well.
After protests, this paragraph was limited to Sammelstiftungen which are now criticising this as an infringement of their autonomy. In their statements filed during the consultation phase, the majority of funds argued that this decree lacks a legal basis as so far the BVG did not include any limits on interest granted on above-mandatory savings.
For Hans Flury, president of the trustree board at the new Symova collective scheme, which succeeds the transport scheme Ascoop, this is an "intolerable discrimination" showing a "distrust" in collective schemes based on some schemes' propensity to make unsustainable promises in a competitive environment.
Flury also finds the wording "improvements of benefits" lacking definition as this could be anything from granting interest after a zero-interest year to using longevity buffers for compensating members for a lower conversion rate - see separate article on that subject.
So the gap between politically set rates and real market returns remains as much of a question as it did ten years ago. And then, as now the question IPE posed in 2002 remains valid: "Will the Swiss saver accept such a loss?"