Switzerland: The problem of converting minds
Legally, Swiss Pensionskassen have to apply a 6.9% conversion rate but the actual rate used is much lower. Barbara Ottawa asks why politics are not adjusting to reality
In March 2011, 73% of the Swiss electorate voted against a further cut in the conversion rate (Umwandlungssatz) which is used to calculate pensions from the accrued personal savings in a Pensionskasse.
However, after the referendum, the Swiss pension fund association ASIP published the results of a survey it commissioned showing that 66% out of 1,000 Swiss people did not know what the conversion rate is.
Thomas Hengartner, editor of Finanz und Wirtschaft put it quite harshly at a discussion when he said that people "voting on technical parameters like the Umwandlungssatz is a bit like if they were to decide on the pressure in a nuclear plant".
The government interpreted the vote as a general lack of faith in the second pillar and introduced the structural reform (Strukturreform) to increase corporate governance and strengthen supervision.
But ASIP rejected this interpretation saying that there might have been some elements of protest against certain intransparencies in some insurance-run Pensionskassen but that the overwhelming ‘no' was mainly down to "people not wanting to accept a further reduction of the benefit level without compensating measures".
Hanspeter Konrad, managing director of ASIP, says the industry "puts great hope" in a paper on the second pillar announced by the government. This will be covering all aspects of the mandatory pension system and ASIP would like the government to "prioritise the most pressing issues" like "the conversion rate that is too high judging by the current market environment".
Ernst Rätzer, a board member at Aon Hewitt Switzerland, also hopes that this report will result in a parliamentary bill on a further reduction in the conversion rate which should include compensating measures "in order to avoid a new referendum".
"A reduction in the minimum conversion rate could be compensated by higher contributions," noted Konrad. However, according to Swiss law, higher contributions have to be fully converted to benefits upon retirement, or paid out in full if a member leaves the fund. As such, higher contributions cannot be used by funds to fill their buffers.
The Pensionskasse of the Swiss federal railways SBB announced a cut in the conversion rate from 6.52% to 5.85% from next year. To compensate its members, it will liquidate buffers set aside for longevity adjustments. The fund explained that those were not needed once the conversion rate is adjusted.
Similarly, the largest Swiss Pensionskasse, Publica, will be cutting its conversion rate next summer from 6.53% to 6.15% while at the same time hiking pensioners' assets with the money from longevity buffers.
"Compensating measures are a wise move, especially when you can take time to build buffers, then such cuts will be better accepted," notes Rätzer.
As with the minimum interest rate (see article in this section), funds like SBB or Publica have the advantage of managing more than just the mandatory minimum people are obliged to contribute under the Swiss law on the second pillar, the BVG.
That means that they only have to nominally calculate the minimum for the BVG-mandatory assets but are free to apply any rate they choose on the above-mandatory part, the Überobligatorium.
This is why the factual conversion rate in a sample of funds surveyed by Swisscanto is currently at below 6.7%, already under the mandatory minimum of 6.9%.
At the Symova collective scheme for transport companies the trustee board has agreed to set up a split fund (gesplittete Kasse) which means that the pensioner's benefits will be physically split between those only covering the BVG-minimum and those above the mandatory contributions.
Rätzer explains that such a measure can be taken by funds where the BVG-minimum times the BVG-minimum conversion rate results in higher benefits than the whole savings account times the above-mandatory rate.
For its above-mandatory benefits Symova is lowering the conversion rate to 6.22% for men.
"Most Pensionskassen will be going down towards 6%," Othmar Simeon, managing director at Swisscanto is convinced.
In fact this trend can be seen in the development of another technical parameter in the second pillar, which is rarely talked about in public debates the technischer Zins.
This is used as a discount rate upon retirement to determine the future appreciation of the pensioner's assets. It is only applied at that point in time and not guaranteed on entering a pension fund. However, once the pension is set it is then fully guaranteed.
This rate is neither set by the government, nor parliament, but it can be determined by every fund according to its risk profile and longevity assumptions. ASIP-director Konrad thinks it is important to have this flexibility.
In contrast, Hans Flury, president of Symova, would like to see both the risk-adjusted technical interest rate as well as longevity assumptions to be fixed for all pension funds. "This would mean that all Pensionskassen publish more realistic and more comparable funding levels." In turn the conversion rate could then be erased from the law as it is derived from these binding factors, he explains.
Usually, the trustee-board sets the technical interest rate every three to five years based on long-term assumptions which explains the considerable difference to the minimum interest rate which has to be guaranteed on active members' savings every year.
"The technical interest rate is okay when looked at over several decades but even taking the period between now and August 2000 it would not hold if you have a bit of volatility in the portfolio," explains Claude Chuard, Swiss chartered pension fund expert and consultant.
From next year, the chamber of pension experts will be publishing a reference index which might help some funds to get some guidance on more realistic assumptions.
At 3.5%, Konrad calls the rate "still ambitious" but closer to reality than the 4% still applied my many funds. He is convinced that the reference rate by the chamber of pension fund experts will help reduce the rate but stressed that not all funds can afford such a cut.
"If a CHF100m (€81m) pension fund wants to cut its technical interest from 4% to 3% they need CHF10m more in funding," explains Simeon. Nevertheless, he says "the funds are aware of the problem and are going more towards 3%" with UBS already having cut the technical rate to 2.5%.
Along with the technical interest rate the conversion rate is cut accordingly with a 3% techinical interest rate leading to an conversion rate of around 6%.
However, there are also funds which still apply technical rates of 4% and conversion rates last seen at the introduction of the BVG in 1985 of 7.2%. Asked how his Sammelstiftung can afford this, Profond president Herbert Brändli said in an interview that a 4.5% return necessary to guarantee such a high conversion rate was "still realistic" and achievable with a globally diversified portfolio. He also cited historic returns of equities back to 1900 of 8.6% on average per annum and 1.7% for bonds.
"If the Pensionskassen cannot achieve returns significantly above the real interest rate, funded occupational pension schemes have no right to exist," he is convinced.
Brändli added that longevity reserves were put aside in the fund to ensure that no money from active members is used for retirees. In fact, this is one of the main worries of experts regarding a high conversion rate. Chuard sees "a great danger" in cross-financing between active and retired members despite solidarity being an accepted theme in the second pillar eg childless people and parents paying the same rates.
"But the demographic relations in the first pillar will be completely out of balance and I am asking myself whether today's children are willing to keep on financing such a system or rather cut pensions," says Chuard.
At the moment, there is almost no way to include pensioners in recovery measures at a Pensionskasse as pension benefits are unalienable.
But the PriceWaterhouseCoopers Pensionskasse in Switzerland has found an innovative solution to the conversion rate problem: It is guaranteeing a low minimum conversion rate which is raised in times of good performance. They are effectively breaking the taboo of pensioners being bound to the fund's fate.
Simeon thinks that allowing pensions to be cut would relieve pressure on the conversion rate problem. But he stresses that such cuts should only be temporary, as long as active members are paying additional contributions as part of recovery measures, for example.
"But politically this cannot be implemented or even discussed," he adds.
Chuard thinks such measures should only be taken "as a last resort - for example if our financial situation would worsen to the level of Greece".
"Cutting rightfully acquired pension benefits would mean that the funded system has failed and it would be like the system raising the white flag," says Chuard echoing the sentiment of many Swiss elderly people. Given that in Switzerland, like many ageing societies, pensioners make up a large part of the electorate this is also the view most politicians take.