The perils of flexibility
According to Swiss pension fund statistics, 3.3m members and their employers contributed more than CHF 32bn (€20.1bn) in aggregate to pension funds in 2005. The third package of the LPP/BVG revision only partially satisfied the general demand for greater flexibility. While the Federal Council has set aside the issue of free choice of pension funds for the time being, some companies are already debating how to cope with demographic trends and are looking for flexible retirement solutions to ages 68 and 70. The following qualitative market review shows how the market, employers and pension fund members are adjusting to the new environment.
Statutory flexible solutions
Pension funds can implement the following flexible solutions:
❑ Voluntary financing of early retirement
Under the first LPP/BVG revision, pension funds may allow their members to make voluntary purchases under certain circumstances to compensate for the reduction in benefits resulting from early retirement. Such purchases are handled on a case-by-case basis, and target benefits may not be significantly exceeded. This provision merely implements the prevailing practice already accepted by most tax authorities.
❑ Plan design with individual options
In future, pension plan regulations may provide for insurance sub-groups defined according to objective criteria. Distinctions may be made, for example, between office workers and field staff, or shift workers and clerical staff. The pension fund may offer each sub-group a choice of three different benefits schemes. The employer contribution must be the same for each sub-group, and total contributions may not vary by more than two thirds.
Choice of investment strategy
Members earning more than the current threshold of CHF 116,100 (€72,960) may be given a choice of investment strategies in different pension funds. By contrast to the recommendations of pension actuaries and the ASIP (the Swiss Association of Pension Funds), the minimum requirements of the Vesting Law must still be observed. As a result, proposed investment strategies have started guaranteeing a minimum return. Complex plans have to be designed, and discussed with the regulatory authorities, to ensure that members share the risks and not just the rewards of their chosen investment strategy.
The LPP/BVG revision stipulates that the minimum risk contribution must equal at least 6% of total contributions (the ‘insurance principle'). So, for a total contribution of 20%, the minimum risk contribution will be 1.2%. This rule enables pension funds to offer schemes with restricted risk benefits where necessary.
Greater complexity, no room for manoeuvre?
The complexity has without doubt increased. Professionals cannot agree if there is added leeway for individual solutions. Most of the flexible solutions already existed. What has been eliminated is the need for discussion with the regulatory and tax authorities. Members are no longer at the mercy of their local tax office's interpretation of occupational benefit rules - greater legal certainty is clearly to their advantage.
The Federal Council decided that it would not be advisable to offer flexibility in the free choice of pension funds. This decision is in line with the recommendations made in most research reports on the free choice issue.
Why has implementation not been successful so far?
Our experience with over 250 pension fund clients shows that, in all segments (from 100 to 60,000 members), the flexible solutions that were developed before the first LPP/BVG Revision are still being maintained. For example, clients that had already introduced (and agreed with the cantonal tax authorities) voluntary purchases for financing early retirement have merely had to adjust their regulations in line with statutory requirements; the solutions adopted before the third package of the LPP/BVG revision came into force were already broadly consistent with legislation.
Clients who are yet to introduce any flexibility are now mainly implementing voluntary purchases for early retirement. We see no trend towards any further implementation of the flexible solutions (or the introduction of free choice for members).
This may be explained as follows for pension funds, members and employers respectively:
❑ Pension funds feel that members do not understand the added flexibility and the new solutions are too complicated to manage. The technical implementation of the administrative solutions must moreover be adapted, at great cost, to satisfy the increased need for communication. Pension funds also maintain that the legal room for manoeuvre is not clear. They argue that neither members nor employers need added flexibility. There is also a degree of resistance to the constant changes required by legislation.
❑ Members would like more individual risk benefits and they expect greater flexibility with the payment of savings contributions to pension funds. Younger members, for example, prefer more disposable income while older members focus on optimising post-retirement benefits.
❑ Employers, on the other hand, are extremely interested in flexibility. Basically, companies see this as an opportunity to offer employees more individual solutions in terms of salary and benefits. The Swiss tax system is restrictive regarding fringe benefits; this explains the great interest in flexible pension fund solutions. Moreover, flexible solutions enable employers to keep risk management under control in this area as well.
Occupational benefit flexibility will increase with the awareness of members and employers since greater flexibility is a consequence of society's growing focus on the individual. Employers will increasingly view pension benefits as part of the total remuneration package and will try to leverage value from the range of means available.
Members will become more interested in "their" money. As a result, pension funds will have to satisfy their clients' needs. Today, some providers of insurance solutions are already offering retirement pension alternatives, promoted as "securing your income after retirement".
Administrative costs are expected to rise. Progress will be made in clarifying the legal room for manoeuvre, and the courts will hand down new rulings. Communication with members will be-come more and more important. Pension funds will encourage their members to investigate the options available using internet powered solutions. Naturally, the AVS/AHV pension and the third pillar have to be taken into account in comparing options.
Despite these developments, or rather because of them, the flexible options can be criticised for being too complicated.
The provisions of the Vesting Law in conjunction with those of the LPP/BVG have produced unexpected hindrances (for example, choice of investment strategy, plan design and choice of individual member contributions). This is essentially why pension funds will take longer than foreseen to implement the additional flexibility. Nevertheless, pension funds can be expected to take appropriate steps to mitigate the inadequacies, taking due account of the needs of members and employers. If they do not, the debate on free choice will intensify once more.
Roland Schmid, is a Schweizer Actuar Vereinigung (SAV) pension actuary and managing director of Hewitt Associates