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Ups and downs of guaranteed rates

The beginning of 2004 has ushered in a number of changes in the guaranteed rates of return for pension funds across Europe. Here we focus on Switzerland, Germany and Finland.
After three years of underperforming equity markets, the Commission of the BVG, the mandatory occupational pension system in Switzerland, recommended a reduction in the minimum interest rate to 3.25%, which came into effect at the beginning of this year, to ease the pressure on funds.
According to consultants Watson Wyatt, “affected are mostly ‘cash balance’ plans, including those that provide only minimum benefits as per the BVG law. Final pay plans are not affected except in a remote way by the change in BVG minimum interest rate.”
Watson Wyatt expressed some concern at this move, commenting that “a decrease in the minimum interest rate could signal to pension funds that they should decrease the risk of their investment portfolios. The Federal Council’s current ‘tactical minimum interest policy’ can lead to sub-optimal investment results.”
They added: “in future, the policy for the minimum interest rate should take into consideration the implications for the investment decisions of pension funds. The investment return, as the ‘third contributor’ to the pension fund … is too important to the financing of pension funds to become a political football.”
It has been suggested that the authorities are more concerned with the welfare of the pension funds than with that of the end users. Countering this claim, John Anthony, managing director of Watson Wyatt’s Zurich office, argues that “the Swiss authorities are concerned with having a well-funded system”.
In Germany meanwhile, the guaranteed minimum rate of return has been reduced from 3.25% to 2.75% with effect from last month. Peter Abrahams, spokesman for BAFin, the German regulator which is responsible for recommending rates to The Ministry of Finance, says that the change “applies to new contracts drawn up with new tariffs with all ‘deregulated’ Pensionskassen. These account for around 10% of the total 152 Pensionskassen. They also provide one form of building up pension benefits in Germany; the deregulated variety always have the same rate of return as life insurance companies.
In order to be deregulated, which gives it the freedom to set its own tariffs, a Pensionskasse must be of a minimum size and have been in existence for at least five years.
The rate of return has been reduced as a result of the low rates of interest from the capital markets. Abrahams of BAFin points out that “we look mainly at bonds and calculate the rate at 60% of the average yield for the last 10 years”. The review is carried out every two years.
Klaus Stiefermann, general manager of the German Pensions Association (ABA) adds that “the rate has always been set very conservatively in relation to what the funds have yielded. We don’t want the Pensionskassen to find themselves in a position that they have promised too much.”
The Pensionskassen have rules that dictate how they can invest the funds. “German Pensionskassen do not have the same freedom as Anglo Saxon pension fund managers”, says Stiefermann.
In Finland, the investment return requirement has been increased to from 4% to 4.5% with effect from the beginning of this year. This was confirmed by Hely Salonaa at the Pensions and Insurance Supervisory Authority.
The rate, which is reviewed on a six-monthly basis, applies to the funded portion – 20% to 25% – of the statutory state pension scheme for employees on permanent contracts. This portion is managed by pension insurance companies. Around 94% of the population belong to this scheme.
The 4.5% consists of the standard discount rate of 3% and a further 1.5% which is used to increase the fund. The rate is based on the expected future yield from the market and the level of funds’ buffer reserves which are required to protect their solvency.
The larger the buffer, the more risk fund managers can take, and after a decline during the stock market downturn, the solvency funds are now looking much healthier. This, combined with the positive outlook for the stock makes it likely, as Salonaa agrees, that the fund managers will move to more risky investments. Unlike their German counterparts, Finnish fund managers have the freedom to invest the funds as they see fit.
However, Lauri Oravisto, actuary at consultants Poravista believes that “the increase in the rate will not affect asset allocation because very long term view taken. It simply reflects the fact that there is now some life in the stock market.” He adds: “the rate could be higher given the improving returns from the stock market. The rate has deliberately been set at a low level to boost the reserve funds.”

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