Is politics getting in the way of a Swiss pension recovery? Emma Cusworth finds out
As the recovery in funding levels for Swiss pension funds falters, they are left grappling with the result of a no-vote on benefit rate cuts and the threat of increased regulation. Poor market returns, meanwhile, tighten the strangle-hold as yields continue below the mandatory interest rate schemes have to pay on capital, further reducing their ability to break even.
According to the 2010 Risk Check from consulting firm Complementa, at the end of June, the average Swiss scheme’s unweighted coverage ratio was 103% (105.2% for private and 91.5% for public schemes). This ended the market-driven recovery during 2009 when funding improved by 12.6 percentage points on average to 104.3%. Around a quarter remain underfunded, down from 60% at the end of 2008.
Despite this relatively positive picture, the cumulative performance for 2010 to 30 August, based on the UBS Pensionskassen-Barometer, was only 0.63% as foreign equity markets (-6.69%), hedge funds (-2.94%) and weakening euro and US dollar rates hit performance.
At this yield level, Swiss schemes will fall considerably short of the mandatory minimum interest rate (BVGR) they have to pay on members’ capital, worsening their recovery outlook. The Credit Suisse Swiss Pension Fund Index would have to improve 11% to close the gap between the actual and mandatory returns in 2010.
Swiss pensionskassen have long lobbied for the right to set key parameters, including the BVGR, currently prescribed by Bern.
In August the BVG-Kommission voted in large majority to maintain the BVGR at 2% this year and next. The Commission considers yields on assets, particularly federal bonds, but also equities, bonds and real estate.
“This was definitely the wrong decision,” said head of Mercer Investment Consulting Switzerland’s Sven Ebeling. “It was based on political, not economic, reasoning.”
For most schemes, the BVGR creates a vicious funding cycle. “Because the rate has been set too high over the last decade, there has been an inherent decrease in funding levels leading to tighter risk budgets and, therefore, even lower returns,” said Swisscanto chief investment officer Peter Baenziger
According to Swisscanto figures, the average pension fund must return 3.9% to break even.
Looking at the BVG-Pictet indices, which give theoretical performance of schemes based on different asset allocation models within the regulatory guidelines, the average annual performance for the last ten years for schemes with a 25% equity weighting has been 2.6%. The BVGR over that period has been 2.9% on average. For those with a 40% equity weighting, average annual returns were only 1.7%.
At the end of 2009, Swisscanto figures show the average equity allocation was 26.9%.
Bern also sets the minimum conversion rate for benefits, a particularly contentious issue in recent months. The conversion rate, currently 7.05% for men and 7% for women, will fall to a flat 6.8% by 2014. A further cut to 6.4% by 2015 proposed by representatives of the second pillar was recently rejected by national vote.
According to Hanspeter Konrad, director of the Association of Swiss Pension Funds (ASIP), the No vote resulted from too much false information: “The voting public need to understand what the issue is really about. It is not about reducing pensions, but about bolstering the numbers and making sure everybody gets what they’ve been promised.”
Reducing the rate, he stresses, does not necessarily mean a benefit reduction as it is only a minimum limit. Furthermore, younger generations would feel disgruntled if they have to bear the considerable burden of more generous benefits for today’s pensioners.
Konrad continued: “Those who talk of a great pensions robbery are closing their eyes to the truth.” He warns of a moral hypocrisy as critics contradict their own arguments. Those same critics called for an end to the ‘casino capitalism’ of risky investments during the financial crisis. By demanding higher benefits, they are necessarily requiring schemes to achieve unrealistically high returns, only possible by taking more risk.
Lobbying for a more lenient regulatory approach will be difficult for the second pillar, currently beleaguered by allegations of corruption at BVK, the Canton of Zurich pension fund. A parliamentary commission has been established to investigate the allegations after former head of asset management, Daniel Gloor, was arrested.
Coupled with the proposal to further cut benefits, which some experts believed to be politically unwise, trust in the second pillar has been dented and the pressure on government to increase regulation could mount.
According to Ebeling, it will be markets, rather than lobbying efforts, that drive any change: “In the current environment, it will be difficult to bring about a shift. Much depends on how markets behave in 2011. If they perform badly, there will more likely be a realisation that how the minimum interest rate was defined historically is no longer realistic and a more market-
oriented approach is needed. Positive market returns could postpone the discussion for many years.
“There is also a lot of dialogue going on around how benefits are paid. We may see a move towards a two-part payment with a fixed segment based on the legal conversion rate and a second, floating segment related to market performance. It will be interesting to see if this finds a majority view, but it would be a major change.”
Bern has made some efforts to hand over control. Earlier this year, parliament passed structural reforms, transferring public sector pension fund supervision to the jurisdiction of cantons, who in turn are expected to establish regional supervisory bodies.
The response has been mixed. The canton of Solothurn announced in September it will keep its own supervisor. While it didn’t rule out future cooperation with other cantons, it pointed to specific cantonal conditions and familiarity with members.
Other cantons had already created regional supervisory authorities in anticipation of the reforms. In 2006, Luzern, Nidwalden and Zug joined with some others and in 2007 Zurich and Schaffhausen agreed to cooperate. Others, including Appenzell and St Gallen, followed suit in 2008.
While this reform has the full support of ASIP, which represents over 1,000 Swiss schemes, concerns over the costs of additional regulation in the future prevail.
As Markus Huebscher, head of the national railway scheme, PK SBB, explained: “Switzerland has a very granular pension structure with thousands of small schemes. High regulation is very costly for small funds so the government has to be very sensitive about imposing additional controls. Events like fraudulent behaviour can always happen. The regulator has to weigh up, for example, an extra CHF10m annual cost of additional regulation versus a fraud of CHF2m every ten years.”
From an investment perspective, there has also been some regulatory relaxation. In early 2009, asset allocation guidelines included up to 15% in alternatives for the first time. Few feel they are better off as a result, however.
The timing was unfortunate: poor performance by many fund of hedge funds, the preferred alternative investment for Swiss schemes during the financial crisis, proved bitterly disappointing in terms of absolute returns and higher-than-expected correlation to traditional asset classes.
Many pensionskassen had also held alternative allocations before 2009 due to the guidelines’ ‘comply or explain’ nature. “As long as Boards can justify their decision,” Huebscher explained, “they were always free to overrule the investment guidelines regulation. I therefore do not expect much impact from the new guidelines.”
Unsurprisingly, a recent Ernst & Young study showed regulation was a key concern for Swiss schemes. Half of institutions surveyed believed the effects of policies emanating from Bern were “generally negative”, while 8% said “very negative”. Few schemes felt optimistic about the future of regulation; 67% believed political influence would likely increase.
According to National Council member Guy Parmelin: “I appreciate that everything which restricts schemes’ room for manoeuvre regarding optimal and cost-effective management is regarded as unnecessary and an obstruction of the dynamics essential to the sector. However, the demand that politicians meddle as little as possible with occupational plans and leave administration to the experts goes too far.”
Parmelin is a member of the governmental Commission for Social Security and Health, responsible for the pensions sector.
He promised to continue working with the pensions industry “with the necessary diligence”, but called for the same constructive attitude from the second pillar, adding personal egos should be put aside for the benefit of general public interest.
Ernst & Young’s survey demonstrated some willingness by schemes to work with government. Funds did not object to “justifiable” control mechanisms and requirements with 40% in favour of a solvency or stress test, provided it accounted for specific industry conditions.
Whatever the outcome of future negotiations between Swiss pension funds and their regulator, improving funding ratios will be a long battle.
As Ebeling concluded: “Even if actuarial issues such as benefits and the minimum interest rate are adjusted, there is no dramatic or fast recovery for Swiss schemes. This will be largely driven by market factors and in the current environment; there is no clear trend in bond or equity markets. Despite strong improvements in funding levels during 2009, poor returns this year have reversed that trend. Over the next few years, it will be hard for schemes to improve funding as we are unlikely to see another year like 2009.”
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