Few issues in the world of Swiss pensions are generating as much heat as the question of whether the guaranteed minimum interest rate of 4% for mandatory occupational schemes should be lowered.
The guaranteed interest rate is one of the cornerstones of Switzerland’s BVG system of mandatory supplementary pensions. The rate has remained unchanged since the system was introduced in 1985 and is now highly prized by pension fund members.
In the past, Swiss pension funds have relied on their investment in federal bonds to provide most if not all of this 4% return. However, lower inflation in the 1990s depressed net yields, which fell to 2.8% in 1998.
Normally, the funds could rely on returns from equities to make up the shortfall. However, volatility in the capital markets over the past two years has also depressed equity performance and drastically reduced returns.
The combination of these two factors has made it increasingly difficult for many insurance companies and pension funds to provide the compulsory 4% return. Swiss Life recently blamed its poor results almost wholly on the compulsion to return 4% to its pension fund savers.
The problem is compounded by a condition of the BVG legislation that says that the 4% minimum shall be paid at the end of each year, regardless of market conditions. To some this seems oppressive. Claude Chuard, a pensions consultant based in Berne, and a member of the pensions think tank Innovation Second Pillar, says: “Paying this rate is simply not possible today. The market doesn’t give 4% so how are you supposed to provide it? Over five years you could do that but not every year.”
He adds: “The guaranteed minimum is a political rate, not a real rate. Politics and reality rarely coincide.”
The issue is not new. Back in 1998, the Schweizerische Versicherungsverband (SV), the Swiss association of underwriters, on behalf of the insurance companies, asked the BVG-Commission, the body that oversees the BVG, the mandatory component of the second pillar system, to lower the minimum guaranteed interest rate. The BVG-Commission rejected the plea. However, it said it recognised that the life assurance companies are subject to other regulations than the pension funds, and set its real interest committee to report on any problems the minimum rate was posing for insurers.
Insurance companies, who insure roughly half of all pension savers, have had little or no support from other pension providers. ASIP, the association of Swiss pension funds, which represents large autonomous corporate funds like Nestlé and Novartis, says it sees no need to follow the example of the insurance companies.
They point out that, although some pension plans may have trouble paying a guaranteed return of 4%, most can draw on the substantial ‘fluctuation reserves’ that they built up when markets were buoyant. For example, Asga Pensionskasse, a St Gallen pension fund with 35,000 members, achieved a return of 4.75% last year and expects to return 4.25% this year.
The unions, too, are strongly opposed to any reduction in the rate. Colette Nova, general secretary of the SGB, the Swiss union of public employees, has said that the insurance companies should lower their rates only after they had opened their books to their customers and demonstrated that they can no longer provide a minimum interest rate of 4%.
However, the insurance companies have received some support from the real interest rate committee of the BVG Commission, which has been looking at the issue of whether the guaranteed minimum rate should remain nominal or should switch to a real rate to take into account inflation.
The real interest rate committee announced last month that it recommended keeping the rate nominal. However, crucially, it decided that the central problem of the guaranteed minimum rate was not whether it should be nominal or real but whether the rate itself was too high and whether the BVG should have the freedom to adjust it.
The committee has suggested, as a compromise, setting up a mechanism whereby the BVG could adapt the nominal guaranteed minimum interest rate to take account of economic conditions.
The committee recommends that the BVG Commission should be check the minimum interest rate regularly against a series of benchmarks. This will be done in a number of stages.
Each year, the Bundesamt für Sozialversicherung (BVS), the Federal Office of Social Security, will report to the BVG-Commission each year about the movement of three benchmarks over the past year. These benchmarks are:
q the pension fund index, which shows the overall performance of the pension funds;
q the net yield of federal bonds, and
q earnings growth as measured by the growth rate of the general wage index.
Every month, the BSV will calculate a ‘reference rate’ from the performance of these benchmarks. It will then check how much this deviates from the 4% minimum interest rate.
The BVS will then decide whether to formally request BVG Commission to consider a re-assessment of the guaranteed rate. It will base this decision on the performance of the reference rate. If it deviates by at least 1 % either side of the 4% minimum interest rate, the BVS will produce a discussion document setting out the case for reassessing the rate.
The BVG Commission will consider this document and decide whether to ask the upper house of parliament to approve a change in the minimum interest rate. If the BVG Commission does go to the upper house, it will suggest the new level that the rate is to be set at.
However, relaxing the guaranteed 4% will not solve the problem on its own. A second worry is the level of the conversion rate, another cornerstone of the mandatory second pillar system. The conversion rate is the guaranteed percentage of accrued contributions that is paid out as a retirement pension under the BVG system. The rate is currently 7.2%.
Insurance companies and pension funds complain that this rate is based on life expectancy calculated at the beginning of the 1980s. Since then life expectancy has lengthened and therefore pensions have to be paid out over a longer period of time.
Werner Nussbaum, a Berne-based pensions expert who helped design the original BVG schema, says that the conversion rate is likely to be lowered as part of a package of changes to the mandatory LPP BVG scheme, which is the subject of a federal government bill.
In this package, the 7.2% transformation rate will be lowered to 6.65%. Nussbaum says that the contribution structure of the defined contributionscheme would need to be modified to compensate for the resulting loss of retirement benefit.
He suggest that the current four contribution rates (7%, 10%, 15% and 18%, according to age) could be reduced to three and the initial contribution rate could be increased from 7% to 10%. “The solution is to delete the first age category and increase the other having only three,” he says “This would compensate for the reduction of the conversion rate and the guaranteed interest rate.”
Some change to guaranteed rates of the BVG system appear now seems inevitable. “The legislators will have to accept the reality.” Claude Chuard says: “At the moment you have to cheat the law because the law is wrong.”
The main change to the system is unshackling pension funds from a specified rate of return, he says. “You can write down a principle down but you cannot write down a figure.” But to do this would mean losing the magic figure of 4%. The question is, will the Swiss saver accept such a loss?