Public sector pension institutions play an important, if often controversial, role in the Swiss pensions arena, argues Graziano Lusenti
The Swiss claim to be the first in the world to have coined, sponsored and successfully implemented the now almost universal concept of the three pillars in pensions - social security, occupational pensions and personal retirement provisions - in the 1970s and 1980s. Whether this claim is justified or not, and it might indeed be, it implies at least that, over the years, they have gained an extensive experience in dealing with the varied aspects of pension provisions- from investments to supervision, taxes and vested rights.
In an international comparison, the Swiss occupational pension system stands out by its comprehensive and almost universal coverage of the workforce, both employees and independents: all salaried workers with an annual salary in excess of CHF19,890 (€12,500) are insured by way of the minimal rules of the Federal Law on Occupational Pensions, (BVG). The self-employed, without membership in a second
pillar foundation, are free - and therefore not obliged - to cover themselves but, if they do, they benefit from tax deductions of up
to CHF31,824 a year. In principle, the BVG provides for minimum rules regarding benefits, (defined minimum) contributions, organisation, and so on, but its compulsory rules also apply to almost any pension fund activities.
By any standards, Swiss pension assets are quite large and exceed CHF700bn (including some CHF120bn second pillar assets with insurance companies, some CHF30bn with vested rights foundations and around CHF20bn privileged funds used for the individual acquisition of direct real estate), which implies one of the highest amount per capita and one the highest ratios of pension assets to GDP worldwide.
As in most countries, the law, initially limited in scope and extent, has expanded to become a huge administrative nightmare for all those involved.
But since its introduction in 1985, the BVG, which initially introduced a federal mantle for a system that was already working properly, has saved employees major pension bankruptcies like those seen in the UK (Maxwell media group) or in the US (Enron and the like), because there exists a pension guarantee foundation (Sicherheitsfonds/Fonds fédéral de garantie) which steps in to pay due minimum pension whenever the original fund is no longer in a position to honour them.
In comparison to the Netherlands, there are only very few industry-wide or sector pension funds. This explains why the Swiss system is much less concentrated: the total number of pension funds (foundations) still exceeds 2,200 (covering 3.3m people and 800,000 pensioners - for a total population just under 8m) and there are relatively few large funds, with assets in excess of CHF1bn.
Notwithstanding this, the system has already gone through a concentration process, which is likely to speed up in the coming years.
Trade unions play only a limited role in this system, which has a special feature: the managing body of all funds - in the most cases, the Stiftungsrat/conseil de fondation, the equivalent of the board of trustees - comprises an equal number of employer and employee delegates, making pension funds one of the rare fields in Swiss economic and social life where a form of ‘cogestion’ is implemented.
Switzerland not being a member of the EU, its pension funds are not directly concerned with the EU directives in the field of occupational pensions, especially those relating to IORPS, solvency and supervision. But everybody in the industry expects these rules to have at least an indirect influence collectively and most professionals are concerned that, longer term, this flourishing and seasoned domestic business sector is going to lose out to the new ‘pension hubs’ that inevitably will emerge in a few favoured European countries - just as happened in the mutual funds industry 20 or 30 years ago.
In practice, the Swiss pension fund universe is made up of three parts, each with its features and specific problems:
The private sector pension funds are the largest of the three by any standard and probably the one with the least issues to address - although problems of appropriate governance in investments have surfaced occasionally (as in the Siemens PK-Swissfirst case) The second group comprises the collective and group foundations (Sammelstiftungen/fondations collectives et communes), run by insurance companies, banks and a few independent providers on behalf of the many thousands of small and medium sized companies in the country, with only a few salaried persons each. The problems faced by this group relate mostly to operational and investment efficiency - due to the high costs incurred for managing the plans and assets of so many small adherents and their employees and the necessity for the for-profit providers like insurance companies and banks to make a profit for their shareholders. Time and again over the last 10 years the shortcomings that were spotted have provoked uproar in the media and in various political circles (mainly on the left). Most heated discussions regarding the proper setting of the minimal return on investments - 2.5% at present, most likely 2% in 2009 - and the adjustment of the rate for converting pension assets at retirement time life annuities - the so-called Umwandlungssatz/taux de conversion - focus on this group of institutions. The third group encompasses all pension institutions of the public sector - which unlike the two previous groups might be a department of a public body rather than a pension foundation. However, it is split into three levels: the federal, the 26 cantons and some (mostly large) cities like Zürich, Geneva and Lugano. In total, there are less than 150 public sector funds, but some of them are among the country’s largest. Public sector institutions profit from an advantage with respect to the other two groups. They can run a cover ratio deficit - the ratio of total assets to total liabilities can be less than 100% - if they benefit from a formal and irrevocable guarantee by a public body that it will ensure the ‘perenity’ of the fund, that is pay in a recurring way any pension payments that were not financed in anticipation.
The main problem that this group of pension institutions faces now and will in the future is a gap in the coverage ratio. The gap is not huge in relative terms, as on average it was less than 95% at the end of 2007 - although the poor investment performance in 2008 has had a sizeable impact, reducing it to possibly 90% at the end of August 2008. This new situation might require a number of funds to take painful measures, most likely on the benefits side (for example, indexing and retirement age).
The sector’s average cover ratio is probably high in an international comparison of public sector funding, if one were to take into account the huge gaps in financing civil servants’ pensions in countries like Germany, France and Italy - to name only a few OECD countries. But nonetheless, because it varies widely from one fund to another it remains an issue of debate. And it became even more so after the federal government published draft legislation last year that would require public sector institutions to reach a 100% cover ratio within 40 years and to transfer all assets to a separate legal entity.
The proposal provoked anger in some parts of the country, especially the francophone areas, where most pension provision is still defined benefit and where the cover ratios are somewhat lower. Most funds with a gap are financed by a so-called mixed system, where a small part of the benefits is financed by a pay-as-you-go system. The funds using such a financing method want to keep it and oppose the new draft legislation. Recently, their cause was backed by the finance and social security ministers of several large cantons, who expressed concern that the new rules would not only be expensive - at stake are hundreds of millions of Swiss francs a year for
many years - but will also limit investments the cantons plan for such priority sectors as infrastructure and education. So the fight between what one might call federal pension orthodoxy and cantonal pension pragmatism is not yet resolved.
The average asset allocation of Swiss public sector pension funds does not differ much from that of the other groups, with one exception: the importance of direct domestic - and in most cases regional or local - real estate. This provided quite a positive overall investment performance in 2007 and 2008 when this asset class was one of the very few gainers. Actually, Swiss pension funds overall, and public sector funds in particular, are very fond of real estate, domestic and international, direct and indirect, their allocation to this field being one of the highest worldwide.
Another striking feature of public sector pension fund allocation is the reduction to close to zero of any investments with the sponsoring public sector body - either direct deposits, loans or bonds. This can be interpreted as both a sign of independence and of professionalism.
The large public sector funds regularly appear to be front-runners when it comes to innovation and efficiency in investments. They were among the first to invest significantly in private equity, commodities, non-domestic indirect real estate, hedge funds and socially responsible investments and they are now in microfinance. The extended diversification in most cases was accompanied by an improvement in internal and external fund governance, that is the working together of non-professional, part-time delegates within governing bodies like trustee boards or investment committees, as well as with external professional parties like asset managers, custodian bank, actuaries and investment consultants, for the purpose of selection, reporting and controlling.
Last, as shareholders, public funds successfully battle with the management of the country’s largest listed companies to cap management remuneration and for more transparency.
Graziano Lusenti is an accredited pension fund actuary and managing partner at Nyon-based consultancy Lusenti Partners LLC
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