Swiss pension outcomes are falling – could “matching” be part of the answer?

Low, even negative, interest rates and uncertain growth prospects is becoming a “new normal” in Switzerland. The impact on pension fund finances is well documented – pressure on funding levels, tough to find the right investment opportunities and focus on cost transparency. This environment also poses challenges for insured members, and as a result their employers. Expected retirement outcomes have fallen. What does this mean for employees and employers? 

10 years ago an insured person would expect higher returns on any money they invest for retirement than they would today. The mandatory interest credit for Swiss pension plans according to BVG/LPP was 2.50% in 2007 compared to 1.00% today.  Ten-year Swiss government bonds yields have fallen from 2.6% to -0.1% in the same period. This not only affects expected returns on the assets set aside but also the cost of providing an income for life after retirement. Life expectancies for retiring pensioners have increased by about 1 year for females and 2 years for males in that time which also needs to be funded.

All of these factors have had a major impact on retirement outcomes. Based on our calculations, in 2007 a 40 year-old could invest CHF 7’100 and expect a pension of a CHF 1’000 a year for that investment. Today a 40 year-old would expect to have to invest CHF 14’700 – more than doubling of the cost of retirement over 10 years. In that time, inflation expectations have also fallen, but overall the cost of retirement has increased.

What can pension funds do?

Pension funds aim according to our experience to maintain the level of retirement benefits they provide while financing the promises already made. But pension funds are in a “zero-sum” game – without extra funding, members will ultimately receive lower benefits on average when results are not what was expected. Robust analysis and forecasting of what employees can expect to receive, combined with clear communication may be the best what they can do. Other measures are down to employees and employers as recipients and sponsors of retirement benefits.

What does this mean for individuals and employers?

Find higher returns? In conventional collective Swiss plans, employees share in the overall returns of the fund as they are credited to them. This limits opportunities to take more risks, with an expectation of higher returns. For higher earnings, it is possible to have individual strategies through a “1e” pension plan. These plans can be used to seek higher returns, but this may not be suitable for all.

Later retirements? Without saving more, employees have to retire later for the same outcome.  In some ways this is only reasonable: If life expectancies increase without changing retirement ages, the proportion of life we spend in retirement rises. Employers may have to prepare for the ageing effect on their business – not only their workforce recruitment and retention, but possibly their business strategy and target markets.

Employers pay more? One answer may be employers paying more. But employers face economic challenges themselves, with increasing competition and pressure for results. For most companies, raising costs or investing cash may not be palatable.

Employees pay more? Creating more awareness of the individual options available for the employees is one option. Additional voluntary employee contributions are typically deductible for tax purposes. Some employees don’t have confidence in their pension plan and are not keen to lock away money until retirement.

How can companies create further incentives for employees to pay more? A look abroad could help.

Could “matching” be part of the solution?

In the US as well as the UK, contribution “matching” is widely used in pension plan design. Employer contributions are adjusted to “match” those of employees. When an employee contributes a percentage of their salary into the plan, the employer contributes an amount directly linked to what the employee pays. This could be 1:1 – i.e. if the employee pays 2% of pay, employer pays the same. Or some ratio like 2:1 or 1:2.

The big advantages of matching are two-fold: it encourages employees to pay more; and it focuses employer spending where it is most valued by its employees. One of our clients challenged the common Swiss plan option of employers paying the same for all employees, whereas employees can choose their level: “Why can employees choose to pay less, but I cannot follow when they do?” A reasonable question that matching helps to address.

The challenge is that legislation in Switzerland currently restricts the ability to apply matching within the regular plan. The law requires the employer contribution rate to a pension plan to be the same for all employees in the same situation (e.g. age, grade etc). “Matching” can be done through the buy-in system. So with the right plan design, matching can be incorporated within the Swiss plan.

This won’t for every situation as the use of buy-ins is subject to certain caps and restrictions which may become a barrier. Plan administration may be more complex. But in challenging times for pension outcomes, new solutions may be needed.

Contact

Richard Köppel
Pensionskassen-Experte SKPE, People and Organisation
Tel. +41 58 792 11 72
richard.koeppel@ch.pwc.com
Adrian Jones
Director, People and Organisation
Tel. +41 58 792 40 13
adrian.jones@ch.pwc.com

Consequences of the 2020 Pension Scheme Reform (AV2020) on comprehensive pension plans

1. Initial position

On 17 March 2017 Parliament approved the 2020 Pension Scheme Reform (AV2020). It contains an extensive package of actions in the 1st and 2nd pillar, with the aim of ensuring financial stability and maintaining the previous pension level. The reform is to come into force in 2018 and is expected to be submitted to the public for voting on 24 September 2017.

2. Basic information

The changes to occupational benefits in AV2020 are as follows:

  • Retirement age: increasing the retirement ‘reference’ age for women from 64 to 65 and increasing the earliest possible retirement age from 58 to 62 in general (exceptions possible).
  • Retirement conversion rate: gradual reduction of the minimum conversion rate from 6.8% to 6.0% over 4 years, starting after 31 December of the year when AV2020 comes into force (we expect from 1 January 2019).
  • Insured salary: increase due to the reduction of and additional flexibility in the coordination offset, which equals 40% of the pensionable salary according to BVG. In addition, the coordination offset cannot be less than the minimum AHV/AVS pension and not more than 75% of the maximum AHV/AVS pension (also expected from 1 January 2019).
  • Saving credits: increase in saving credits by 1% of the insured salary for BVG minimum plans from ages 35 to 54 (also expected from 1 January 2019).
  • Transition generation: guaranteed benefits will be calculated according to current law for plan members aged 45 and over with the measurement date one year after the AV2020 comes into force. These will be financed by subsidies from the BVG Security Fund.
  • Continued insurance from the age of 58 on termination: if the employee has to exit compulsory occupational benefits due to termination of employment by the employer, the plan member can continue his / her previous insurance on request.

3. Challenges for comprehensive pension plans

Not all measures of the reform have the same relevance for all pension plans, with ‘comprehensive’ plans providing benefits higher than the legal minimum. The portion of the over-mandatory account balances is key in this context. The AV2020 will not necessarily result in higher contributions for the employer and the plan members within a comprehensive pension plan. Nevertheless, various challenges arise for comprehensive pension plans:

  • Retirement age: the new reference age for women and an adjustment to the early retirement age seem to be a top priority. As a result, the target level of benefits for women is being re-adjusted, which can also lead to an adjustment of the plan’s conversion rates for women.
  • Insured salary / saving credits: The increase of the compulsorily insured salary and saving contributions reduces the over-mandatory portion of the plan member’s account balances. If the saving process remains unchanged an additional reserve or funding of termination benefits may be required under certain circumstances.
  • Conversion rate: the reduction of the minimum retirement conversion rate increases the over-mandatory portion of the retirement pension. This increases the potential for a reduction of the plan’s conversion rates, particularly in plans with a small portion of over-mandatory account balances.
  • Transition generation: by granting the minimum retirement pension according to current law, an additional BVG shadow calculation for plan members of the transition generation might be required (details to be determined by the Federal Council). Again, this increases the complexity of occupational benefits and requires additional efforts in technical administration (one-off: adjustment of systems; ongoing: settlement subsidies from Security Fund BVG).
  • Continued insurance from age 58 on termination: under the aforementioned conditions pension funds will be obliged to provide external insurance on request. The contribution processing (saving if continued, as well as risk and cost contributions) is no longer handled by the employer but by the plan member. As a result, this means additional work for the pension funds. For instance, pension funds may have to deal more with outstanding contributions from such plan members.

In addition to these challenges, further innovations will emerge for pension plans, where the application in practice is unclear. This includes the newly created legal basis in Art. 17 FZG: it will be possible to deduct a contribution to fund actuarial losses at retirement from the relevant employee contributions when calculating the minimum termination benefit. Such an ongoing premium to fund actuarial losses at retirement has so far not been explicitly foreseen in the funding procedures of the 2nd pillar.

It is not certain that there will be a referendum on the entire AV2020, as only the increase in value-added tax to the additional funding of AHV is in general subject to the obligatory referendum. Either way, it is unpredictable how the reform will be accepted by the public. The advantages of the 1st pillar and the advantages of the 2nd pillar social security clash with each other. Nevertheless, in our view, a board of trustees or pension committee for comprehensive pension plans can no longer ignore the reform in strategic decisions on the pension plan setup.

Contact

Richard Köppel
Pensionskassen-Experte SKPE, People and Organisation
+41 58 792 11 72
richard.koeppel@ch.pwc.com

Markus Schneeberger
Director, People and Organisation
+41 58 792 56 45
markus.schneeberger@ch.pwc.com