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| "Pension Theft" or Necessary Adjustment? Conversion Rate Takes Center Stage |
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In the run-up to the referendum, the reduction of the minimum conversion rate from 6.8% as planned to 6.4% from the year 2015 is a topic of heated debate. The arguments for and against could not be more dissimilar. They range from "pension theft" and the erosion of pension funds all the way to warnings that the second pillar is threatened by instability.
On March 7, 2010, the Swiss electorate will have to vote on the reduction of the conversion rate for pension funds. If another reduction is approved, the resulting changes to the law will only affect insured who retire from 2015. Current pensions will not be affected, as a pension that has been guaranteed once cannot be reduced during the rest of the pension payment period.
The conversion rate is used to calculate the lifelong annual retirement pension that results from the retirement assets saved by the insured until retirement. Insured who save approx. CHF 400,000 in pension assets during their working life will receive a lifelong annual retirement pension of CHF 28,000 with the current conversion rate of 7.0%. The planned reduction in the conversion rate to 6.4% would reduce the annual retirement pension by CHF 2,400 to CHF 25,600 per year.
Pension funds distinguish between mandatory and extra-mandatory pension assets. The Federal Act on Occupational Retirement, Survivors' and Disability Pension Plans (BVG) governs the minimum mandatory benefits that must be insured and which all pension funds in Switzerland must provide. Pension funds are, however, free to offer better pension provision than the minimum prescribed by the law. The minimum conversion rate determined by the Federal Council also applies only to the mandatory employee benefits insurance.
The conversion rate depends on the one hand on the life expectancy of pensioners, and on the other on the long-term potential for returns on the capital markets. If one of these parameters changes, an adjustment to the conversion rate is unavoidable.
Rising Life Expectancy
According to the Swiss Federal Statistical Office, the life expectancy of people born in Switzerland is constantly rising and is already among the highest in the world. When the BVG was introduced in 1985, men aged 65 were expected to live for another 14.9 years on average, while 65-year old women were likely to live for 19 more years. By 2008, the Swiss mortality table painted a very different picture. On average, men of 65 can enjoy their retirement for 3.8 years longer than in 1985, and women of the same age already live to the age of 87. A reversal in the rising life expectancy trend is currently not in the offing.
| Year |
Life expectancy of a
65-year-old man |
Life expectancy of a
65-year-old woman |
| 1985 |
14.9 |
19 |
| 1990 |
15.3 |
19.4 |
| 1995 |
16.1 |
20.2 |
| 2000 |
17 |
20.7 |
| 2005 |
18.1 |
21.6 |
| 2008 |
18.7 |
22 |
Source: BSF, ESPOP, BEVNAT
For pension funds, these demographic trends mean that retirement pensions must be paid out for a longer period than is covered by the available pension assets. The resulting retirement losses – triggered by the longer pension period and a conversion rate that is too high – must be borne by the pension funds and threaten their long-term financial stability. Adjustments are therefore essential to counter these changes in the parameters.
Supporters of the referendum (see the "Referendum" information box) emphasize the fact that retirement pensions have already been reduced since the introduction of the BVG and that another reduction is not viable as the people who will be affected by this reduction will have to make unfair financial sacrifices. The conversion rate reduction to 6.8% that has already been approved will reduce future retirement pensions and at the same time the Federal Council has reduced the minimum interest rate for pension assets from 4% to 2%. These arguments may be justified, but catchphrases such as pension theft or rising poverty among the aged go too far, especially as most pension funds these days offer their insured better benefits than the statutory minimum benefits.
Falling Yield Expectations
The second factor that influences the conversion rate is the long-term yield expectation, which, unlike life expectancy, has dropped substantially in the past few years. Referendum supporters claim that a future return of 4.5% is really quite realistic, but the graph below gives the lie to this argument.
The current conversion rate is based on a technical interest rate of around 4%. This interest rate is an estimate of the percentage interest that can be paid on the assets reserved for financing the lifelong pension payments (asset depletion). The technical interest rate is not the same as the expected yield. To calculate the expected yield, reserves for the increase in life expectancy and for administrative and asset management costs must be added to the technical interest rate, which means that a return of 4.5% per year is needed. In the past, most pension funds did not manage to generate this return. The interest rate earned on low-risk investments, such as the 10-year federal bond that is used as a 2nd-pillar benchmark, has been dropping constantly from an all-time high in 1992 to a record low of less than 2% in 2005. The technical interest rate is still substantially higher than the interest rate for low-risk investments, which was 1.97% at the end of December 2009. A technical interest rate that is too high is not a good thing for pension funds, as they must accept too much risk if they wish to earn the resulting target return.
Average yield on 10-year federal bond
Source: Datastream, SNB
Financial Stability of Pension Funds Must Be Guaranteed
If insufficient attention is paid to the changed parameters, the 2nd pillar will be threatened by destabilization in the long run. This does not serve the interests of the current or future generations of pensioners. An appropriate conversion rate of 6.4% will make it possible to distribute the accrued pension assets over a longer period, thus bringing the pension payment period in line with life expectancy and avoiding the need to pay out "uncovered" pensions due to an unrealistic conversion rate.
Referendum
During the first BVG revision the Federal Council decided to gradually reduce the conversion rate of 7.1% for men and 7.2% for women that has been valid since 1985 to 6.8% in 2014. In view of the rising life expectancy and lower yield expectations, the Federal Parliament approved another reduction to 6.4% from 2015 during its 2008 winter session. Various associations and parties then called for a referendum on this decision, and the Swiss electorate must vote for or against another reduction on March 7, 2010. |
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