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Sunday 20 October 2019

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Building bridges

Written by Adam Cadle
January/February 2012

Adam Cadle reports on the current state of the Swiss pension market and provides an outlook for 2012

The Swiss pension system is one of the best in the world. According to the 2011 Melbourne Mercer Global Pension Index, Switzerland is currently ranked in third place with an overall index value of 72.7, with only Australia and the Netherlands standing ahead of it with index values of 75.0 and 77.9, respectively. However, the sheer strength of volatility sweeping through European and global financial markets last year, which had a profound impact on investment returns and funding levels, meant that not even Switzerland’s three pillar pension system could escape the repercus-sions of this occurrence.

Statistics included in the Swiss Pension Finance Watch published quarterly by Towers Watson showed that over the third quarter of 2011 the funding level of a typical Swiss pension plan had declined by around 9%. However, according to Towers Watson’s senior investment consultant Edouard Stucki, funding ratios will vary from one pension fund to another.

“Indeed, liabilities will increase and funding ratios will decline as we deal with an ageing population and some poor investment returns. If you have pension funds that are mature with over two thirds of members being pensioners, then there will be considerable problems building up,” he says.

The Credit Suisse Swiss Pension Index posted a -0.56% return for the 2011 investment year, under-performing the BVG target by 2.56%. With regards to performance contributions, Swiss equities were recorded at -1.01%, foreign equities at -1.46%, liquidity at -0.32% and alternative investments at - 0.11%.

Furthermore, for the end of September, performance of Swiss pension funds with funds of more than CHF 1 billion saw annual performance recorded at -3.24% and funds with less than CHF 150 million saw performance levels at -3.47%.

“When you look at the per-formance levels of Swiss pension funds in 2011, it depends a great deal on each individual fund’s asset structure. So if a fund was quite heavily invested in Swiss franc bonds and Swiss real estate with only few equities, then you could reach a performance of up to 3% whereas the more a pension fund invests in equity and foreign currencies, then the performance could drop to around -1 or -2%,” says Unigestion’s director of institutional clients Daniel Ritz.

“The Swiss pension fund system is based on parameters which were originally defined in 1985, so one of the key assumptions was that you could expect to achieve a return of 4% from the investment side but if interest rates are below 1% it becomes very difficult to maintain these returns and stabilise coverage ratios without adapting contributions or benefits.”

So with these figures in mind, how are Swiss pension funds looking to amend their investment strategies in order to combat the current state of the financial markets? Stucki remarks that whilst the asset allocation of Swiss pension funds is traditionally very slow to change, there has indeed been a certain degree of thought from funds with regards to amending portfolio arrangements.

“Allocations have really remained quite stable over time apart from changes due to market movements,” he comments. “What you can see is pension funds thinking about what to do to overcome the low yields earned on fixed income, placing an emphasis on not increasing equities, considering diversification in real estate and looking at some alternative investment classes. There is also more interest in insurance-linked security funds which are good diversifiers and provide a nice access to the insurance risk premium.”

Investment in real estate is also an element which is picked up on by Swisscanto chief economist Thomas Liebi. “Pension funds are a bit reluctant to invest even more in stocks because they have on average more than a quarter of their assets in this area. Real estate has been a good investment strategy and in 2012 I don’t expect prices to drop too much,” he states. Real estate investments have increased by about 2% in allocations; however the problem very much at the forefront of investors’ minds is that the real estate market is not particularly large in Switzerland, therefore potentially hampering investment opportunities.

In fact, many investors have growing concerns that a property bubble is emerging in the Swiss market due to low rates, demand exceeding supply and with many regarding property as a safe investment. Swiss pension funds invest in real estate typically in multi-family housing, as this offers stable returns. However, now there is potential for funds to invest outside in non-domestic real estate. “Ten years ago real estate was out of fashion. Now we have a rebound where it has become a new trend because it offers more or less no volatility in Switzerland and provides a stable balance sheet,” says Aon Hewitt’s managing director in Switzerland Werner Hertzog.

With workplace pension plans becoming increasingly unaffordable in Switzerland, the government in March last year, on advice from actuaries, attempted to reduce the minimum annuity-conversion rate used to calculate individual annuities for mandatory occupational pension plans. Their proposal was however met with widespread disapproval as 73% of Swiss voters made it clear that they were against the change. The Swiss government has said that a cut in the conversion rate from 6.8% to 6.4% makes sense in order to account for rising longevity.

Stucki supports the government’s proposals. “Everybody knows and accepts that the assumptions that are used to calculate conversion rates are too high and that these need to come down. The rate needs to come down to account for increasing longevity and lower earned rates,” he emphasises.

This is a point which is also backed up by Liebi, who underlines that many people do not fully comprehend what the conversion rate proposals are all about. “Conversion rate cuts are definitely necessary. The only other way of perhaps dealing with the sustain-ability issue, is for people to work for longer. Italy and Germany are increasing their retirement ages. People thought that the conversion rate proposals were an attempt by insurance companies to increase their profit taking whilst increasing the burden on workers. The conversion rate is quite a technical issue.”

Due to this issue, there are growing fears that an intergene-rational conflict could emerge as the younger generation bear the weight of future reforms, having to contribute more to recovery measures and suffering from lower conversion rates on future pension assets.

Taking all these factors into consideration, how do financial experts therefore expect Swiss pension funds to fare in 2012?

“It depends very much on how the Swiss equity market performs,” comments Mercer’s head of retirement in Switzerland Willi Thurnherr.

“We expect bond rates to remain low and in general we predict a very flat 2012 with liabilities perhaps even increasing a bit more. If you look across the border however, from a stability point of view we are pretty well funded with our pension evaluations remaining quite conservative. Most pension funds are taking measures to deal with underfunding complexities but these measures will not have an immediate effect. In the long run, I am quite sure that if we avoid another dramatic financial crisis, then pension funds should recover and enjoy positive returns and healthy funding levels.”

Worries over bond rates are also discussed by Reyl Asset Management’s head of sales and marketing Pierre-Olivier Pourcelot. “What I hear from Swiss pension funds is that they do not feel comfortable with the bond bench-marks that they use which are the Swiss bond index and the Citigroup World Government Bond Index, in which the countries with the highest indebtedness have the largest weight. People are starting to question whether they want all this exposure in the sovereign bond market. The downgrade of the US and France means that the market is no longer risk free,” he comments.



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