Credit Suisse study on the challenges faced by Swiss pension funds

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The FINANCIAL — Credit Suisse on May 2 published a study entitled “Swiss pension funds survey – Low interest rates and demographics as the main challenges”.

Starting point of the study, written by Credit Suisse’s economists and strategic investment consultants for institutional clients, are the results of a survey among almost 200 pension funds. Based on the survey results, the authors estimate that in 2015, some CHF 5.3 billion of second-pillar funds were redistributed from active insured persons to pension recipients. In this context, the reduction of the minimum conversion rate that is envisaged in the “Old-age Provision 2020” reform is a welcome measure, although many pension funds believe that there is a need for further political action. In particular, they are demanding a de-politicization of the minimum conversion rate. Most pension funds see the low interest rate environment as their greatest challenge. As a reaction to this situation, many of them have adapted their investment strategy, favoring real assets over bonds. Using model calculations, the authors of the study show that the technical interest rate is likely to rise only negligibly in the coming years, if at all, according to Credit Suisse.

At the end of 2016, Credit Suisse carried out a survey of almost 200 Swiss pension funds on current topics pertaining to the occupational pension system. As was already the case in the most recent Credit Suisse pension fund surveys in 2011 and 2014, the continuing low interest rate environment is cited most often as a challenge. For 93% of those surveyed, this represents one of the three main problems, and over half even see it as their greatest challenge. For almost 60%, the minimum conversion rate being too high and demographic change rank among the top three concerns. “Increasing life expectancy and the pressure on returns are forcing pension funds to take measures both in terms of benefits and investment,” explains Beat Zeller, Head of Pension Funds & Corporate Investors at Credit Suisse. 

Extraneous redistribution of CHF 5.3 billion between active insured persons and pension recipients in 2015

Conversion rates and technical interest rates that are set too high given the current demographic and economic conditions are causing, amongst other things, an unplanned redistribution in the second pillar from active insured persons to pension recipients. Based on the results of the 2016 pension funds survey, the authors of the study estimate that this redistribution amounted to approximately CHF 5.3 billion in 2015, which indicates that the problem of redistribution has heightened in recent years. An earlier Credit Suisse estimation set redistribution at CHF 3.5 billion for 2010.    

Pension funds continue to lower technical interest and conversion rates

93% of the pension funds surveyed at the end of 2016 said that they had reduced their technical interest rates in the previous five years, while 82% had reduced their conversion rates. According to the survey, the average technical interest rate applied in 2015 was 2.5%, compared with 3.5% in 2010. At the same time, the average applied conversion rate dropped from 6.8% in 2010 to 6.2% for men and 6.1% for women in 2015. Most pension funds however applied conversion rates in 2015 that were still above the actuarially correct rates, which should be in the area of 5% according to pension actuaries. The authors of the study estimate that thanks to the measures that have been taken, an additional redistribution of around CHF 4 billion could be avoided in 2015. Looking at developments over the next five years, 92% of the pension funds surveyed said that they had either already decided to lower or are considering lowering their technical interest rates. The corresponding figure for conversion rates was 87%. The pension funds are aiming for an average technical interest rate of 2% and an average conversion rate of 5.5%.    

“Old-age Provision 2020” does not go far enough for most pension funds

Unsurprisingly, 94% of the pension funds surveyed support the planned reduction of the minimum conversion rate from 6.8% to 6.0% that is part of the “Old-age Provision 2020” pension reform. 53% of those surveyed nevertheless call for measures regarding the second pillar that go beyond those proposed in the “Old-age Provision 2020” bill. In particular, they think that the minimum conversion rate needs further modification, and most of all that a de-politicization of the setting of the rate is desirable. The raising of the retirement age over 65, the presently missing possibility to adjust current pensions, and the abolition of the minimum interest rate are also subjects which many pension funds would like to see on the table for further political debate.

Record proportion of real estate and alternative investments in portfolios

After a weak year in terms of investment performance in 2015 (with a yield of 1.0%), Swiss pension funds achieved an average yield of 3.9% in 2016, according to the Credit Suisse pension funds index. Due to low interest rates however, it has become increasingly difficult in recent years to obtain the necessary returns without recourse to riskier investments. 60% of those funds questioned said that they had altered their investment strategies as a reaction to this. The proportion of bonds was reduced in favor of equities, real estate and alternative investments. Within alternative investments, the subcategories infrastructure, insurance-linked securities, private equity and senior loans were either introduced or increased by many funds. Bonds were still the most important asset class for Swiss pension funds in 2016, but their proportion – estimated at 31% – had never been so low since the year 2000. Conversely, the proportion of real estate (19%) and alternative investments (9%) reached record levels, while the level of equities (30%) was at its highest since 2000.                                                 

Technical reference rate unlikely to rise significantly in coming years

With investment returns under increased pressure, the issue of the correct level for the technical reference interest rate is increasingly coming to the fore. The formula laid down by the Swiss Chamber of Pension Actuaries (SKPE) in their Guideline 4 (FRP 4) to calculate the technical reference interest rate is coming under widespread critical debate. 29% of the pension funds surveyed by Credit Suisse are demanding that the guideline be abolished, while a further 63% think that it should be adjusted, so that the assumptions in the formula take better account of the current market environment. According to Credit Suisse simulations, the reference interest rate as calculated on the basis of FRP 4, which currently stands at 2.25%, should not fall below 2% in the coming years, and from 2021, it is set to increase slightly to 2.5%. Model calculations which take alternative formulas into account, however, show that depending on the assumptions, the technical interest rate could go down to 1.25% – or even lower – by 2022. 

Coverage through occupational pensions primarily depends on level of income

The study also looked into the significance of the second pillar for the financial situation of Switzerland’s retired population. The analysis shows that coverage through occupational pensions has increased from one generation to the next, but that the second pillar only plays a significant role among the higher income classes. The extraneous redistribution described above is thus primarily borne by high-income active insured persons. Furthermore, societal changes, and in particular the growing spread of part-time work, is threatening to accentuate the differences between the income classes even more. Over three-quarters of the pension funds surveyed see part-time and other flexible forms of work as one of the three main social challenges for the occupational pension system. These lead to the insured people concerned being at a disadvantage in the current occupational pension system.

 

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