The Swiss pension system is a three-pillar system. The first pillar is the state pension fund—the federal old-age and survivors’ insurance (AHV); the second pillar is the occupational pension funds, provided by employers (Berufliche Vorsorge, BVG); the third pillar is private—partly tax-deductible (Pillar 3a)—savings.
There exist around 1500 occupational pension funds in Switzerland. They hold aggregate assets of a total of CHF 875 bn. (USD 860 bn. BFS, 2019). According to OECD (2019), they account to one of the world’s largest markets for pension assets.
The legal framework for the occupational pension system is defined in the Federal Law on Occupational Retirement, Survivors’ and Disability Pension Plans (BVG/LLP), and the Ordinance on Retirement, Survivors’ and Disability Pension Plans (BVV2/OBB2). The supervisory authority is the Occupational Pension Supervisory Commission (Oberaufsichtskommission Berufliche Vorsorge, OAK-BV) and cantonal or regional authorities.
Each employer is mandated to provide an occupational pension fund to its employees. The funds save for employees’ retirement but also provide disability and death insurance to employees (and their relatives). The majority of funds offer defined-contribution (DC) pension plans which are funded by contributions (savings) of the employer and the employees.Footnote 2 When employees join another employer, their accumulated savings are transferred to the new employer’s pension fund. Contributions are proportional to an employee’s salary and increase with age. With some restrictions, employees are allowed to withdraw some savings as collateral for mortgages already before retirement. They can also contribute and save more than the regular contributions with additional lump sum payments to the fund. When employees retire at the age of 64 (women) or 65 (men), the total annual pension payments are determined by multiplying the retiree’s savings times the conversion rate (Umwandlungssatz), which is defined by the pension plan.Footnote 3
$$\begin{aligned} Annual\;Pension = Conversion\;Rate \times Savings\;at\;Retirement \end{aligned}$$
The annual pension is generally fixed and paid up until the end of the insurant’s (and their partner’s) lifetime. Based on a study by Swisscanto (2019), the average conversion rate in 2019 was 5.7% (2010: 6.7%).
Each fund has a board of directors, or a pension commission, equally composed of employer and employee representatives. The board’s (or commission’s) responsibilities include the annual decision how much interest will be paid on employed insurants’ savings.
The Swiss pension scheme distinguishes between obligatory and over-obligatory pension benefits. Obligatory pension benefits are the minimum pension benefits funds need to provide, which is to insure salaries up to the amount of CHF 85’320 (BSV, 2019b). If pension funds also insure salaries above that threshold, the benefits based on the exceeding amount are called over-obligatory benefits. The law defines requirements only for the obligatory benefits. For example, the minimum conversion ratio for obligatory benefits is currently 6.8% (BSV, 2019c), and the minimum interest rate that has to be paid on savings is determined by the federal council and is currently at 1% (BSV, 2019a).Footnote 4 Most pension plans that insure salaries higher than the obligatory maximum do not distinguish between obligatory and over-obligatory benefits. Thereby, interest paid on savings, as well as the conversion rate of the plan, can be lower than the minimum requirements when determined based on total benefits. However, a fund needs to guarantee that the minimum requirements for the obligatory part of benefits are fulfilled.Footnote 5
From a regulatory perspective, the (technical) funding ratio is the most relevant financial indicator to determine the viability of a pension fund. Following, Art. 44, App. 1, BVV2/OBB2, the funding ratio is defined as the pension fund’s assets at market value (less debt and other liabilities) divided by the pension liabilities (including what is owed to retired insurants and the savings of active insurants, without reserves not attributable to the insurants).Footnote 6 Pension liabilities are determined as the net present value of expected future pension payments. The present value of expected future pension obligations depends on the pension fund’s assumptions about life expectancies. The value also depends on the technical discount rate (technischer Zinssatz) to discount expected future pension payments.
According to Art. 65d, BVG/LLP, pension funds that become insufficiently funded need to achieve full funding within appropriate time (which is generally 5–7 years). Funds have to take recovering actions if the funding gap is not only temporary and funds cannot overcome the gap without further measures in appropriate time. Such recovering action may include the adjustment of plans to re-achieve full funding (Peter, 2009). Only if these measures are insufficient, can they ask for one-time contributions from employed insurants and the employer to recover. Theoretically, retired insurants can also be required to contribute in case of a necessary recovery—though only with strict limitations.Footnote 7\(^,\)Footnote 8 As a further recovery measure, a fund is allowed to pay exceptional interest rates on the obligatory benefits lower than the minimum interest rate (though not for longer than 5 years and not more than 0.5 percentage points less than the minimum requirement).Footnote 9
The orange part of the bars in Fig. 2 shows the number of Swiss pension funds with a funding ratio below 100%. A clear observation is that market turbulence following the global financial crisis of 2008 yielded a sharp increase in the number of insufficiently capitalized funds.
An employer can run a pension funds for their employees on their own. Alternatively, they can join a collective fund (Sammeleinrichtung) or a joint fund (Gemeinschaftseinrichtung). Collective and joint funds pool administration, investment, as well as pension, disability, and death risk of multiple employers. The forms in which these risks are pooled are manifold. Joint funds often offer a single pension plan for all joined employers. Collective funds consist of multiple sub-funds for each employer and allow employer-specific plans. Banks and insurance companies often act as collective funds and provide pension fund services for other companies. Over the years, most employers have ceased offering own funds and joined a collective or joint fund. This has resulted in a decline in the total number of pension funds as visible in Fig. 2.
Pension funds can be further divided between private and public funds. The latter are funds of public employers, such as agencies, public administration, or state-owned companies. Historically, the pension liabilities of public funds were explicitly guaranteed by a state guarantee provided by the (in most case cantonal) governments. In the past, public funds with an explicit state guarantee were not required to be fully funded. Only since 2012 they are required to maintain a funding ratio level of at least 80% and need to achieve 100% by 2052 (PPCmetrics, 2020). Given the different minimum requirement that apply, public pension funds with state guarantees need to be evaluated separately and are discarded from the analysis of this paper.
2.1 Managerial discretion
Funds have several options to control the funding ratio. To illustrate the most obvious strategies, consider the stylized formulation of the funding ratio \(FR_t\) as the ratio of relevant assets divided by the net present value of pension liabilities. Assets can be re-written as the cumulative sum the of past years net profits \(\pi (\sigma ,i)\), including return on assets (which depends on the risk allocation \(\sigma\)), contributions from employers and employees, pension payments, the interest paid on savings (i) and other expenses. Liabilities can be re-written as the sum of expected future pension payments E[P] discounted using the discount rate r)
$$\begin{aligned} FR_t = \frac{Assets_t}{Pension\;Liabilites_t} = \sum _{s = -\infty }^t \pi _s(\sigma _s,i_s) \; \; \Bigg /\; \; \sum _{d = t}^\infty \frac{E_t[P_{t+d}]}{(1+r)^d} \end{aligned}$$
(1)
Lower pension benefits \(P_{t+d}\) would increase the funding ratio. More conservative discount rates (r) would lower the ratio. Furthermore, by changing its choice of asset allocation (and risk \(\sigma _s\)), a pension fund can affect (future) profits what affects the funding ratio. The following discusses these options in more detail.Footnote 10
Future pension promises (\(\varvec{P_{t+d}}\)). A pension fund can improve its funding by lowering future pension promises \(P_d\). Currently, almost every Swiss occupational pension fund provides funded and DC pension plans. Hence, upon retirement, an insurant gets an annual pension, which is proportional to the savings (contributions plus interest) they accumulated during their working life. The proportion which determines the annual total pension payments is the conversion rate. A lower conversion rate positively affects the funding ratio. For the conversion rate, the regulation only requires that the BVG minimal rate of 6.8% is guaranteed for the obligatory benefits. The pension determined at retirement is in general fixed and cannot be reduced. However, pension funds can provide, for example, inflation compensations.
Technical discount rate (\(\varvec{r}\)) The technical discount rate is the rate at which pension funds discount future pension liabilities. The regulatory framework allows some discretion concerning the choice of the discount rate. While a external independent pension fund expert must provide recommendations about the appropriate discount rate, the final decision is set by the pension fund’s board. In cases where the expert deems the decision inappropriate, he/she is required to notify the supervisor OAK-BV. A lower discount rate would lower the funding ratio as it increases pension liabilities owed to retirees. However, applying higher discount rates improves the ratio only from an accounting perspective but does not improve funding fundamentally.
Asset allocation (\(\pi (\varvec{\sigma _s})\)) A fund can decide to investing more riskier assets to potentially earn a higher return (Seiler Zimmermann and Zimmermann,2017). Rauh (2009) discusses different theories about incentives for funds’ risk choices. On one hand, taking too much risk can threat a fund’s financial situation if markets turn south; on the other hand, by taking more risk, a fund could gamble for resurrection by betting on positive market outcomes. A simple measure of fund’s risk choice is the share of assets invested in equities. The regulatory framework given by BVV2/OBB2 lays out some investment limits for different asset classes. The maximum share of assets that is allowed to be invested in equities is limited to 50%. Funds can only deviate from these limits with good reasoning (e.g., deviations caused by losses or profits); otherwise, the pension fund expert is also mandated to notify the supervisor OAK-BV.
In an environment with lower interest rates and higher life expectancy, the fundamentally meaningful and sustainable strategy for pension funds to improve funding is to align the conversion ratio (Kupper Staub and Eggenberger, 2017) with returns on assets (Seiler Zimmermann and Zimmermann, 2017). Otherwise, a pension fund will sustain structural losses. Figure 3 illustrates this point. The figure plots for different conversion rates and market returns how long it takes until a retired insurants own savings are depleted. Suppose two different pension plans: plan A with a conversion rate of 5%, and plan B with a conversion rate of 6%. If the average market returns were 2.5%, a pensioner’s savings would last for about 28 years under plan A, while it would only last for 22 years under plan B. If market returns were only 1%, the savings would last for about 22 years, in plan A but only 18 years in the plan B. Hence, if the average retired insurants lived longer than the savings last, the financial gap would need to be financed by other insurants’ savings. The alternative strategy to apply favorable discount rates improves a funds funding only from an accounting perspective. If funds choose this strategy only to postpone necessary reforms, they will burden the cost to overcome the disguised structural funding gaps on later generations.
The paper focuses on the technical discount rate, and the share of assets invested in equities. While it would have been especially interesting to look at funds’ conversion ratio, the available dataset does not include information about this variable.Footnote 11