The most recent pension fund study by Swisscanto Pensions Ltd. reveals enormous performance discrepancies, with returns ranging from 3.0% to 19.3%. This is particularly significant, since higher capital gains offer a way out of the political impasse: according to the study, an additional annual return of just 0.6% could, for example, render the politically controversial increase in the retirement age unnecessary. The benefit reductions resulting from a decrease in the minimum conversion rate from 6.8% to 6.0% could also be offset, meaning that the pillar 2 pension reform would be more likely to gain public approval.
This year marks the 20th edition of the Swisscanto Pension Funds Study. The current findings of this anniversary edition reveal that Swiss pension funds are securely positioned. They have responded to demographic change and the ongoing negative interest rate environment and reduced conversion rates. However, active insured members and the newly retired have had to accept declining benefit levels for more than ten years. Consequently, the pillar 2 pension system is facing major structural challenges.
In order to maintain the long-term pension benefits target, reform is urgently required. Additional contributions are needed to compensate for the declining level of benefits. The way forward is via higher capital market returns and further measures to increase individual retirement assets.
Wide discrepancies in asset allocation and performance
In 2019, pension funds had an excellent investment year with an average return of 10.85%. But the enormous differences between performance are striking. Returns ranged from 3.0% to 19.3%. These wide discrepancies in returns are likely attributable to pension funds’ varying investment strategies.
The top-performing ten per cent of pension funds have generated an annual return of 5.4% over the last five years. The one percentage point difference compared with the average of all pension funds (4.0%) is considerable. Looking at the investment strategy of these high-flyers, the high proportion of equities and the low proportion of bonds is notable.
At the end of 2019, the poorest-performing ten per cent of pension funds still held a substantial 39% of their assets in unprofitable bond investments, even though the healthy ratio between active insured members and pensioners would allow them to bear higher risk and thus enjoy better earnings opportunities. Over a period of five years, they generated an average return of 2.6%. This is a substantial 2.8 percentage points p.a., or cumulatively more than 14%, lower than the return achieved by funds at the top of the ranking.
Higher capital gains offer a way out of the political impasse
Taking a closer look at the source of the pillar 2 savings contributions reveals a surprising fact: in 2019, the “third contributor” accounted for 66% of the contributions to pension fund assets. This means that capital market income last year was almost twice as high as the contributions paid in by employers and employees combined last year.
In a long-term comparison, the performance contribution made by the capital markets over ten years also overshadows the other two sources of funding, at almost 40%. In contrast, just 37% of savings contributions came from employers and 26% from employees. The capital market has the highest relevance for occupational pensions. It should be much more involved in the development of solutions for the proposed reforms.
Iwan Deplazes, Head of Asset Management, Swisscanto Invest by Zürcher Kantonalbank: “An additional annual return of just 0.6% on the pension capital saved could, for example, compensate for the increase in the retirement age. Based on total estimated pension assets of just under CHF 1,000 billion for Switzerland as a whole, an additional return of 0.6% would mean additional income of CHF 6 billion. The fact that better returns can be achieved by making full use of risk capacity is clearly demonstrated by the top-performing pension funds.”
Due to their long-term investment horizon, pension funds can withstand short-term fluctuations in promising investments. To achieve this, however, the regulator must also take a longer-term view and allow the pension funds more leeway in the event of underfunding.
Without reforms, pensions will fall even more sharply
Over the past ten years, the pillar 1 and 2 pension benefit target for an AHV salary of CHF 80,000 has fallen from 80% to 69%, i.e. from an annual pension of CHF 64,000 to an annual pension of CHF 55,200. This is due to the continual reduction in conversion rates. To halt the decline in pensions, Swiss pension funds have taken measures to maintain benefit levels.
The majority of the funds surveyed (55%) have increased the regulatory savings contributions of employees and employers over the past three years, and virtually all schemes plan to do so in the next three years. A quarter of funds have lowered or will lower the starting age for pillar 2 contributions. In many cases, the transitional generation of baby boomers is being granted additional cushioning measures, and 60% of pension funds are increasing the savings capital of new pensioners from provisions.
Promoting individual saving
One way to absorb the declining level of benefits is through individual saving, whether in pillar 2 or 3. It should be encouraged accordingly. Half of pension funds currently offer insured members a choice of savings plans. For the first time, the Swisscanto pension fund study asked which savings plans are most frequently used by insured members. Willingness to save on an individual basis has so far been low. Only about 20% of active insured members make the maximum savings contribution, with half choosing to make the minimum contribution.
Heini Dändliker, Head of Key Account Management / Corporate Clients Market Switzerland, Zürcher Kantonalbank, commented: “Pension funds have implemented initial measures and plan to cushion the declining benefit levels with further compensation measures. In future, active insured members will increasingly be required to increase their retirement assets through higher savings contributions to pillars 2 and 3. Up to now, they have been reluctant to do this, so policymakers need to provide appropriate incentives. I am thinking, for example, of the proposal to be able to make retrospective payments into pillar 3.”
Pension funds assume social responsibility
Swiss pension funds have significant social responsibility, which they are increasingly taking into account through sustainable investment. The proportion of investments made according to ESG (environmental, social and corporate governance) criteria has risen sharply across all sectors over the last five years. Major pension funds are already more heavily invested in ESG investments (46.6%) than small funds, whose ESG investments accounted for 11.2% of assets in 2019.