Pension benefits – How to get round the drop?

The fall in the conversion rate will impact on future beneficiaries only. The employer will not be asked to contribute more, although the legislator has recommended a system of equal contributions by employees/employers.

Occupational pension provision (known as the 2nd pillar) provides insurance cover for death, invalidity and old age. It is a system of compulsory savings, under which the employer and employee contribute in equal amounts. The system was introduced in 1985 and affects employees whose annual income exceeds CHF 20,520.-.

The cumulative total occupational pension provision currently stands at CHF 660 billion and includes at least 3.7 million insured persons.

At retirement, the insured person has the option of converting his/her accumulated pension assets to pension benefits by applying the conversion rate to that cumulative total. The value of pension benefits is therefore dependent, firstly on the pension assets accumulated while the insured person was in employment, and secondly on the conversion rate.

% movements in the conversion rate: 

For the purposes of comparison, we will look at the following example of a person whose accumulated pension assets on retirement amount to CHF 250,000. Here the impact of movements in the conversion rate to be applied to the annual pension benefit will be as follows:

This means the pension benefit has already dropped by 6% over 10 years (2004 to 2014); acceptance of a further drop to 6.4% would lead to a reduction of 11% over 12 years (2004 - 2016).

A further significant factor in occupational pension provision relates to the improvement and perpetuation of the system of return on assets.
Interest is paid on the capital which, in addition to contributions, is used to fund pension benefits. Definition of the minimum interest rate must, in law, take account of returns on Confederation bonds, equities, bonds and real estate assets. 

The minimum interest rate is therefore dependent both on trends in the markets described above, of which it is a partial reflection, and on the performance of the fund manager with reference to the assets in question.

Movements in minimum interest rate:

Maintenance of living standard

Under the Constitution, occupational pension provision (LPP), combined with old-age, survivors' and invalidity insurance (AVS-AI), makes it possible for an insured person to maintain his/her accustomed standard of living.

In theory, first and second pillar pension benefits should amount to 60% of the insured person's last salary.

With regard to the LPP, the mandatory section corresponds to the sum insured, as required in law, for each employee. The maximum salary considered is CHF 82,080.-.
The optional section is built up when the occupational pension plan provides for benefits which exceed the minimum prescribed by the LPP, subject to a maximum insurable salary of CHF 820,800.-.
Please note that the vote to be taken on 7th March relates to the mandatory requirement of the LPP only.

In practical terms, in view of the current maximum AVS annual benefit of CHF 27,360.- and the pension benefit payable under the LPP (golden rule), the percentage of the retirement benefit in relation to the maximum AVS salary of CHF 82,080.- is as follows:

Clearly, as a result of the adjustments applied and the proposed initiative, the figure falls short of the 60% target. Although a number of declarations have been made, no concrete action has been taken to remedy this situation.


One solution to the reduction in pension benefits

The fall in the conversion rate will impact on future beneficiaries only. The employer will not be asked to contribute more, although the legislator has recommended a system of equal contributions by employees/employers.
Due to a progressive drop in the conversion rate from 7.2% to 6.8% from 2005 onwards, the Federal Council decided to offset this reduction by increasing the insured salary, and hence the savings contributions.

Currently, the initiative to cut the conversion rate is not accompanied by any offsetting proposal.
One solution to counter a further drop in pension benefits would be to increase old-age allowances by 1%, as follows:

The old-age allowance is a contribution to the personal savings (pension assets) of each insured person, funded by the employer and employee. The old-age allowance is calculated as a percentage of the insured salary, defined as a function of the employee's age bracket.

Returning to our example, as a result of a 1% increase in old-age allowances, the accumulated pension assets would rise from CHF 250,000.- to CHF 270,000 (40 years of contributions).
The retirement pension would then amount to CHF 17,280.- if the conversion rate is calculated at 6.4% (according to the initiative). This would mean the value of the pension benefit would remain more or less static (CHF 17,000.-).

This supplementary contribution would be funded in equal shares (employer/employee).
 

Disregarding the current political and media hype and arguments based on figures, expert opinions, performances and perspectives, the solution of a unilateral 1% rise in contributions is relatively simplistic and does nothing to tackle problems relating to the performances of managed funds and the expertise required to cope with the contingencies of the financial markets.

We are proposing to consult our specialists, analyse your situation and offer you solutions.



Sources:

Federal Law on Occupational Pension Provision [LPP]:
www.admin.ch/ch/f/rs/831_40/index.html

Federal Social Insurance Office (OFAS):
www.bsv.admin.ch/themen/vorsorge/aktuell/index.html