Focus: Occupational pensions

Dynamic pensions

Heinz Hartmann
COO and CFO, PwC Switzerland

Switzerland’s three-pillar system is rightly acknowledged as a success. But thanks to a steady, drastic shift in the equilibrium between active contributors and pensioners, the first pillar, funded on a pay-as-you-go basis, is gradually in danger of being thrown out of balance. So it’s a good thing it’s topped up by the second pillar. Here members and their employers both contribute to savings basically intended for the individual member. Cross-subsidisation is not supposed to take place.

But at the moment this pillar too is being shaken because the pensions promised in the past were too high. Given growing life expectancies and insufficient returns on investment, the capital accumulated up to retirement is no longer enough to fund current pensions for the full remaining lifetime of retirees. Additional funds have to be injected at the expense of active members. This doesn’t mean, however, that the second pillar has passed its sell-by date – on the contrary, in fact. On the other hand it is in urgent need of repair to reduce the scale of the imbalance, but because of a combination of unplannable parameters such as longevity and investment returns and benefits that can’t be changed, this isn’t possible. Benefits would have to be adjusted in line with reality.

More flexible with a pension bonus

In 2005 PwC’s pension fund in Switzerland introduced a new, dynamic pension model. Our aim was to reduce the cross-subsidisation by active members and assure the solvency of the pension fund in the long term. The idea behind this approach is to promise less but pay as much as possible. The model involves splitting benefits into a fixed retirement pension and a variable bonus component. The bonus component makes it possible to regulate the outflow of retirement capital.

The model in practice

The retirement pension paid by PwC’s pension fund is based on a technical interest rate of 1.5%, which translates into a conversion rate of 4.9% in 2020. In addition to this, a standard bonus of 12% of the retirement pension is paid. The pension and the bonus are both based on a technical interest rate of 2.5%.

Each year we work out whether the pension fund is making a gain or loss with the pensions it pays. To this end we do a comparison of targeted and actual investment returns. The percentage target return of approx. 3.1% results from the sum of the technical interest rate (2.5%), a supplement for the increase in life expectancy (0.5%) and the approximate administrative costs (0.1%). Any adjustment in the bonus component is determined by the result over an observation period of three years.

Figure 2: Example of a profit and loss calculation (without carryovers from the previous observation period) for the variable bonus component over three years.

Year	Coverage capital of pension	Target return	Actual return	Result in %	Result in CHF
1	100 Mio.	3.1%	3.4%	0.3%	+0.3 Mio.
2	120 Mio.	3.1%	1.9%	-1.2%	-1.4 Mio.
3	150 Mio.	3.1%	5.9%	+2.8%	+4.2 Mio
Result for the observation period					+3.1 Mio.

Adjustments in small increments

If the result after three years is positive, the bonus component is increased; if the result is negative it is reduced. The adjustment is made in moderate steps of two percentage points. The expenses of increasing the bonus or the savings resulting from a reduction are subtracted from the result. The remainder is carried forward to the next three-year observation period.

A solution for all seasons

The conversion rate can go either way: you can set it too high or too low. Whatever happens, you face a lot of bother and expense. The pension fund solution we’ve created on the basis of fixed pensions and performance-related bonuses matches our strategic objective of promising benefits that reflect reality as closely as possible and can be funded sustainably. The payments made to pensioners can be adjusted to the actual situation on an ongoing basis. This way active members and pensioners each get a fair slice of the pension fund’s gains and losses. Pensioners can plan for and weather any adjustments because they’re made incrementally.

By making retirement benefits more flexible we’re able to reduce the insidious cross-subsidisation, support the principle that the second pillar should be fully funded, and – as a positive side-effect – align pensions with purchasing power, all while keeping the administrative expense within reason. This way we’re able to provide maximum security and transparency for our pensioners and active members, and build trust in our pension fund.

Summary

The fact is that retirees are currently being massively and consistently cross-subsidised by the active members of pension funds. That was never the intention. Financing pensions on a fully-funded basis is only possible with variable benefits. PwC’s dynamic pension model bolsters trust in the second pillar as a fundamental principle of social security in Switzerland. At the same time it helps us avoid the risk of problems entailing remedial measures that make a pension fund, and ultimately the employer, unattractive. It’s time to take an unprejudiced look at the intergenerational contract. Our pension fund solution is a step towards achieving sustainable, respectful coexistence between the generations. We’ve chosen a solution that will work for us in the long term. Not everyone has applauded the move, but the large majority of our employees and pensioners have received it favourably.

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