As the Swiss daily Neue Zürcher Zeitung reported on 9 January 2009, Swiss pension funds have posted the worst investment results since the introduction of occupational pension schemes in 1985. The pension funds, which manage the occupational pension funds (BVG/LPP) of the employed working population in Switzerland, were unable to escape the effects of the financial crisis.

Since pension funds are obliged to pay interest on credit balances, they have to invest the funds that have been paid in so that an adequate return can be earned. In addition to interest, administration costs as well as certain provisions have to be covered. Despite a relatively defensive investment strategy, many pension funds have been faced with major accounting losses since the beginning of this year – most of them on Swiss and foreign shares.

As a result, the coverage ratio at about half of the pension funds has fallen below 100 percent. Such insufficient coverage ratios mean that these pension funds would not be in a position to pay out all their credit balances if an unforeseen event such as a liquidation forced them to do so.

Does this mean that people’s savings for their old age are endangered? Swiss law allows pension funds to run insufficient coverage ratios for a temporary period, and this is no reason for concern. However, in the event of such insufficient coverage, the pension funds are obliged to undertake restructuring measures. Here are some ways in which they can go about the task:

• Many pension funds attempt to reduce administrative costs in order to increase their efficiency. However, this measure on its own seldom solves all the problems.
• Interest paid on old-age savings is reduced. In exceptional cases, the pension fund may pay a rate lower than the statutory minimum interest rate of 2% (as of 1 January 2009, as laid down by legislation on occupational pension funds (BVG/LPP)).
• Benefits are not inflation-adjusted.
• Pension funds can require insured employees to pay in contributions to cover losses. The scope for requiring contributions to cover losses from pensioners is extremely limited.

Pension funds generally refrain from short-term alterations in their investment strategy (e.g. selling shares) since they have a long-term investment horizon and the security prices are expected to recover after the financial crisis. In other words, they have to ‘sit out’ the crisis, as far as possible.

On behalf of the iconomix team

Boris Kaiser