Pensions & Health

No retirement provision without Pillar 3

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Low interest rates, political uncertainties, slowdown in growth, and demographic change: these are factors weighing heavily on Swiss pension funds and therefore also on the insured members’ pension assets. Private pension provision is becoming more important due to the reform backlog in Pillars 1 and 2.

In 1992, assets of CHF 50,000 in a conventional savings account increased by CHF 2,600 within a year. Back then, banks credited their clients with an incredible rate of 5.2 percent. 1992 is not that long ago, but it was a different world. Today banks only pay interest of between 0 and 0.25%. Admittedly, the comparison is a bit misleading and a savings account in the 1990s was not entirely without risk either, given the Swiss real estate crisis. This is because when the Swiss National Bank increased its key interest rates to dampen real estate speculation, the bubble burst and banks in turn collapsed.

Back to the future. In the current low interest rate environment, nothing will change that quickly - quite the opposite. In Italy, another government has finally been established, but its “half-life” is uncertain; in the United Kingdom, the Brexiteer Prime Minister Boris Johnson is putting pressure on parliament; and in Germany, Europe’s economic engine, there is the threat of recession. 

Alternatives and reforms

Long and sustained periods of low interest rates are worrying, particularly for pension funds. This is because after retirement, Pillars 1 and 2 are supposed to guarantee a pension of around 60% of a person’s last salary. But Pillar 2 in particular is contributing less and less, as the interest payable on retirement assets and the conversion rate in the supplementary portion are constantly falling. Combined with rising life expectancy – at age 65, it is currently three years longer for men and two years longer for women compared to 1998 – it is increasingly difficult to reach this figure. Alternatives - and reforms - are therefore needed to close the pension gaps. 

“We have in any case already made many redistributions, now we’re one step ahead.”

Martin Eling, Professor of Insurance Management at the University of St. Gallen

But the latest package negotiated by the employer’s association and the unions for occupational pensions has been met with criticism. Martin Eling, Professor of Insurance Management at the University of St. Gallen, talks of “skewed” reform. “The proposed reform further softens the basic principle of a joint AHV that is funded on a pay-as-you-go basis and of occupational pensions that are not jointly but individually funded on a fully-funded basis. We have in any case already made many redistributions, now we’re one step ahead.”

Backlog in reforms, low interest rate environment that looks set to continue and people living longer: a toxic cocktail for occupational pension provision. In this conflict situation, the tax-deductible private pension, Pillar 3a, is becoming more important, as it offers a relatively easy process for closing a pension gap.

More money in private pensions

Yes indeed, says pensions expert Eling. In some cases, paying into a pension fund is also attractive, but in others, Pillar 3a is the better model. Essentially, it depends on the pension fund’s cover ratio and every individual’s asset situation. However, a study by AXA Investment Managers recently showed that Pillar 3a is the most popular vehicle for closing pension gaps. 

And more and more money is being paid into private pensions. According to figures from the Federal Office for Social Insurance, pension assets in Pillar 3a rose by around 3.2 percent annually between 2013 and 2017, and they now stand at more than CHF 103 billion. There is a similar picture at AXA. “Since 2004, the volume of Pillar 3a pension assets increased as an annual average by more than 4.3 percent to CHF 6.7 billion at the end of 2018”, says Lukas Kienast, Head of Product Management Private Pensions.

“Those who can plan their pensions with foresight should invest at least part of their pension savings in shares.”

Lukas Kienast, Head of Product Management Private Pensions.

The interest rate effect also plays a key role in Pillar 3. Despite interest rates being at their lowest, most people rely on a conventional account, which is paying hardly any interest at the moment, with a Pillar 3a pension solution. “Those who can plan their pensions with foresight should invest at least part of their pension savings in shares,” says Kienast. “Because from a historical perspective, these are yielding the highest return. On a longer term investment horizon and with broad diversification, the risks are manageable, especially if contributions are made regularly.” On an inflation-adjusted basis, the annual return from Swiss equities according to Pictet is 7.4 percent. Kienast: “In September, AXA therefore launched SmartFlex, the new Pillar 3a pension solution that is more geared towards equity funds and is therefore no longer dependent on interest rates.” (See box)

Does that mean that there is no alternative to saving with equities? “Not necessarily”, says Eling from the University of St. Gallen. “Equities should be part of a long-term-oriented investment portfolio. But aside from equities, there are other interesting investment opportunities, especially for long-term-oriented investors.” The St. Gallen Professor is bringing into play the recurring idea of infrastructure investments. “Discussions with SBB show that there is a substantial investment requirement that can be funded with long-term pension assets,” says Eling. At the end of the day, it’s all in the mix. “From my perspective, the existing global investment opportunities are not yet sufficiently exploited,” says Eling. It is clear that there is no way around Pillar 3a in the current three pillar system.

What is SmartFlex?

In September, AXA launched SmartFlex, the new Pillar 3a pension product. Given the lower interest rate environment, it is more geared towards equity funds and is therefore no longer dependent on interest rates. However, high priority is placed on the safety factor. The pension assets in SmartFlex are divided into legally secured safety capital and share-based return-oriented capital. Clients themselves choose what portion of their premium should be protected and what portion is channeled into return-oriented capital. This split can be adjusted at no cost at any time and features simple safety options.

The website contains more information on SmartFlex.

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