Helvetia Occupational Benefit Scheme helvetia.ch The conversion rate.

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1 Helvetia Occupational Benefit Scheme helvetia.ch The conversion rate. The conversion rate is a factor used to calculate retirement pensions. There are also many other parameters and factors that influence the level of pension benefits. It all starts quite young, normally around the age of 25.

2 Get to know the facts understand the context. This publication provides information on the present development, significance and application of the conversion rate and its definition for occupational benefits in Switzerland. It outlines political, economic and social factors related to the level of the conversion rate. Purpose of the conversion rate 3 Historical development of the minimum conversion rate 5 An unrealistically high conversion rate and its consequences 12 Conclusion 13 Definitions of the conversion rate 7 Development and trends in context 9 Helvetia and its employee benefit schemes 14 Planning and advice 15 2/16 Helvetia Occupational Benefit Scheme Conversion rate

3 Purpose of the conversion rate. Example Old-age savings CHF 300,000 x 6% (conversion rate) = annual retirement pension CHF 18,000 In an occupational benefits scheme, capital known as old-age savings is accrued during the entire insurance period. When an insured person retires, the annual retirement pension is calculated from these savings using the conversion factor. The retirement pension is life-long. For example, if the conversion rate is set at 6%, this means that oldage savings of CHF 300,000 result in a pension of CHF 18,000 a year (CHF 300,000 x 6%). To put it very simply, the purpose of the conversion rate is to convert the oldage savings at the retirement date into equal annual pension instalments, which are paid out during the remainder of the insured person's life. Occupational benefit plans may vary between employers, but they always have to pay the minimum benefits set by law. The conversion rates can differ from one pension fund to another. A minimum conversion rate is only set for mandatory insurance. It is 6.8% for retirement at the age of 65 (men) and 64 (women). In accordance with the statutory provisions, the statutory retirement pension is calculated by multiplying the capital saved (LOB old-age savings) by this conversion rate. A lower conversion rate is used to calculate the pension for people who retire early, while for those who continue to work after the standard retirement age and postpone drawing a pension, a higher conversion rate is used. This reflects the longer or short period of retirement. The conversion rate is not relevant for capital withdrawals. The conversion rate depends, in particular, on the period for which the pension has to be paid. A pension fund or insurer derives this from statistics on future life expectancy. Assumptions are also made about the future interest on the portion of the old-age savings that does not yet have to be paid out. The following rule of thumb can be used to derive the duration of pension payments from the conversion rate: 100 divided by 6.8 (conversion rate) = 14.7 years, i.e. using this conversion rate a pension can be paid for 14.7 years. This example disregards interest and any limited continued pension payments to surviving spouses. See the chart below and further details of the present life expectancy of men and women from the age of 65. Conversion rates have to be reviewed periodically and adjusted to altered conditions where necessary in order to maintain the financial stability of the pension fund. Only new pensions are affected by a change in the conversion rate, in other words, the pension paid to current pension recipients does not change. The old-age savings are accrued from contributions paid by the employee and employer during the period of employment. The savings period for occupational benefit schemes is normally 40 years. It starts at the age of 25 and ends at the age of 65 for men (64 for women). During this period, the pension fund manages, invests and pays interest on the capital saved individually by each employee. When employees change job, the individual account is automatically transferred to their new employer. Occupational benefit schemes vary between employers but they always have to ensure the minimum benefits set by law. The employer pays at least half of the contribution to the occupational benefits scheme. 3/16 Helvetia Occupational Benefit Scheme Conversion rate

4 The life-long retirement pension paid by an occupational benefits scheme is determined by the conversion rate at the time of retirement; the old-age savings, including interest and compound interest, accrued during employment. Old-age savings are determined by the following factors: Number of years worked Pensionable salary The benefit scheme (percentage of earnings used to pay contributions); this varies between employers The conversion rate is determined by three parameters Average life expectancy The technical interest rate (discount rate): this is an arithmetic rate. It is used to pay interest on the pension payments that are not yet due, based on expected future income. The technical interest rate is not the same as the effective rate applied to the savings. Benefits for children of pension recipients and widows /widowers pensions and orphans pensions following death of the pension recipient. Today, we face the following challenges: The minimum conversion rate that has to be used to determine the statutory retirement pension is too high. Average life expectancy does not reflect reality, and the returns generated are below the technical interest rate. Many employee benefit institutions use technical interest rates that are too high. The investment returns are too low. The capital does not increase sufficiently to pay the guaranteed retirement pensions. Some institutions have investment strategies that are too aggressive. The necessary value fluctuation reserves are not available. Example: the present minimum conversion rate is 6.8% Actual life expectancy is about two years longer than the life expectancy used to calculate the tariff. The technical interest rate is about 5%. This rate should correspond to the return generated by investing the claims reserve. If pension recipients live longer and/or the necessary return on investment is not achieved, additions have to be made to reserves. Such additions can only be made at the expense of today s employees, because current pensions are guaranteed and their amount cannot be changed. Instead of being used to increase the interest credited to old-age savings, the return earned on investment of employees old-age savings has to be channelled to the reserves for current retirement pensions. 4/16 Helvetia Occupational Benefit Scheme Conversion rate

5 Historical development of the minimum conversion rate. Minimum conversion rate, minimum interest rate, LOB salary and coordination Occupational benefit schemes are part of the three-pillar pension concept. Together with the first pillar, they are designed to ensure that pension recipients continue to enjoy an appropriate standard of living. The Federal Act on Occupational Old Age, Survivors and Invalidity Pension Provision (LOB) came into effect in Since then, apart from a few exceptions, employees over the age of 18 with a minimum income of CHF 21,330 have been insured in an occupational benefit scheme. The law sets minimum benefits. Alongside the mandatory pensionable salary on which contributions are payable, and the minimum old-age savings to be accrued, it sets a minimum conversion rate and minimum interest rate. For salaries up to CHF 85,320, the target benefit from the first and second pillars together should be around 60% of the insured person's final salary. Target benefit 100% 80% Percentage cover 60% 40% 20% OASI + LOB OASI 0% Income in CHF 1,000 Until the end of 2004, the Federal Council was responsible for setting the minimum conversion rate and the minimum interest rate through an ordinance. Following the first review of the LOB, the minimum conversion rate was integrated directly into the law (Art. 14(2) LOB). Therefore, all key factors determining the level of benefits from mandatory occupational benefit schemes in Switzerland result principally from political decisions and are defined by law. They can only be altered via the political process. Consequently, the LOB conversion rate does not (adequately) reflect social and economic trends such as demographic trends, changing lifestyles or the effective return on secure, long-term investments. Although the conversion rate has to be reviewed by the Federal Council every ten years, this has only resulted in an adjustment on one occasion in the history of the LOB, from the original level of 7.2% to 6.8%, which is the rate still applicable today. This reduction took place as a result of the first and so far only review of the LOB and was implemented gradually over 5/16 Helvetia Occupational Benefit Scheme Conversion rate

6 several years to cushion the impact on people approaching retirement. Proposals by parliament for an urgently needed reduction in the conversion rate have been rejected by the people. Subsequent proposals put forward by parliament for an urgently needed reduction were rejected by the people in 2010 when a rate of 6.4% was proposed (73% voted no) and in 2017, when it was recommended that the rate should be corrected to 6.0% (53% voted no). Similarly, the Federal Council has to review the minimum interest rate for LOB old-age savings at least every two years. The minimum interest rate has been reduced continuously since the introduction of the LOB. Starting in 2003, it has been reduced from the original rate of 4% to 1% (status 2019). There is no doubt that adjusting the conversion rate affects the level of benefits and that action needs to be taken to prevent pensions failing to meet the target level. The LOB retirement pension (mandatory/minimum benefit) is defined as follows: Condition Regular retirement age (65 years for men and 64 for women). Amount Annual retirement pension is 6.8% of the old-age savings. The total minimum old-age savings as defined by the minimum LOB level (excluding interest) are accrued by deducting a certain percentage of employees salaries. This is graduated by age group over people's entire working life. Insurance is mandatory up to a salary CHF 85,320 less the coordination deduction of CHF 24,885. The minimum pensionable salary is CHF 3,555. Age in years Old-age credit in % of pensionable income Calculation Total in % years x 7% years x 10% years x 15% / years x 18% 180 Sum total 25 64/ The conversion rate, return or interest on capital, the level of the retirement pension and the components of the savings process therefore cannot be altered in isolation or can only be defined via the political process. The employer and employees can jointly define the salary and savings steps for their company. In this way, they can improve the occupational benefit scheme or set pension benefits above the LOB minimum. 6/16 Helvetia Occupational Benefit Scheme Conversion rate

7 Definitions of the conversion rate. Mandatory and supplementary old-age savings and the conversion rate As already explained, the LOB is a law that sets minimum requirements. The guidelines it sets for credits to old-age savings and the interest on them apply to the mandatory portion of the LOB old-age savings, which is referred to in short as the mandatory savings. The statutory minimum retirement pension is calculated by multiplying the mandatory old-age savings by the minimum conversion rate. All old-age credits on salary components above the LOB salary or above the minimum percentage of the salary deducted as contributions under the LOB are accrued as supplementary oldage savings. The pension conversion rates are set by the Board of Foundation or the reinsurer of the employee benefit institution/ pension fund. A uniform rate can be applied to the entire old-age savings or separate rates can be set for the mandatory and supplementary old-age savings. Irrespective whether a uniform or split conversion rate is applied, the offsetting principle can be applied. In other words, the total old-age savings, including interest, must cover at least the minimum retirement benefits defined by the LOB. If the minimum conversion rate and minimum interest set by law for the LOB old-age savings are too high, the supplementary old-age savings can be used to offset any funding shortfall. In the case of a LOB all-encompassing pension solution, the employee benefit institution uses shadow accounting to ensure that the actual individual LOB old-age savings and the resulting benefits can be determined for each insured person at any time. 7/16 Helvetia Occupational Benefit Scheme Conversion rate

8 Single, uniform conversion rate Many pension funds do not use two different conversion rates for mandatory and supplementary old-age savings. For the sake of simplicity, they use a single conversion rate for the entire capital. This may be below the minimum conversion rate, provided that the pension calculated in this way is not below the LOB retirement pension (mandatory benefits). Insured persons are notified annually of the valid conversion rates in their pension certificate. The pension certificate provides detailed information on the current insured benefits and expected benefits, contributions paid and their funding as of the anniversary date. Split conversion rate A split conversion rate means that the employee benefit institution uses different conversion rates for mandatory and supplementary old-age savings and discloses the separate conversion rates. The mandatory and supplementary pensions calculated in this way are added together to form the total pension. A split conversion rate is normally used by insurance-related employee benefit institutions (e.g. those that offer full insurance). Normally the rates for the mandatory old-age savings are close to the minimum conversion rate. The rates applied to supplementary old-age savings are generally somewhat lower because they normally take account of effective life expectancy and the expected return on the capital invested. Therefore, they include the actual development and the trend. The total pension must always be at least the LOB minimum pension. 8/16 Helvetia Occupational Benefits Conversion rate

9 Development and trends in context. Level and development of the politically defined parameters - minimum conversion rate and minimum interest rate - from introduction of the LOB in 1985 to the present: Change in the LOB minimum conversion rate and minimum interest rate Politically defined parameters The LOB conversion rate of 6.8% is based on the statistical life expectancy of pension recipients as calculated before This assumes a sustained return of at least 4% on the capital invested. That was close to reality when the principles were introduced on 1 January However, the situation has altered significantly since then LOB minimum interest rate in % LOB minimum conversion rate in % - women aged 64 LOB minimum conversion rate in % - men aged 65 Source: Federal Social Insurance Office (FSIO) Politically defined interest rate and effective return Development of the actual return on 10-year federal bonds (benchmark for secure investment for occupational benefit schemes) compared with the politically defined minimum interest rate for LOB old-age savings: Until the mid-1990s, pension funds were able to earn an adequate return on their assets. The third contribution payer (interest) played a strong part in increasing old-age savings and securing life-long retirement pensions despite rising life expectancy. Although the minimum interest rate was adjusted continuously, the adjustments did not keep pace with reality. In addition, the conversion rate has not been adjusted to the necessary extent, as illustrated by the chart showing life expectancy from the age of 65. LOB minimum interest rate compared with 10-year federal bonds year federal bonds LOB minimum interest rate Source: Federal Social Insurance Office (FSOI) and Swiss National Bank (SNB) 9/16 Helvetia Occupational Benefit Scheme Conversion rate

10 Effective minimum interest rate and inflation-adjusted real interest rate Development of the minimum interest rate for LOB old-age savings, inflation (based on the Swiss Consumer Price Index CPI) and the inflation-adjusted real interest rate since introduction of the LOB: The real interest on LOB old-age savings has always been positive despite the declining returns earned by pension funds, which are facing with a prolonged period of low interest rates and negative interest rates. Positive real interest on old-age savings LOB interest rate in % CPI inflation Real interest rate Source: Federal Social Insurance Office (FSIO) and Federal Statistical Office (FSO) Demographic change and life expectancy at age 65 in Switzerland Since 1981, the life expectancy of women has increased by 4.4 years to 22.6 years. That is an increase of nearly a quarter. Men still have slightly lower life expectancy, but the difference between men and women has narrowed. In the same period, men's life expectancy has actually risen by 5.5 years: Using the rule of thumb from chapter 1, based on a conversion rate of 6.8%, the period for which a retirement pension can be paid starting at age 65 is just under 15 years. In fact, at present women retiring at the regular retirement age of 64 draw a pension for more than 23 years, while men retiring at the age of 65 draw a pension for nearly 20 years. Low returns plus the fact that the conversion rate is too high has led to a serious pension funding shortfall. This situation is being exacerbated enormously as the baby boomer generation reaches retirement age. Average life expectancy of men and women at age 65 in years Men Women Source: Federal Statistical Office (FSO) 10/16 Helvetia Occupational Benefit Scheme Conversion rate

11 Lower expected returns mean that the technical interest rate (discount rate) has to be reduced, so pension funds have to increase reserves Based on present return expectations, the realistic and sustainable technical interest rate would be between 1.5 and 2.5%, depending on the model and the structure of the employee benefit institution/pension fund. Calculated correctly, the conversion rate would therefore be below 5.0% today. As a rule of thumb, a 0.5 percentage point reduction in the technical interest rate reduces the conversion rate by around 0.3 percentage points, assuming that life expectancy remains unchanged: Impact of the technical interest rate on the conversion rate Implied technical interest rate 5% 4% 3% 2% 1% 4.0% 4.5% 5.0% 5.5% Actuarial conversion rate 6.0% 6.8% Source: own data 11/16 Helvetia Occupational Benefit Scheme Conversion rate

12 An unrealistically high conversion rate and its consequences. Unintended redistribution within the system runs into billions Since the pension conversion rate is too high, life expectancy has risen and interest rates are low, the old-age savings accrued by insured persons are no longer sufficient to fund their pension for the remainder of their lives. Nevertheless, employee benefit institutions have to guarantee a life-long pension. According to a report published in 2018 by the Occupational Pension Supervisory Commission (OPSC) on the financial position of employee benefit institutions, this cross-subsidization amounted to around CHF 7 billion a year between 2014 and In other words: Every employee insured in the 2 nd pillar subsidizes pensions by an average of CHF 1,700 a year, and the trend is rising. This unintended and unwanted redistribution within the occupational benefits system is exacerbated by the Every employee insured in the 2 nd pillar subsidizes pensions by an average of CHF 1,700 a year, and the trend is rising. large number of employees in the baby boom generation, who will be retiring in the next few years. As a result, adequate reserves need to be established for the above-average number of new pensions. At the same time, these insured persons will cease to subsidize pensions. Redistribution will therefore increase enormously. The funding shortfall can only be covered as follows: Investment income on employee's old-age savings will be used to fund current pensions, instead of being credited to them as surpluses or additional interest on their old-age savings, and/or the risk premiums (contributions) payable for death and disability will be higher than would otherwise be necessary. Many employees who are approaching retirement have in the past contributed to funding the additional reserves required to pay pensions of the early retirement generation. Now they are faced with lower conversion rates for their own old-age savings. In addition, since their risk premiums are too high, their net salaries are lower and/or less interest from surpluses has been credited to their old-age savings. Both result in lower old-age savings, and that means a lower retirement pension. 12/16 Helvetia Occupational Benefit Scheme Conversion rate

13 Conclusion. The LOB conversion rate of 6.8% is based on the statistical life expectancy of pension recipients as calculated in the 1990s. Note that this assumes a sustained return of at least 4% on the capital invested. This level of return is far from realistic these days and the outlook is hardly optimistic. As a result of low interest rates, employee benefit institutions are reducing the technical interest rate (expected return) in order to ensure sufficient reserves for subsequent pensions. Based on the present technical interest rate, the realistic level of the conversion rate should be between 4.5% and a maximum of 5%. Conversion rates are therefore constantly being reduced. The politically defined parameters for occupational benefit schemes, i.e. the minimum conversion rate and minimum interest rate, are unrealistic and too high. They result in unintended cross-subsidization and thus to redistribution of the funding process in the 2 nd pillar, where each employee should be saving their own capital, supported by their employer. Until this is corrected, the imbalance between insured persons/employees and pension recipients will continue to increase. That puts solidarity between the generations at risk. Redistribution also jeopardizes the financial stability of employee benefit institutions, especially those that only provide mandatory insurance or concentrate on LOB-based occupational benefit schemes because they are required to calculate pensions using an unrealistically high conversion rate for the entire old-age savings: there is no scope for them to use supplementary old-age savings to compensate for this. 13/16 Helvetia Occupational Benefit Scheme Conversion rate

14 Helvetia and its employee benefit schemes. Helvetia advocates fair and transparent conditions for occupational pension schemes Helvetia runs several employee pension foundations based on different models. Employers affiliated to one of Helvetia's group foundations for employee pensions can obtain advice at any time on suitable occupational ben- Helvetia group foundations for employee pensions efit schemes for the employees and arrange for a staff consultation. In addition to this, individual employees insured with a Helvetia group foundation can request a personal consultation. Helvetia LOB Invest Group Foundation for pension solutions offering return opportunities (partially autonomous model) Helvetia Group Foundation for pensions solutions offering a full guarantee (full insurance) Helvetia Prisma Group Foundation for supplementary occupational benefits, exclusively for pension benefits above the mandatory minimum level (full insurance) Ready to retire. Looking for a pension. Solution found. 14/16 Helvetia Occupational Benefit Scheme Conversion rate

15 Planning and advice. Recommendation: Check and adjust occupational and private pension provision regularly We recommend employers and employees to have their occupational pension provision checked privately at regular intervals to ensure it reflects present conditions, their situation and their needs. Forms and information sheets on the following topics: insurance certificate, voluntary purchase of insurance cover, capital or pension, early retirement and continued insurance after retirement age at Conversion rate tables for the Helvetia group foundations are available at (select foundation). Information on pension planning and contacts for a personal consultation: Employees insured with the Helvetia group foundations can access information on their occupational pension online, call up their documents and run simulated calculations: 15/16 Helvetia Occupational Benefit Scheme Conversion rate

16 Helvetia has been a leading Swiss insurance company with customised insurance and pension solutions for companies and private customers since Helvetia supports a range of social commitments Official partner of Swiss-Ski since Committed to the protection forest topic since Presenting Partner of the Helvetia Swiss Cup since Helvetia Insurance T (24 h),