Swiss Pension Fund Survey 2013/14

Transcription

1 GLOBAL REPORT October 2013 Swiss Pension Fund Survey 2013/14 Benefits, financing, trends, financial situation and structural profile of Swiss pension funds

2 Contents Executive Summary 4 Introduction 9 Chapter 1: Participants and characteristics 10 1 Overview of participating pension funds 10 2 Profile and breakdown (size, system, sector, private sector vs. public sector) 10 Chapter 2: Risk and trends 13 1 Introduction 13 2 Risk perception 13 3 The development of occupational pension plans 15 Chapter 3: Occupational benefits at a glance 19 1 Facts and figures 19 Chapter 4: Financel health, profile and risk capacity 20 1 Age structure (or degree of maturity) 20 2 Demographics 20 3 Discount rate and interest crediting rate 21 4 Evaluating return requirements 22 5 Funded status 23 6 Portfolios 24 7 Underfunding 26 Chapter 5: Benefits and funding 28 1 Method and assumptions 28 2 General comparison 28 3 Retirement benefits and how they are financed 28 4 Risk benefits 31 Chapter 6: Organisation 32 1 Organisation 32 2 Administration solutions 32 3 Supplemental plans 33 4 Administrative costs per member 34 Chapter 7: Conclusion 35 Chapter 8: Participating pension funds 36 Chapter 9: Benchmarking 38 2 Aon Hewitt (Switzerland) Inc.

3 Foreword Dear Reader, Have you ever wondered why there are so many surveys? Collecting and delivering the necessary data is a costly and time-consuming process for all involved. The normal reaction is: Oh no, not again! But, judging from the results in this case, I am convinced the effort was worthwhile. Although all stakeholders are close to the action in the second pillar, the Swiss Pension Fund Survey always offers a few surprising insights. What strikes me first is the high quality of the work generally done by pension fund governing bodies. Despite the persisting difficult investment environment, those in charge have managed to maintain their pension funds on course. Of course, one could say that pension funds are simply treading water. But the steady lowering of the average discount rate and the simultaneous preservation of funded status testify to sound management and a structural recovery. The second noteworthy feature is the decoupling of the actual behaviour of those in charge from the political debate. In other words, pension funds are no longer waiting for politics to provide major stimulus and solutions: they are acting and quite rightly so. It is in the very nature of politics for difficult technical problems to be resolved in the political process only after prolonged negotiations. The latest attempt by the Federal Council will also take time, and the expected consensus is questionable at best and predictable at worst. Courageous and determined action is the appropriate response for pension funds in this complex situation. The third point is somewhat less evident. The question is: how long can we go on lowering the discount rate? There is not much potential for reduction left and the lower the rate is set, the greater the risk of calling into question the fundamental sense of the fully funded method. Before waking sleeping dogs, we had better be sure we know how to deal with them. Moreover, in this context there is also the complex issue of intergenerational redistribution which demands new approaches and solutions. The recent debate on new pension models shows that a good number of pension funds are much closer to practical solutions in this regard than many observers believe. Problems encourage creativity and crises strengthen the system provided the crisis is survived. The second pillar has proven that it can overcome crises skillfully, so there is no reason to lend too much credence to the eternal pessimists. Plain common sense and a good measure of pragmatism have brought the second pillar further than theory and political dogmatism. Werner Hertzog Managing Director Aon Hewitt (Switzerland) Inc. Swiss Pension Fund Survey 2013/14 3

4 Executive Summary I Participants II Risks and trends The 2013 Swiss Pension Fund Survey covers 160 participating pension funds with one million members and total assets of CHF 237 billion. The shift towards defined contribution schemes continues and 88% of the participating pension funds have adopted this type of scheme. The proportion is 9 in the private sector where defined benefit schemes are clearly on the way towards extinction: The persisting low interest rate environment has mobilised pension fund boards and focused concerns on the fundamental issues relating to investment strategy. The poor investment performance (an average of 1.5% per annum over the 5 years from 2008 to 2012 and 2.2% over the 7 years from 2006 to 2012) has underlined the difficulty of covering the discount rate in the long term. Private sector pension funds Public sector pension funds Percentage of pension funds with defined contribution schemes 69% PFS % 27% PFS % 43% PFS % 56% PFS % PFS 2013 In the public sector, the trend has clearly accelerated. While nearly one half (44%) of the public sector pension funds had a defined benefit scheme in 2011, the number has halved in two years, falling to 23% in 2013! Coming in the wake of the 2008 financial crisis, the sovereign debt crisis intensified the debate on the discount rate and accelerated the process of discount rate reductions which had started at the end of the last decade (see graph Discount rate below). In just four years, the average discount rate has dropped from 3.72% (2009) to 3.25% (2013) and participants future intentions to lower the rate confirm that the downward trend will continue with the rate quickly falling to about 3%. The massive reductions in discount rate have had the immediate effect of driving conversion rates down even lower. The average rate is 6.4 (6.69% in 2011) and most pension funds apply conversion rates between 6.2% and 6.7% (see graph Conversion rate on next page). PFS 2005 PFS 2007 PFS 2009 PFS 2011 PFS 2013 Projection Percentage of pension funds Discount rate 2% 6% 6% 16% 48% 69% 2% 4% 5% 7% 7% 15% 13% 35% 22% 4% 2% 2% 79% 77% 49% 37% 3% 3.25% % 4% The term projection refers to the intentions of the pension board (specific question raised on this subject) 9% 4 Aon Hewitt (Switzerland) Inc.

5 Conversion rate 3% 3% 7% 28% 3% 4% 12% 22% 1 19% 19% 3 33% 32% 6.2% > 6.2% 6.4% > 6.4% 6.6% > 6.6% 6.8% > 6.8% 7% > 7% 39% 22% 18% 24% 9% 6 23% 6% Percentage of pension funds PFS 2005 PFS 2007 PFS 2009 PFS 2011 PFS 2013 Most (7) pension funds believe that the legal conversion rate should be 6% or lower. Over the past two years, there has been a noticeable change in perception about what the appropriate rate should be (on average 6.36% in 2011). Moreover, this result shows that there is a significant variance between the rates actually applied and those considered appropriate, underlining the practical difficulty of reducing promised benefits or imposing countermeasures. III Occupational benefits at a glance Each parameter used in the survey is explained as follows: Weak investment returns and low interest rates Defined benefit system disappearing in the private sector Towards new solutions: the variable pension model echoing a change in paradigm Significant challenges for financial equilibrium Cost: Administration (avg): CHF 300 p.a. per member Investments (avg): 0.25% of assets (not all pension funds provide a detailed breakdown) Benefits: Average pension target (at age 65): 44.8% (in % of base salary for a salary of CHF ) Funding: Average employer share of 59% Performance: Average08 12 (5 yrs): 1.5% Average06 12 (7 yrs): 2.2% Median06 12: [ 13.6%; +10.8%] Average13 (to July): 7.3% Funded status 2012: Private sector (avg): 107.2% (end 2011: 102.8%) Public sector (avg): 94. (end 2011: 90.4%) Conflicting aims between weak returns and benefits promises Plan design: DC: 88% DB: 12% Private sector: 90/ Public sector: 77/23% An extra-ordinary ability to adapt to social and economic constraints and realities Return requirement: Average: 2.8% (3.15% in 2011) DC: 2.6% (2.8%), DB: 4. (4.3%) Maturity: Median at 4.6 Demographics: Median at 46% Crediting interest (DC): Average 2012: 1.47% Discount rate: Combined: 3.25% (Projection: 3.02%) DC: 3.19% DB: 3.58% Conversion rate: Average: 6.4 (2011: 6.69%) Appropriate rate: for the majority (7) 6. (2011: for 38% between 6.2 and 6.4%) Systemic redistribution between generations A significant reduction in discount rates In-depth structural changes (conversion rates, plan design, IFRS) See abbreviations and comments on page 19 Swiss Pension Fund Survey 2013/14 5

6 IV Financial health and profiles Demographic development has considerably reduced the capacity of pension funds to take effective recovery measures. It is, as a result, all the more important to avoid structural losses through appropriate legislation and parameters adapted to the new environment. Discount rate The differences are still significant depending on plan design. Defined contribution plans apply an average rate of 3.19% (3.5 in 2011). Defined benefit plans apply an average rate of 3.58% (3.85% in 2011) which is higher than the reference discount rate set by the Swiss Chamber of Pension Actuaries. The average rate for private sector pension funds is 3.17% and 3.55% in the public sector. Interest crediting rate In defined contribution plans (which represent 88% of the participating pension funds), the average interest crediting rate was 1.7 in 2011 and 1.47% in Even if it contributed to a marked improvement in funded status, the good performance realised in 2012 should not conceal the difficulties with which pension boards have to cope. In the 7-year period from 2006 to 2012, the average annual performance was 2.2%. This is considerably lower than the return requirement of 2.8% (with significant differences depending on plan design). Strategy As at 2012, equities represented on average and bonds 42% on average of pension fund portfolios. Bonds remain the main class of asset for pension funds: % 27% Return requirements Taking into account the plan design of each participating pension fund, the estimated average return requirement is 2.8% of pension liabilities (3.15% in 2011). This average rate is 2.6% for defined contribution plans and 4. for defined benefit plans. 17% 13% 6% 4% 15% Performance 2006 to 2012 was a period of extreme volatility in investment performance: the median ranges from 13.6% to +10.8% and the extremes from 34.4% to +20.5%: Cash FX equities CHF bonds Alternatives CHF equities Real estate FX bonds Performance in % % 10.8% % Average for 5 years: 1.5% per annum Average for 7 years: 2.2% per annum (2007: median performance of 2. (not shown on the graph above)) Funded status The effects of the successive crises of 2008 and 2011 are still being felt: one quarter (23%) of the participating pension funds were underfunded on 2012 and had funded statuses under 9 nearly all of which (85%) in the public sector: 6 Aon Hewitt (Switzerland) Inc.

7 Funded status between 2004 and 2013 in accordance with Art. 44 OPP2/BVV % 18% 53% 16% 6% % 7% 5 13% 27% 5 5% 2012 Percentage of pension funds < % % % 1 The picture (in terms of funded status) at the end of 2012 is more or less the same as it was at the end of In this interval, pension funds noticeably strengthened their structural bases (and continue to do so) 1 : Breakdown of pension funds by funded status (FS) FS 1 2% 7% 7% 6% 7% 1 FS < 1 5% 15% 18% 12% 27% 10 FS < 1 25% 5 53% 47% FS < 10 46% 2 16% 28% 13% 5% FS < 9 22% 7% 6% 12% At the end of 2012, the average funded status of private sector pension funds was 107.2%. It was 107. at the end of 2009, 107.7% at the end of 2010 and 100.9% at the end of In 2012, funded status improved by 6.3% on average. Investment fluctuation reserve (IFR) Following a decade of unprecedented financial turmoil, there is a recognised need to build adequate investment fluctuation reserves. of participating pension funds set the target IFR at 17.5% (or more) of pension liabilities and nearly 6 set it at 15% at least. The average target is 14.9%. The average funded status (private sector) of 107.2% as at 2012 means that pension funds have on average provisioned half of the necessary reserves. V Benefits and financing Retirement benefits The average pension target at age 65 is 44.8% of the last base salary 2. It varies depending on plan design (defined benefit: 51.5% and defined contribution: 43.8%). The replacement ratio at age 65 is between 39% and 5 (to the nearest %) with significant differences depending on economic sector. Including social security (AVS/AHV) benefits, the average replacement ratio at age 65 is 78. (assuming a 1.5% gap between the annual interest credited on retirement savings capital and annual salary growth), significantly higher than the constitutional target of 6. Following the golden rule (whereby interest credited on retirement savings capital is assumed to be equal to 1 Relative reduction of 13% in the average discount rate over 4 years (and of in the very short term) 2 Calculations based on a reference salary of CHF 84,240. Target IFR 8% 13% < 12.4% 12.5% 14.9% 15% 17.4% 17.5% Percentage of liabilities 28% Percentage of pension funds 35% 25% 15% 5% Swiss Pension Fund Survey 2013/14 7

8 salary growth, i.e. a gap of ), the average replacement ratio is 66%, with half the pension funds in the range of between 6 and 7. Results differ considerably depending on plan design and economic sector. Compared with the 2011 report, however, there is no significant change. Funding On average, the employer s share of total contributions is 59%, with the most generous employer paying 88% of total contributions. Three quarters of the employers finance between 5 and 64% of the contributions (15% between 65% and 69% and pay a share of 7 or higher). The differences between defined benefit and defined contribution plans are not insignificant: Defined contribution plans: 77% of the employers finance between 5 and 65%; Defined benefit plans: 75% of the employers finance between 55% and 7. Risk benefits Half the pension funds insure a disability pension of between 28.3% and 50.5% of base salary. These figures have not significantly changed since the last survey, and the average disability pension equals 47.3% of base salary. 32% of the surveyed pension funds indicated that their annual administration cost per member (asset management costs excluded) is less than CHF 200 (28% estimate this cost between CHF 200 and CHF 350 and estimate it is higher). The average cost is around CHF 300. Participants indicated that asset management costs amounted to around 0.25% of pension assets on average. This rate should be interpreted with caution because certain pension funds do not yet provide detailed cost information while others have been doing so for several years. VII Conclusions and reflections Due to the quality and significance of the 2 nd pillar, and in the interest of its stability, a number of reforms are necessary in order to perpetuate the Swiss occupational benefits system, preserve its structure as a social partnership and satisfy members requirements in terms of security, transparency and trust. The survey shows that the governing bodies are fully mindful of the need to strengthen the foundations and financial solidity of their pension funds. They are neither awaiting political decisions nor sitting back hoping for better times: reforms are already underway and proceeding apace! VI Organisation 42% of the pension funds participating in the survey outsource their pension fund administration to an external provider ( increase). Half the pension funds outsourcing services to external providers opt for comprehensive outsourcing while the other half is divided between those that outsource only the technical aspects and those outsourcing both the accounting and administration services. Supplemental plans are quite widespread in Switzerland. About 49% of all participating employers have such plans. In 59% of all cases, supplemental plans are offered through the main pension fund (4 through a separate institution). Supplemental pension plan objectives are quite homogeneous: supplemental benefits for managerial staff (36%), insurance of variable compensation (17%), splitting of benefits between mandatory and non-mandatory elements (25%), or a combination of all the above (22%). 8 Aon Hewitt (Switzerland) Inc.

9 Introduction The 2013 Pension Fund Survey conducted by Aon Hewitt offers a representative overview of Swiss pension funds and their benefits, including the funding, general trends, financial situation and structural profile of the participating pension funds. The survey gives interested readers and pension fund stakeholders a specific and informed perspective of the main trends and components of Switzerland s second pillar system. The Survey offers valuable comparative information for decision making purposes for the governing bodies of pension funds, political and economic stakeholders and pension fund members. Benefits and financing were evaluated based on the information contained in the regulations of the participating pension funds. Only the main plans were surveyed. Financial data, trends and organisation are based on a questionnaire which participating pension funds were asked to complete. This 6 th edition of the Survey, conducted in the wake of a highly turbulent decade, focuses once again on the structural profile and financial health of Swiss pension funds. Stock market volatility has been extreme in recent years. Longer life expectancy and lower returns induce and fuel certain realities (through a number of legal parameters) that were neither originally intended nor expressly foreseen. Against a backdrop of demographic challenges and diminishing prospective returns, the fully funded system faces the danger that potential problems and risk exposures go undetected. The Swiss occupational benefits system is very good by international standards and its strengths and advantages should be recognised and appreciated. However, there is no denying that the existing structures and framework conditions need to be improved whilst maintaining the foundation of the system. To maintain the stability of the 2 nd pillar and uphold its quality and significance, reforms must be undertaken to counteract the gradual erosion of the fully funded system, prevent excessive redistributions and avoid the risk of underfunding with a view to perpetuating the occupational benefits system, safeguarding its organisation as a social partnership and satisfying members concerns in terms of security, transparency and trust. Pension boards and managers have not sat back waiting for political decisions or better times; reforms are already underway and proceeding apace! This is evident by the trends detected in the 2013 Swiss Pension Fund Survey a significant reduction in discount and conversion rates and the near disappearance of the defined benefit system in the private sector and the many improvements suggested by the participants. The fact that 2012 was an excellent year should not conceal the difficult environment pension funds have to cope with and the major challenges facing their governing bodies with imminent new discount rate reductions. We extend our warmest thanks to survey participants for their valuable cooperation and willingness to answer topical questions. We wish you an informative reading of the Survey. Alain Kolonovics, LPP/BVG accredited pension actuary Marianne Frei, LPP/BVG accredited pension actuary Swiss Pension Fund Survey 2013/14 9

10 Chapter 1: Participants and characteristics 1. Overview of participating pension funds Participating pension funds Pension Fund Survey Number of pension schemes Pension assets (in CHF bn) Active members 637, , , ,560 Pensioners 280, , , ,691 The pension funds participating in the survey serve over one million members with total pension assets of CHF 237 bn. The pension funds are autonomous or semi-autonomous and insure employees working mainly in the following sectors: Large national or regional companies; Large internationally-oriented companies headquartered in Switzerland; Swiss subsidiaries of multinational groups headquartered in other countries; Public sector employers. 2. Profile and breakdown 2.1. Size Participating pension funds by size Number of active Number of Members Number of funds members pensioners up to ,937 5,160 2% from 500 to % 16,268 3% 8,294 3% from 1000 to % 31,530 5% 15,528 6% from 2000 to % 79,046 12% 26,838 9% more than % 502,085 79% 224, , ,308 Roughly one quarter of the pension funds represent 8 (to the nearest %) of the members. Most of them (about 85%) are public sector pension funds. Structural reform has contributed clearly to the process of concentration observed in the occupational benefits landscape for several years. The different profiles (with reference to size) are duly and evenly represented in this survey Defined benefit vs defined contribution system Participating pension funds by type of pension plan design (within the meaning of Articles 15 and 16 LFLP/FZG) Pension funds Active members System DC 88% 8 74% 72% 65% 8 76% 57% 58% 48% DB 12% 19% 26% 28% 35% 24% 43% 42% 52% The shift towards the defined contribution system is continuing. From two thirds of participating pension funds representing about half of the members in 2005, 88% of the participating pension funds with 8 of the members have adopted this system today. Of the pension funds with a defined benefit plan (12%), around one third (35%) are public sector pension funds, representing around one quarter (23%) of the public sector pension funds in this survey. 10 Aon Hewitt (Switzerland) Inc.

11 Distinction between private sector and public sector pension funds Pension funds with defined contribution plans 69% 27% 67% 43% 78% PFS 2005 PFS 2007 PFS 2009 PFS 2011 PFS % 85% 77% Private sector pension funds Public sector pension funds In the private sector, defined benefit schemes are clearly on the way to extinction! In this sector, 9 of participating pension funds provide defined contribution plans. Only still provide a defined benefit retirement plan, compared with 15% in 2011, 22% in 2009 and 33% in Moreover, several of those pension funds are already considering a change. Since 2007 and in the interval between two surveys (conducted every two years), on average one third of the remaining private sector pension funds which still had defined benefit plans have switched to a defined contribution system every two years. That is a very fast pace. While in the past, the changes were driven by growing mobility and individual career trends, the acceleration of the process is the result of the successive financial crises of the last ten years, underlining how difficult it is for such plans to react effectively during periods of turmoil in the face of new employer demands such as de-risking. The trend is similar in the public sector where the process of change (in relative terms) has clearly accelerated since our last survey. While nearly one half (44%) of the public sector pension funds had a defined benefit system in % in 2009 and 73% in 2007, the percentage has halved in two years, dropping to 23 % in 2013! In the last survey, we observed that public sector pension funds were relatively resistant to change, owing no doubt to the political process and the partial funding principle, i.e. their interpretation of the notion of underfunding and, therefore, their sensitivity to the need to take recovery measures (or not). With the change in LPP/BVG law from 17 December 2010 regarding the financing of public sector pension funds, the rules of the game have now changed. The new law creates significant challenges for the pension funds concerned, stipulating restrictive mechanisms (demographics and partial funding with different coverage rates to be steadily increased as set-out in the law) which have forced them to take quick and decisive action. The pension funds which continue to apply a defined benefit system tend to be larger institutions. Swiss Pension Fund Survey 2013/14 11

12 2.3. Economic sector Participating pension funds by industry Pension Active Industry funds members Pensioners Assets Finance 15% 16% 28% Industry 27% 15% 17% 17% Luxury 3% 4% 3% 2% IT/Telecom 5% 4% 4% 6% Pharma/Chemicals 6% 2% Public services 19% 32% 28% 23% Transport 3% 6% 1 7% Health 6% 6% 2% Retail 4% 15% 17% 12% Other 7% 2% 2% The financial () and industrial (27%) sectors are heavily represented in the survey. Pension funds in the public sector represent 19% of the plans surveyed. As expected, the public sector is characterised by large-size pension funds representing 32% of active members and one quarter of the pension assets of the participating pension funds. 12 Aon Hewitt (Switzerland) Inc.

13 Chapter 2: Risks and trends Introduction Occupational benefits are a central pillar of Swiss retirement pensions and have a unique significance for social policy and the economy. Fully-funded retirement pensions are one of the cornerstones of our three-pillar system and a success measure for Swiss social policy and the overall quality of benefits. With total assets of CHF 625 billion 1 a pension fund s assets often exceed the equity of its sponsor the assets of Swiss pension funds have grown 5, or CHF 200 billion in today s money, in ten years 2. It comes as no surprise, therefore, that pension boards consider the recent succession of financial crises and the persisting low interest rate environment as the main challenge and that the fundamental issue of investment strategy is at the heart of much heated debate. 2. Risk perception 2.1. Investment risk Investment risks are a major concern and 85% of participants (compared with 76% two years ago) regard such risks as being high or very high. Sensitivities have clearly been aggravated by the sovereign debt crisis, the persisting low interest environment and a fundamental shift in paradigms which has cost numerous government bonds their reputation as risk-free investments. This finding and the related performance and return targets 3 inevitably generate substantial debate in respect of pension benefits and the structural bases of pension funds. The fundamental issues connected with risk, strategy and optimising investments cannot be isolated from pension liabilities. By definition, the financial equilibrium of a pension fund must reconcile the constraints arising from its assets and its liabilities. Discussions about technical parameters and benefits inevitably succeed concerns in connection with changes in asset returns impacting the rate at which interest is credited to savings accounts for defined contribution schemes. The point of convergence is enhanced security. Pension boards are faced with a conflict of objectives given low(er) (expectations of) returns and the need to review benefits in the light of this reality. Moreover, this increases the risk of redistribution from active members to pensioners since legislation requires pension funds to first meet pension liabilities (guaranteed pensions in payment). To guarantee stability, the structural reform has introduced substantial requirements, in terms of qualifications and professionalism, for asset managers in the 2 nd pillar. The framework conditions for asset management encourage a judicious combination in respect of security, returns, risk distribution and liquidity. In the process, the technical parameters (conversion and discount rates) used by pension funds to determine and discount pension liabilities must be appropriately set, otherwise they will result in understated liabilities or, worse still, the adoption of excessively risky investment strategies (see graph Rates on next page) Percentage 8% Disability 4% Costs 36% Board responsibilities 14% 4 Demographics 25% 37% Complexity/Regulation 46% Investment risks 5% Disability 4% 16% Costs 46% Board responsibilities 16% 17% 44% Demographics 49% Complexity/Regulation 43% 42% Investment risks of pension funds Very high 4 High 3 Intermediate 2 Low 1 Very low 1 Source: OFS, May 2013 (total assets at end 2011) 2 OFS: total assets of 416 billion at end Financial market trends are a predominant factor in a fully funded system. Swiss Pension Fund Survey 2013/14 13

14 Rates (market, minimum LPP/BVG, reference discount rate) Minimum LPP/ BVG interest rate 10-year Federal Bond rates on Average performance of the last 10 years Pictet LPP/BVG index on Average performance of the last 20 years Pictet LPP/BVG index on Reference discount rate (Guideline DTA 4 of ) 8% 7% 6% 5% 4% 3% 2% Although the minimum LPP/BVG rate is at a record low (1.5%) after another one half percent reduction on 1 January 2012 ten year federal bond yields are still significantly lower (0.7% at the start of 2012 and 0.6% at the start of 2013). Whereas in the past, that rate set in advance could be covered by low risk investments, that has not been possible for several years. The low interest rate environment has mobilised pension fund boards since, over and beyond the minimum legal (LPP/BVG) rate, weak investment performance underlines the difficulty of covering the discount rate in the long term and, de facto, the value of determining pension liabilities and funded status. The average ten year market performance (illustrated here by the index Pictet LPP 25+) hardly covers the reference discount rate over the period (determined retroactively in accordance with DTA 4 for the period 2005 to 2011). As a result, a reasonable safety margin between performance and the discount rate cannot be achieved. Actual pension fund performance (average annual performance of 1.5% over the last 5 years and 2.2% over the last 7 years) presented in detail below barely covers the minimum LPP/BVG rate. Performance has not covered the discount rate (see survey results below) over a medium-term period without additional financing Other main concerns The growing complexity of the field, accentuated by expanding regulation, and demographics are the participants other two major concerns. Both these concerns are growing although concerns with respect to regulation are now high per the survey as compared with very high per the previous survey. In 2011, there was a perceptible degree of mistrust in anticipation of the implementation of the structural reform including significant debate around change in law and implementation. But with hindsight and a better understanding of the intended objectives, reactions have been rather positive to the improved governance (with exhaustive functions and clarified responsibilities), stronger controls and transparency (integrity, ethics and independence) and restructured regulation. Pension boards perceive demographics as the third major risk. This finding shows that pension boards are keenly aware of the stakes and realise that the fully funded system is not immune to demographic risk. Above all, it highlights concerns about the risk of intergenerational conflict. The strong intergenerational solidarity with substantial redistributions in defined contribution plans from active members to pensioners is becoming increasingly unsustainable. Solidarity (sharing of risks) is certainly a component of the insurance principle but it should not open the door to systematic redistribution between active members and pensioners at the risk of not adhering to the intergenerational contract sooner or later. The point of convergence between assets and liabilities ensures ongoing financial stability by reconciling the fluctuations and strong pressure from the financial markets with new pension models offering greater flexibility. 14 Aon Hewitt (Switzerland) Inc.

15 3. The development of occupational pension plans 3.1. Weak returns on financial markets Portfolio performance between 2006 and 2012 reflects both the extreme volatility over the entire period the median lies between 13.6% and +10.8% depending on the year and the extreme values vary between 34.4% and +20.5% and the average 7 year performance of 2.2% which is insufficient to cover pension fund investment return requirements. The return requirement inevitably depends on the discount rate. The effects of a low return on investment are much more penalising when the discount rate is high. When the return on investments is lower than the discount rate, pension promises are no longer sufficiently funded. If pension funds cannot achieve sufficient investment returns to cover the discount rate over a longer period that means they are underestimating their pension liabilities. Coming in the wake of the 2008 financial crisis, the sovereign debt crisis intensified the debate on the discount rate and accelerated the downward shift which started at the end of the last decade. Whereas in 2011, 37% of participating pension funds (and nearly 8 in 2007) applied a discount rate of 4%, today only a minority (9%) continues to do so, and reductions are imminent. That corresponds to one half of survey participants intentions reported in the 2011 survey (two years earlier, the projection showed a value of 17%) and confirms a clear downward movement which is stronger than predicted. In this context, we should reflect on the implementation of Guideline DTA 4 of the Swiss Chamber of Pension Actuaries from 1 January In a matter of four years, the average discount rate 1 has fallen from 3.72% Comparison of performance % 10.8% year average: 1.5% p.a. 7-year average: 2.2% p.a. (2007: median performance of 2. not on chart) (2009) to 3.25% (2013) and the 2013 survey participants intentions to lower the rate (specific question raised on this subject) indicate that this downward trend will continue with the rate quickly falling to 3%. So far, nearly 6 of participating pension funds apply a discount rate of 3.25% or lower. One third apply a rate of 3.5%. The ratio is due to quickly reach 80:20. There are clear intentions to lower the rate again and most pension boards have placed this item on their agendas for discussion. 1 The breakdown by plan design is provided in Chapter % Performance Discount rate 2% 6% 6% 16% 48% 69% 2% 4% 5% 7% 7% 15% 13% 35% 22% 4% 2% 2% 79% 77% 49% 37% 3% 3.25% % 4% The term projection covers the intentions of pension boards to lower rates (specific question raised on this subject). 9% Percentage of pension funds PFS 2005 PFS 2007 PFS 2009 PFS 2011 PFS 2013 Projection Swiss Pension Fund Survey 2013/14 15

16 3.2. In-depth structural changes In addition to the significant reduction in discount rate, pension funds are trying to determine how best to deal with increasing longevity and the latest disability trends. At the beginning of the new decade, most pension fund boards examined again the question of their actuarial tables with a view to deciding which tables to apply. Clearly, this process was not limited to liability calculations but had more extensive implications, affecting funding, benefits schemes, possible transitional measures and reinsurance. Conversion rate The significant reductions in discount rate and the change in actuarial tables have had the immediate effect of accelerating the downward trend in conversion rates. 9 of the participating pension funds apply a conversion rate that is lower than the minimum legal (LPP/BVG) rate (6.8% in 2014) 5 apply a rate equal to or lower than 6.4% and the average (as well as the median) is 6.4% (see graph on next page). At the end of 2012, 78% of participating pension funds applied the LPP/BVG 2010 tables and 8% the VZ 2010 tables. A minority still use older tables, in particular the public sector institutions which have scheduled a change for the end of this year at the same time as they implement their funding plans. The unification of the actuarial tables is not surprising since the EVK tables are no longer updated. The choice is limited de facto to the generic tables (LPP/BVG) or the specific public sector tables (VZ). Henceforth, pension funds have a choice between generational tables and periodic tables. One third already apply or are considering applying generational tables. While this number is growing (one quarter in 2011), the enthusiasm for this approach is not high due to the costs involved. PFS 2005 PFS 2007 PFS 2009 PFS 2011 PFS 2013 Percentage of pension funds Actuarial tables 47% 44% 4 35% 3% 15% 23% 18% 2% 33% 23% 26% 3% 5% 4% 2% LPP 2000 LPP 2005 EVK 2000 VZ 2000 VZ 2010 LPP 2010 Other 8% 9% 78% 8% 4% 1 5% 16 Aon Hewitt (Switzerland) Inc.

17 Pension Fund Survey Average conversion rate % % 7.0 Most pension funds apply a rate between 6.2% and 6.7%: 3% 3% 7% 28% 3% 4% 12% 22% 1 19% 19% 3 33% 32% 6.2% > 6.2% 6.4% > 6.4% 6.6% > 6.6% 6.8% > 6.8% 7% > 7% 39% 22% 18% 24% 9% 6 23% 6% Percentage of pension funds PFS 2005 PFS 2007 PFS 2009 PFS 2011 PFS 2013 What is the appropriate legal conversion rate? Most (7) pension funds believe that the legal conversion rate should be 6% or lower, with the average at 5.96%. It is interesting to note that, in a matter of two years, there has been a significant change in perception regarding what the appropriate rate should be. These results reflect the discrepancy between the rates actually applied and those considered appropriate and inspire two basic comments: requires substantial provisions to be maintained on the balance sheet in order to cover the cost of applying favourable conversion rates (i.e. conversion rates which are higher than the actuarial rates determined by the tables and discount rate). Second, they show the difficulty in practice of reducing promised benefits even when it is clear that current targets are likely not to be met given financial prospects. First, they show the constraints placed on pension plans close to the minimum LPP/BVG requirements and the significance of the guaranteed minimum rate which generally The appropriate conversion rate % 18% 38% 14% 14% 7 8% 5% 7% ]5.0;6.] ]6.0;6.2%] ]6.2;6.4%] ]6.4;6.6%] ]6.6;7.8%] ]5.0;6.] ]6.0;6.2%] ]6.2;6.4%] ]6.4;6.6%] ]6.6;7.8%] Percentage of pension fund 75% 7 65% 6 55% 5 45% 35% 25% 15% 5% Swiss Pension Fund Survey 2013/14 17

18 3.3. The desire for greater flexibility For pension funds, flexibility is an important human resource tool and means for retaining qualified staff. Driven by increasing customisation, occupational benefit schemes propose flexible solutions to satisfy their members individual needs. Many pension funds offer their members the option of pre-financing early retirement or, at the other extreme, implement the new regulations facilitating continuing access by older employees to the labour market (deferred retirement and continued coverage of the last insured salary). The desire for greater flexibility comes from the pension funds themselves and from employers with the de-risking process gaining in importance. It must be observed that the current environment encourages pension boards and managers to seek alternative solutions and the means to improve their control of pension plan liabilities. The changes in IFRS standards play a part here also (for about of the pension boards). Further strengthening the aspirations for greater flexibility in pension plans and the pressure by companies concerned to impose the adoption of appropriate settings Expected improvements A noteworthy development concerns the suggestions from participants for general improvements they would make in occupational benefits. Apart from the frequently mentioned notions of transparency and autonomy, the suggestions and related comments focus on three main issues (underlining the above-mentioned desire for greater flexibility): Technical parameters: less political control (de-politicisation of the conversion rate) with a view to encouraging the response capacity and lowering the technical parameters on purely actuarial grounds; Flexible benefits: variable pensions and mandatory lump-sum portion are regularly mentioned themes; Costs: simplification and easing of rules and regulations. Other concerns were mentioned (albeit to a lesser degree) such as the participation of pensioners in recovery measures, central regulation, increased transparency and abolition of the solidarity between active members and pensioners. The specific measures referred to and envisaged by pension boards follow three main lines: De-politicisation of the LPP/BVG / appropriate system parameters; Variable pensions; Limitation of the share of benefits drawn as a pension / mandatory lump-sum portion. 18 Aon Hewitt (Switzerland) Inc.

19 Chapter 3: Occupational benefits at a glance 1. Facts and figures Weak investment returns and low interest rates Defined benefit system disappearing in the private sector Towards new solutions: the variable pension model echoing a change in paradigm Significant challenges for financial equilibrium Cost: Administration (avg): CHF 300 p.a. per member Investments (avg): 0.25% of assets (not all pension funds provide a detailed breakdown) Benefits: Average pension target (at age 65): 44.8% (in % of base salary for a salary of CHF ) Funding: Average employer share of 59% Performance: Average (5 yrs): 1.5% Average (7 yrs): 2.2% Median : [ 13.6%; +10.8%] Average 13 (to July): 7.3% Funded status 2012: Private sector (avg): 107.2% (end 2011: 102.8%) Public sector (avg): 94. (end 2011: 90.4%) Conflicting aims between weak returns and benefits promises Plan design: DC: 88% DB: 12% Private sector: 90/ Public sector: 77/23% An extra-ordinary ability to adapt to social and economic constraints and realities Return requirement: Average: 2.8% (3.15% in 2011) DC: 2.6% (2.8%), DB: 4. (4.3%) Maturity: Median at 4.6 Demographics: Median at 46% Crediting interest (DC): Average 2012 : 1.47% Discount rate: Combined: 3.25% (Projection: 3.02%) DC: 3.19% DB: 3.58% Conversion rate: Average: 6.4 (2011: 6.69%) Appropriate rate: for the majority (7) 6. (2011: for 38% between 6.2 and 6.4%) Systemic redistribution between generations A significant reduction in discount rates In-depth structural changes (conversion rates, plan design, IFRS) DC: DB: Projections: Appropriate conversion rate: Maturity: Demographics: Abbreviations and comments: Defined contribution plan Defined benefit plan Expected values in response to a specific question raised on this subject to survey participants Value indicated by participants (specific question raised on this subject) Ratio assets to contributory salaries Pensioners share of liabilities Swiss Pension Fund Survey 2013/14 19

20 Chapter 4: Financial health, profile and risk capacity 1. Age structure (or degree of maturity) The debate on population ageing concentrates mainly on the increase in life expectancy and subsequently on the downward adjustment of conversion rates. Relatively less attention is paid to the breakdown of pension fund membership by age group and the gradual shifting of the age pyramid towards the higher age brackets. Yet age structure is not without implications albeit indirect on pension fund risk capacity. The degree of maturity is measured by the ratio between pension assets and the total contributory salaries. It determines a pension fund s inertia with regard to return or, in other words, its capacity to effectively compensate insufficient returns by additional contributions: Age structure Survey PFS 2011 PFS 2013 Minimum Q Median Q Maximum The ratio between pension liabilities for pensioners and total pension liabilities (for active members and pensioners) is not inherently a critical value in a fully funded system as long as the discount rate is less than the return generated by the pension fund s assets. Conversely, a high ratio considerably reduces the pension fund s ability to adopt effective recovery measures since there are limited possibilities in respect of influencing pensioner liabilities. This indirectly leads to an intergenerational transfer of risks: Demographics Survey PFS 2011 PFS 2013 Minimum Q1 3 33% Median 44% 46% Q3 55% 55% Maximum Nearly one half of the pension liabilities cover pensioner entitlements. Generally speaking, the average annual performance in the last five years has not even covered the average annual return requirement for pensioners! Given a median ratio of 4.6, remedial measures in the form of recovery contributions generally have limited effectiveness. That ratio will tend to increase following the concentration of occupational benefit institutions and the general ageing of the population. The ratio means that a interest loss or gain compared with the pension plan target return (see point 4 below) corresponds to a shortfall in contributions coresponding to 4.6% of the contributory salaries. Thus, to compensate a underfunding you need a contribution of 4.6% of the contributory salaries and a recovery contribution of will only improve funded status by 0.2%. 2. Demographics At first glance, the fully funded method would seem to protect pension funds against the effects of an ageing membership. However, while it is true that a fully funded pension fund is better equipped to deal with demographic risk than a pay-as-you-go social security system like the AVS/AHV, it is incorrect to say that demographic factors have no impact on fully funded pension funds. 20 Aon Hewitt (Switzerland) Inc.

21 3. Discount rate and interest crediting rate 3.1. Discount rate Driven by low market returns and the fundamental rules laid down in Guideline DTA 4 the significant downward trend of this key 2 nd pillar parameter has accelerated even more than we predicted in the last survey. As a reminder, the reference discount rate set in Guideline DTA 4 is 3.5% for 2012, and a quick reduction to between 2.5% and 3. is anticipated. In a matter of four years, the average discount rate has decreased from 3.72% (2009) to 3.25% (2013) and the pension board intentions to lower the rate (specific question raised on this subject) show that this trend will continue with the rate quickly falling to about 3%. Discount rate Survey PFS 2009 PFS 2011 PFS 2013 Average 3.72% 3.58% 3.25% Minimum 2.75% Q Median 3.75% % Q Maximum of the participating pension funds apply a discount rate of 3.5% or lower (6 in 2011 and 5 in 2009) and nearly 5 agree on a discount rate of 3% or lower (16% in 2011 and 6% in 2009) (see graph on next page) Discount rate 3% 3.5% 4% Avg. All pension funds 6% 49% 3.72% Defined benefits 2% 29% 69% 3.88% Defined contributions 7% 45% % 2011 Discount rate 3% 3.5% 4% Avg. All pension funds 16% 37% 3.58% Defined benefits 5% 28% 63% 3.85% Defined contributions 19% 43% Discount rate 3% 3.5% 4% Avg. All pension funds 48% 35% 9% 3.25% Defined benefits 26% 2 42% 3.58% Defined contributions 5 37% 4% 3.19% Projection (trends) Discount rate 3% 3.5% 4% Avg. All pension funds 7 22% 3.02% Defined benefits 55% 3.15% Defined contributions 7 19% 2.99% The differences remain significant depending on plan design. While nearly all the pension funds with defined contribution plans apply a discount rate of 3.5% or lower, only one half of those with defined benefit plans do so. 5 of the pension funds with defined contribution plans apply a discount rate of 3% (or lower) compared with 26% of the pension funds with defined benefit plans. The average discount rate for private sector pension funds is 3.17% (3.53% in 2011) compared with 3.55% in the public sector (3.85% in 2011). Interest credited on savings accounts 2% 6% 6% 16% 48% 69% 2% 4% 5% 7% 7% 15% 13% 35% 22% 4% 2% 2% 79% 77% 49% 37% 3% 3.25% % 4% 9% Percentage of pension funds PFS 2005 PFS 2007 PFS 2009 PFS 2011 PFS 2013 Projection Swiss Pension Fund Survey 2013/14 21

22 Percentage of pension funds Interest credited on savings accounts 7% 7% 5% 7% 12% 12% 1 6% % % 6% 5% 5% ]; ] ]; 2%[ 2% ]2%; 3%] ]3%; 4%] Interest credited 18 % 8% 3% 3% 2% 15% 3.2. Interest crediting rate Half of the pension funds with defined contribution plans (88% of the participating pension funds) applied the minimum LPP/BVG interest rate of 1.5% in 2012 and two thirds credited interest at either equal to or lower than this rate (5% did not pay interest on retirement savings capital at all in 2012) (see graph above). The average interest crediting rate was 1.7 in 2011 and 1.47% in 2012 (at the end of 2012, the average discount rate for this type of plan was 3.19%). Only of the participating pension funds with defined contribution plans applied an interest crediting rate exceeding 2% in the last two years. These rates confirm the strong solidarity of active members in favour of pensioners. This redistribution between the two groups has persisted de facto for many years. 4. Evaluating return requirements Financial market developments play a major role in the fully funded system. In the 2 nd pillar, potential benefits rely to a great extent on investment income, which is why the return on assets is often called the third contributor, in addition to the members and employer. The main function of the third contributor is to cover the pension fund s interest obligations towards its members, i.e. the interest paid on active members retirement savings capital and the discount rate for pensioners, generally increased by an additional 0.5% per annum to finance increasing life expectancy (the discount rate increased by the longevity of all the members in a defined benefit plan). Return requirement Survey PFS 2011 PFS 2013 Average 3.15% 2.8 Minimum 0.66% 0.9 Q1 2.52% 2.24% Median 3.03% 2.7 Q % Maximum Taking into account the plan design of each participating pension fund, the average return requirement for the year 2012 was 2.8% of pension liabilities (3.15% in 2010). The average value was 2.6% for defined contribution plans (2.8% in 2010) and 4. for defined benefit plans (4.3% in 2010). Generally speaking, the return requirement has dropped by slightly more than in two years. This result must inevitably be compared with the actual performance for the year, which was 7.3% on average in 2012 (see point 6). Thanks to this good average performance, funded status improved significantly for most pension funds. Nonetheless, it should be remembered that this is an average value. Moreover, the variance between the average interest crediting rate (1.47%) and the average discount rate (3.25%) suggests a quite distinctive development from one pension fund to another. 22 Aon Hewitt (Switzerland) Inc.