Standing on the shoulders of pillars

Understanding the Swiss pension scheme

In 2005, obligatory pension payouts amounted to CHF 65 billion, or 14% of GDP. All in all, Swiss pensioners can count on 60% of their last salary. Yet how is this system set up?

The concept of not putting all your eggs in one basket was taken very seriously by the designers of the Swiss pension system. Instead, they decided to divide the eggs between three baskets and developed a pension system that is based on three pillars.

AHV

The first pillar of Swiss pensions – the federal old-age and survivors’ insurance scheme (Alters- und Hinterlassenenversicherung, or AHV) – was first introduced in 1947 and received substantial structural reforms in 1995. Contributions to the AHV are obligatory for all self-employed, employed and unemployed over the age of 20. Contributions are evenly split between the employer and the employee and are directly deducted from employees’ salaries. The resulting pension is relatively small and is meant to only cover basic needs. In 2007, AHV pensions were between CHF 1,140 and 2,280 per month.
Men who have reached the age of 65 and women who have reached the age of 64 are entitled to draw an AHV pension. AHV works on a pay-as-you-go basis; thus, the current pensions are paid for with current contributions to the pension scheme.

Company pension funds

Company pension funds are the base of the occupational benefit plan (Berufliche Vorsorge/Prévoyance Professionelle), which is the second pillar of the Swiss pension system and was introduced in 1985. This pillar is intended to provide pensioners with the means to lead a comfortable life. Ideally, AHV and the Company Pension Fund combined should correspond to 60% of the last salary before retiring.
Instead of relying on a pay-as-you-go system, Company Pension Funds are based on a system of capital cover. Thus, rather than redistributing contributions from workers to pensioners, each worker pays contributions towards his personal pension fund. All employees with an annual income between CHF 20,520 and CHF 82,080 are obliged to pay contributions to the scheme. Total contributions increase with age and amount to 7–18% of gross salary.

The third pillar – a wise investment

The so-called individual occupational pension scheme (3rd pillar) subsidizes private pension savings through tax breaks and is voluntary. Contributions are deducted from taxable income and only taxed at the time of payment. Interest on contributions is not taxed.
The idea behind the third pillar is to supplement the state pension with sufficient means to provide for an ultimately comfortable retirement. Increasingly, however, it is used to help secure the basic standard of living.
The high profits these accounts offer make them a wise investment. The third pillar also offers employees more liberty. The first and second pillars are beyond the control of the individual, whereas the third pillar allows the employee to decide how to invest his or her money.
Jörg Rohner, the director of pension products at Credit Suisse, explains that more and more foreigners working for companies in Switzerland are opening private pension 3rd pillar accounts. “We have even started printing the necessary forms in English because of the growing demand.”

Tough times ahead

Holding Tight

“Although extremely stable, the Swiss pension system is not immune to the problems facing pension systems in the rest of Europe”

The three-pillar system has received much attention and praise from various international institutions. A paper published by the OECD on the Swiss system in 2000 hailed Switzerland’s multi-pillar pension system as the “Triumph of Common Sense”, whereas the World Bank has described the Swiss system as the “way forward for pension reform”.
The two main advantages that are regularly highlighted are the fact that risks are spread across the pillars, thus making them more stable, and that pre-funding creates large pools of investment capital.

Yet all this praise doesn’t mean that Switzerland can now lay back and wait for the rest of the world to emulate its example. Although extremely stable, the Swiss pension system is not immune to the problems facing pension systems in the rest of Europe. As a result of a lower birth rate and rising life expectancy, the aging process has witnessed acceleration over the past two decades and is forecast to further increase in the next few years. Switzerland’s birth rate fell from 1.55 per woman in 1980 to 1.42 in 2005.

In 1980, men in Switzerland reached an average age of 72 and women 79. In 2005, these numbers had risen to 79 and 84 respectively. Despite an increase in the number of women at work, the ratio of employed people to pensioners is falling. In 2005, Switzerland counted 3.5 workers for each pensioner. This number is expected to drop to 3 by 2015, 2.5 by 2020 and 2 by 2035.

Where do we go from here?

Given the problems the Swiss pension system is facing, what can be done to avert disaster, while still providing pensions that will allow pensioners to lead a comfortable life and not fall into poverty?
Basically, it comes down to three possibilities that can either be implemented in isolation or combined. The first option would be to provide pension funds with additional capital. This could be reached by raising the percentage of the salary that employees have to contribute to their pension scheme and/or to the AHV program.
A second possibility would be to reduce pensions. Thus pensioners would no longer receive the guaranteed 60% of their last salary, but 50% or potentially even less.
The third option consists of raising the pension age. This last option could have a dual positive effect. Having people retire later would mean they are part of the working force for a longer time. They would thus contribute more to the Swiss economy and pay taxes for a longer period of time; consequently, they would not receive a pension, so there would fewer pensioners to support.

Yet reforming pensions is easier said than done. In 2003, Pascal Couchepin, a former member of the Swiss Federal Council and former head of the Federal Department for Home Affairs, proposed raising the retirement age to 67. This reform proposal has made Couchepin the target of much criticism. From the unions to all the major Swiss political parties, everybody has voiced their opposition to Couchepin’s ideas on pension reform. Even within his own Liberal Party he was not safe from criticism. The arguments raised by his opponents ranged from criticism of generally cutting social services, to the uselessness of such a reform, given that most companies are interested in hiring young workers and laying off older ones. Nonetheless, Mr Couchepin has not withdrawn his position and is still fully convinced of the necessity of pension reforms, no matter how unpopular they may be.

This story exemplifies the difficulties facing pension reformers worldwide. No one is going to cheer you on if you are basically proposing that they have to work longer, pay more and at the same time receive fewer benefits.

The eggs could still break

Not putting all your eggs in one basket has the advantage that if one basket is damaged, you still have two other baskets to rely on. However, if you want your chicks to hatch, you still have to take good care of the eggs. And that is easier said than done.

Article by David Sidler