Swiss Occupational Pension Reform – Update

Swiss occupational pension reform is on the agenda again! Occupational Pensions, also known as  “BVG” in Switzerland is the so called 2^nd part of the “three-pillar” social security model. Furthermore, the BVG covers occupational pensions for employees, complementing the state pension (first pillar) and private savings (third pillar). A national referendum will be held on 22 September 2024 to decide on Swiss Occupational Pension Reforms.

The main reasons for discord are:

• A demographic shift, with the increasing life expectancy and fewer workers supporting more retirees.
• Changing economic conditions with low-interest rates impacting pension funds.
• Concerns about the sustainability and fairness of the pension system.

 Key Issues Leading to the BVG Reform

Ageing Population

Like many countries, Switzerland faces the challenge of an ageing population. The result is pressure on pension funds, as more people retire and live longer. Moreover, at the same time, there are fewer workers contributing to the pension system.

Low Conversion Rate

The so called “conversion rate” is the percentage of pension capital that is paid out annually after retirement. Currently, the mandatory conversion rate is deemed too high compared to the returns generated by pension funds. In fact, this is leading to underfunding issues.

Generational Fairness

Younger workers often face a heavier financial burden compared to older generations. In addition,  their contributions may not yield the same benefits due to changing economic conditions.

Low- and Middle-Income Workers

There are concerns that the current system does not adequately protect low- and middle-income workers, as their pension benefits might be insufficient. In fact, this is especially relevant for part-time workers and those in non-traditional employment.

Proposed Changes

Key considerations of the proposed BVG reform include:

• Lowering of the Conversion Rate
  This change would reflect the lower returns on pension capital due to prolonged low-interest rates.
• Compensation Measures
  To soften the impact of the lower conversion rate, compensatory measures are being proposed. These include increasing the contributions for older workers, as well as providing targeted support for low-income workers.
• Improving Pension Coverage
  The reform also aims to include part-time workers, particularly women who are often underrepresented in the pension system. This could be due to career interruptions or lower salaries.
• Increase Minimum Wage Thresholds
  For BVG contributions, to increase pension savings. Alternatively, to adjust the coordination deduction (the amount deducted from an employee’s salary to calculate pension contributions)

The overall goal of the reform is reportedly to ensure the long-term financial sustainability of the occupational pension system, ensuring that future generations can also benefit from it without overburdening younger workers.

Who will benefit?

The BVG reform in Switzerland is designed to address issues of fairness, sustainability, and inclusion.  While it aims to balance the interests of various groups, certain demographics stand to benefit more directly from the proposed changes.

Low- and Middle-Income Workers

• Increased Pension Coverage. One of the key goals of the reform is to improve pension coverage for low- and middle-income workers. This also includes those working part-time or in jobs with lower salaries. Many of these workers, particularly women, do not currently accumulate sufficient pension savings under the current system.
• Changes to Coordination Deduction. The reform may lower or adjust the “coordination deduction,” which reduces the amount of salary considered for pension contributions. This change will especially benefit low-income workers by allowing them to save more toward their pension.

Women and Part-Time Workers

• Part-Time Workers. Women in Switzerland often work part-time due to family responsibilities. This can result in lower pension contributions and reduced benefits. The proposed reform aims to address this by making the system more inclusive for part-time workers, increasing their savings potential and future pension benefits.
• Gender Pension Gap. By improving the treatment of low-income and part-time workers, many of whom are women, the reform could reduce the gender pension gap that leaves many women with smaller pensions compared to men.

Older Workers

• Compensation for Lower Conversion Rate. The proposed reduction in the conversion rate (from 6.8% to 6.0%) would reduce the amount of pension paid out on retirement savings. To soften the impact of this reduction, the reform includes compensation measures for older workers, particularly those nearing retirement.  This could come in the form of transitional benefits or higher contributions for older employees.
• Increased Contributions for Older Workers. The reform also proposes increasing contributions for older workers, which would boost their retirement savings in the years leading up to retirement.

Young Workers and Future Generations

• Financial Sustainability. By adjusting the system to more realistic economic conditions (e.g., lower conversion rates), the reform aims to ensure the long-term sustainability of the pension system. According to proponents, this would help younger workers by stabilising the system, ensuring they won’t face an overly burdened pension system in the future.
• Fairness Across Generations. Currently, younger workers bear a disproportionate burden because the high conversion rates benefit older retirees at their expense. The reform seeks to create a fairer balance across generations, ensuring that the contributions made by younger workers today will result in adequate pension benefits for them when they retire.

Employers

Cost Stabilisation. It is proposed that employers, who contribute to employee pension plans, stand to benefit from a more sustainable and predictable pension system. This means that the lower conversion rate and adjusted contribution requirements could reduce the financial pressure on companies in the long term, as they won’t be required to make up for pension fund shortfalls caused by overly generous pay-outs.

However, red flags have been raised by smaller companies in the short to medium term. In fact, these may find it harder to absorb increased costs associated with higher pension contributions. Furthermore, this could potentially lead to a reduction in hiring or wage stagnation as businesses try to balance these additional expenses.

High-Income Earners

Impact. Those workers earning significantly above the threshold for mandatory BVG contributions (CHF 88’200 in 2023) may not see much change. Their pension contributions and benefits are typically above the minimum requirements, so reforms to the basic framework may not have a substantial impact on them.

Risks

There are several risks and challenges associated with the proposed BVG reform. These include potential financial, social, and political impacts that could arise from the proposed changes.

Reduced Pension Benefits

• Lower conversion rate and lower pension payouts for future retirees.
• Insufficient compensation. For older workers, there is a risk that these will not fully offset the reduction in the conversion rate, leaving some workers, particularly those close to retirement, with smaller pensions than expected.

Generational Tensions

• Intergenerational Fairness. Younger workers might still feel that they are subsidising older generations if the transition to a lower conversion rate isn’t well-balanced.
• Transitional Inequities. The compensation measures primarily benefit older workers nearing retirement. This could create resentment among younger workers who might feel they are contributing more into the system for less in return, especially if they don’t receive similar compensatory benefits in the future.

Impact on Low-Income and Part-Time Workers

• Complicated Adjustments for Low-Income Workers. While the reform aims to improve pension coverage for low- and part-time workers by adjusting the coordination deduction, there’s a risk that these measures might not be sufficient to ensure adequate retirement savings for this group.
• Insufficient Increase in Pension Savings. Even with lower thresholds for pension contributions, some low-income or part-time workers might not significantly increase their pension savings if their incomes are too low to benefit meaningfully from the reform.

Financial Burden on Employers and Employees

• Increased Contributions. Older employees and their employers might face higher contribution rates. This could increase the financial burden on both parties, particularly in industries where wages are already low or where small businesses struggle with labor costs.
• Pressure on Employers. Smaller companies may find it harder to absorb increased costs associated with higher pension contributions, potentially leading to a reduction in hiring or wage stagnation as businesses try to balance these additional expenses.

Political Risks

• Referendum Uncertainty: In Switzerland, major reforms often face public referendums if there is significant opposition. The BVG reform has been controversial, particularly around issues like the reduction in the conversion rate and compensation for older workers. With the pending referendum, there is a risk that it could be delayed or rejected, leading to further uncertainty about the future of the pension system.
• Compromise and Dilution: To get political approval, the reform may be subject to compromises that water down its effectiveness.

Economic and Demographic Risks

• Longevity Risk. One primary motivation for lowering the conversion rate is the increase in life expectancy. However, if life expectancy continues to rise faster than expected, even the new lower rate might not be sufficient to keep the system sustainable. This could result in future shortfalls in pension funds and more adjustments down the road.
• Low Interest Rates. The BVG pension system relies on returns from investments to grow pension capital. If interest rates remain low, or if there are negative economic shocks, pension funds may struggle to generate sufficient returns. This could lead to underfunding of pensions, requiring either additional reforms or higher contributions in the future.

Risk of Increased Inequality

• Uneven Impact. While the reform seeks to improve pension coverage for part-time and low-income workers, the benefits might not be evenly distributed. There is a risk that high-income earners and those in well-paying jobs with substantial voluntary (third-pillar) savings will still fare much better than low- and middle-income workers, potentially leading to greater pension inequality.
• Disproportionate Impact on Certain Sectors. Workers in industries with lower wages, part-time jobs, or higher proportions of women (such as retail, healthcare, or hospitality) could see a disproportionate impact if the reforms do not fully address the structural challenges they face.

Public Opposition and Social Tensions

• Opposition from Trade Unions and Advocacy Groups. Some labour unions and advocacy groups could oppose parts of the reform, particularly if they believe it will result in reduced pension benefits for retirees. In addition, there could be public backlash, especially from groups representing older workers or low-income employees, potentially creating social tensions.
• Disillusionment with the System. If the reform leads to a reduction in benefits without clear compensatory measures, some individuals may lose trust in the pension system and become less motivated to contribute, especially if they feel that they will receive inadequate benefits upon retirement.

Summary

The main risks of the BVG reform in Switzerland revolve around potential reductions in pension benefits, particularly due to the lower conversion rate. This could bring associated financial pressures on employees and employers. While the reform aims to ensure fairness and sustainability, the success of these efforts depends on careful implementation, sufficient compensatory measures, and the ability to balance the interests of different generations and income groups.

Additionally, the political risks, such as the possibility of a referendum or diluted compromises, add uncertainty to the process, making it challenging to predict whether the reform will achieve its goals without triggering unintended consequences like increased inequality or social tensions.

We will have to wait now until after the vote on 22 September, to see what the Swiss electorate decides. The BVG is a highly sensitive and complex issue with many different views from all sides of the public spectrum. This is reminiscent of a quote from the famous British politician, Winston Churchill who famously said: The best argument against democracy is a five-minute conversation with the average voter.

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