In the spotlight: occupational pensions
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Director, Tax and Legal Services
Named after the legislation that forms their legal basis (Article 1e of the Ordinance on Occupational Old-Age, Survivors’ and Disability Benefit Plans, OBB2/BVV2), ‘1e’ pension plans are a special arrangement enabling employees to choose the investment strategy for pension contributions based on earnings above CHF 126,900 (1 January 2016). Typically that’s people in middle management and above, depending on the industry and organisation. In theory, 1e plans are a great way of giving financially aware and engaged employees greater control of, and greater responsibility for, their retirement savings – which will be vital to the health of occupational pensions in this country going forward (see Room for manoeuvre despite regulation). In practice, however, adoption of 1e plans (with the exception of a handful of large organisations) has been very limited. Why is this?
The main reason is an ‘accident’ of law whereby pension funds, and ultimately the employers behind them, had to guarantee the amount invested in the 1e plan, effectively retaining risk with the company. This has meant, above all, that 1e plans have been viewed as defined benefit plans for financial reporting purposes – which in turn has meant that the risk associated with this promise has had to be accounted for on the balance sheet, often in the form of substantial reserves. A change to the relevant law, due in 2016, should do away with the legal requirement to provide a minimum guarantee upon exit from the pension fund. Significantly, this will mean that ‘defined contribution’ accounting will be possible for the 1e plan under IFRS and US GAAP. Once the fund promises a lump-sum benefit on retirement instead of a pension, and if other biometric risks are provided in the form of a lump sum and are insured, there will be no significant further risks to the company. The expense will be the cash contributions payable to the plan, but there will be no balance sheet item. A seemingly minor change in the law will mean that suddenly 1e plans will look a lot more attractive for many employers that would previously not have considered offering them.
The switch to much more advantageous defined contribution accounting has significant benefits, but it’s by no means the only advantage of 1e plans for employers. Another plus is that they reduce the risk of underfunding because the pre-retirement investment risk is transferred to the employee. In addition, as 1e plans usually provide a lump sum at retirement rather than a pension, the post-retirement risks are also removed. This has an added effect of eliminating some of the cross-subsidies between higher and lower earning employees and pensioners (see Room for manoeuvre despite regulation). Added to this, 1e plans encourage greater employee engagement in pension plans, which means better value for money on corporate spend. Implementing a plan is also an opportunity for an organisation to review its benefit and provider set-up for cost and value management purposes, as well as enabling combined IT solutions with other long-term incentive plans. This substantial upside means that 1e plans will become a much more attractive proposition for organisations, especially those that can’t afford to maintain the risk inherent in their current system, that are set to enjoy valuable financial reporting benefits, or whose employees value the ability to choose their own strategy.
In our experience at PwC – reinforced by the findings of a comprehensive survey of Swiss employers’ views and awareness of 1e plans that we’re about to publish – many employers are not even aware of 1e plans, never mind the potential benefits under the new law. Many of those who do know about the option tend to assume that setting up a 1e plan will be too complicated. The fact is, however, that there are already providers in the marketplace, with more ready to go on stream, that can provide solutions for organisations of any size. Some of these providers will be able to offer the entire spectrum of services: from parts that an employer can use to build on their existing solution to a full package including access to the provider’s IT infrastructure and administrative services. While there are a lot of important questions to address before embarking on a 1e plan, specialist advice, and support with managing the transition from the old to the new set-up, is available. Getting neutral advice has the added benefit of building the trust of employees, as they may well value independent input on the changes.
Implemented intelligently, a 1e plan is a win-win situation for employees and employers. A well set-up plan represents an attractive state-of-the-art pension solution that allows employees greater choice and responsibility in managing their retirement savings. A 1e plan gives them a better fit with their own individual risk/return profile and can enable them to harmonise and optimise the asset allocation within the 1e plan with their private investments. Last but not least, a 1e plan gives employees transparency.
Assuming you, as an employer, have become aware of the benefits for you and your employees and are seriously consider implementing a 1e plan, what questions do you have to consider? They’re not for everyone, so first of all you have to think about whether you have what it takes to make a 1e plan work. You need to see strong benefits on the accounting side. And you need enough financially aware high earners to justify the cost of setting one up (although it’s important to remember that many providers also cater for small numbers of employees). Significantly, our survey has showed that what Swiss employers and funds want in their plans is met by many of the benefits of 1e – so it pays to give it careful thought.
Once you’ve decided to take the plunge, you have to negotiate the challenges of implementing a 1e plan. This includes deciding on eligibility: by grade or by salary or a combination? You have to identify provider preferences, prepare a short list, and organise a beauty parade. You should review your past service and decide how much of it can or should be transferred to the 1e plan. Moving out past service has implications for the remaining fund as there will be less assets and obligations in the portfolio. This needs careful review and some elements of the fund may need to be recalibrated. Finally, you have to assess the accounting impact and find out precisely how the plan has to be designed to ensure it’s accounted for as defined contribution. Above all this means avoiding offering any explicit or implicit guarantees such as retirement conversion rates. A 1e plan paying a lump sum is much more likely to qualify as defined contribution, and avoids the longevity risk to boot; a plan promising a pension will probably not qualify as defined contribution. It’s vital to seek external advice on these matters.
Other matters you have to consider include how to communicate the 1e plan and get your employees on board, how to set up (or buy into) the relevant systems, and whether to partially liquidate your present pension arrangement. Plans for earnings below CHF 126,900 will not be directly affected by the changes, but if a plan or fund needs to be split into a 1e and a non-1e component there will clearly be design, structural and governance implications. Again, the situation varies from organisation to organisation, so it pays to seek advice.
As we said in the introduction, 1e plans have the potential to change the face of Swiss pensions by bringing the concept of individual choice of investment strategies, and individual responsibility for the risks of retirement, into the spotlight. Although the option has been possible in the past, the number of companies implementing 1e plans has been so small that it has really had no effect on the system as a whole. If 1e plans are a success following the change in the law, they may cover a greater proportion of the assets and liabilities in the system today, and they may be the precursor to further change in the system.
Following a change in the law due in 2016, 1e pension plans are set to become much more attractive for both employees and employers. Employees get greater control over their retirement savings, and employers can potentially reap significant financial reporting and risk management benefits – among other things. Despite reservations on the part of many employers, implementing a 1e plan need not be as costly or complex as anticipated, and may be an attractive proposition even for smaller numbers of higher-earning employees. Get the key details right and a 1e plan can be an important step in easing the pressure on pensions while giving employees what they want.