Speech
Embargo
31 October 2019, 4.30 pm
Challenges confronting the pension system - options and
limitations of monetary policy
PK-Netz conference
Thomas J. Jordan∗
Chairman of the Governing Board
Swiss National Bank
Berne, 31 October 2019
© Swiss National Bank, Zurich, 2019 (speech given in German)
Ladies and gentlemen
I am delighted to be able to talk to you at this important event. It gives me the opportunity to
explain our position in what is a difficult financial market environment for you especially as
pension fund managers. The Swiss National Bank (SNB) is responsible for our country's
monetary policy and not for its social policies, nor for its pension schemes. At the same time,
however, it is important for us as the central bank that the occupational pension system should
be able to fulfil its constitutional mandate: together with Pillar 1 - the Old Age and Survivors'
Insurance scheme (AHV) - it is required to ensure that insured persons can maintain their
previous lifestyle in an appropriate manner after retirement.
Solid funding is crucial for this, as a pension system must be financially sound if the
population is to have confidence in it. Such confidence is, in its turn, of fundamental
importance in ensuring that the occupational pension system can perform its key economic
role. This consists of giving people the certainty that the assets they have saved in their
pension scheme during their working lives will actually be available to them in their old age.
A good pension system makes it possible for people to reliably plan their future material
needs, and fosters security for individuals and stability for society. It is therefore a key
precondition for the prosperity and development of a modern economy. A healthy pension
system is central to ensuring social cohesion and is one of the cornerstones of Switzerland's
success.
With its three pillars - AHV, occupational pension schemes and private pension provision -
Switzerland has for several decades operated a comprehensive and well-functioning pension
system. Our pension arrangements have been envied abroad, which is also reflected in the
relevant rankings. In recent years, however, our country has lost considerable ground in this
discipline (cf. chart 1).
Have we become worse, or have the others improved? Whatever one might think about such
comparisons, it is in Switzerland's own interest to do everything it can to ensure that the
pension funds - as key players in the whole system of pension provision - are able to manage
the numerous challenges facing them as effectively as possible. In what follows, therefore, I
will look at two important and specific challenges: the ongoing low interest rate environment
and the rise in life expectancy. I will then set out what the politicians and the pension funds
themselves could do to meet these challenges in the current situation. The SNB, too, has
repeatedly been called upon to make a contribution. I would therefore like to outline what we
can contribute - within the framework of our legal mandate - to the health of the pension
system, and where our scope for action ends.
Low interest rate environment - increasingly difficult to meet benefit
commitments
The first challenge that you as pension fund managers have faced for some considerable time
now is the persistently low level of interest rates. These low rates are prevalent not only in
Switzerland, but in all the major currency areas. For the pension funds, which traditionally
have large holdings of interest-bearing investments, this situation naturally means lower
investment income. In other words, the share of the 'third contributor' - the capital market -
has diminished considerably. This makes it more difficult for the pension funds to meet their
existing benefit commitments.
In the BVG, the Federal Act on Occupational Old Age, Survivors' and Invalidity Pension
Provision dating from 1982, the entitlements of insured persons as well as other key
parameters, such as the conversion rate1 and the minimum rate of interest,2 were defined on
the basis of certain assumptions.3 These assumptions - e.g. for economic growth, inflation,
and the average achievable nominal return - were based on empirical figures that were wholly
plausible in the 1980s when the occupational pension system was calibrated.
For some years, however, interest on investments across all maturities has been exceptionally
low. For a closer examination, it is useful to differentiate between the long and the short term.
Let us first look at the development of long-term interest rates, represented here by the yields
on Swiss, German and US ten-year government bonds since 1995 (cf. chart 2). There is a
clear downward trend. The decrease in Germany - and therefore in the euro area - was even
more pronounced than that in Switzerland. What are the causes? I would like to highlight
some factors I consider particularly important. To some extent, this development is due to the
fact that since the 1990s the efforts of central banks in the advanced economies to bring down
previously high inflation rates have been increasingly successful. As a result, the markets
deemed the central banks' pledge to maintain price stability to be credible. Inflation
expectations consequently became anchored at a much lower level than before. The amount of
interest that investors would normally demand as compensation for future inflation thus also
decreased. If this reduction in interest rates were to be taken into account accordingly in the
aforementioned pension fund parameters, the lower return would not in itself be
fundamentally problematic for the pension funds, as their invested capital would also be
subject to less inflation.
In recent decades, however, the real rate of interest - i.e. the nominal interest rate less
consumer price inflation - has likewise been falling (cf. chart 3). As central banks have only
limited influence on the development of the long-term real rate of interest, other factors must
have been at work. First, population ageing in the advanced economies has resulted in an
increased propensity to save, which in turn has increased the supply of investable capital.4
Second, productivity growth is declining.5 This reduces the return potential of investments
and hence also the demand for capital to finance investments. The real rate of interest had to
fall in order to balance supply and demand on the capital market.
Negative interest - still essential from a monetary policy perspective
The decline in long-term interest rates also has implications for monetary policy and thus for
short-term rates. What is known as the 'neutral rate of interest', i.e. the rate at which monetary
policy neither holds back nor stimulates the economy under conditions of price stability, is
also lower than it used to be. To achieve the same degree of monetary policy expansion in
these circumstances, short-term interest rates must therefore also be lower now. This is one of
the reasons why many central banks lowered their policy rates to zero or even into negative
territory in the financial and debt crisis. It was because of this that the SNB, too, introduced a
negative rate of interest on the sight deposits that banks hold with it.
We are aware that the negative interest rate is an unconventional instrument, and one that has
side effects. That is why we subject the benefits of this instrument for monetary policy, as
well as any resulting costs, to particular scrutiny. We will only maintain the negative interest
rate for as long as the benefits outweigh the costs. We undertook the most recent evaluation
during our September monetary policy assessment. This showed that the negative interest
rate, and our willingness to intervene on the foreign exchange market as necessary, are still
essential in order to ease pressure on the franc, thereby stabilising price developments and
supporting economic activity. Only in this way can we fulfil our mandate - to ensure price
stability while taking due account of economic developments - in the interests of the country
as a whole. In September, we also adjusted the basis for calculating the exemption threshold,
which defines the portion of a bank's sight deposits at the SNB on which we do not charge
negative interest. This adjustment reduces the overall burden imposed on the banking system
by negative interest to the minimum required for monetary policy purposes,6 while taking
account of the possibility that the low interest rate environment may persist worldwide for
some time to come.
While negative interest rates are unusual and should only be temporary, moderately negative
rates are not fundamentally different in terms of their economic effects from interest rates
above zero. As the negative interest rate has brought about an easing of financing conditions
in the economy, companies are able to take out loans for investments at lower cost. For us,
however, this so-called 'interest rate channel' is not of prime importance. Rather, it is the
effect on the exchange rate that is decisive for Switzerland as a small open economy. With the
negative interest rate, we can ensure that the traditional interest rate differential versus other
countries is not eroded excessively. Any further narrowing of the interest rate differential
would increase the upward pressure on the franc, which would lead to lower economic growth
and higher unemployment.
The measures taken by the central banks to combat the financial and economic crisis - low
policy rates, forward guidance on the expected course of short-term interest rates, and
securities purchases - have undoubtedly increased downward pressure on the general level of
interest rates in the short and medium term. But the decline in capital market rates, which we
saw in the chart earlier, began long before the outbreak of the crisis. This reinforces the notion
that when interest rates fall, it is the aforementioned powerful structural drivers which are at
work - i.e. persistently lower inflation expectations, greater propensity to save and lower
propensity to invest. From today's perspective, therefore, the neutral interest rate that is
relevant for monetary policy is also below previous empirical levels. Consequently,
shortterm interest rates could remain below their usual levels even if the central banks normalise
monetary policy again at some point in the future.
Longer life expectancy - success story and challenge
Ladies and gentlemen, the low interest rate environment is a challenging situation for pension
funds. And I cannot even give you an idea of when Switzerland will be able to return to
positive interest rates. All I can say is that the timing will greatly depend on developments in
the global economy and the performance of the international financial markets.
Another challenge that is sure to preoccupy you as pension fund managers is that of rising life
expectancy - on the face of it a very gratifying development and, indeed, one of humanity's
success stories. Rising life expectancy is not only influencing the propensity to save but is
also having a direct impact on the pension funds. Given an unchanged retirement age, it
steadily lengthens the average duration of pension payments. This in turn results in higher
payments and extra strain on the pension funds.
The consequences of these developments are clear. Lower inflation and reduced real rates of
interest are resulting in lower nominal interest rates and are thus diminishing the pension
funds' earnings prospects. On the benefits side, increased life expectancy means that pensions
are being drawn for longer, thus increasing the volume of savings capital needed to finance
these benefits. As a result, the system becomes unbalanced.
Price stability - the SNB's contribution to a healthy pension system
What could be done to find a workable solution? Which measures would make sense and
which would not? Let me start at home, so to speak: at the SNB. People frequently call for the
SNB to abolish the negative interest rate in order to significantly ease the pressure on pension
funds. But if we think things through, would that actually happen?
If there were no negative interest rate, the franc would be even more attractive internationally
and would appreciate. That would slow down our economy considerably, and unemployment
would rise substantially. In this gloomy scenario, long-term interest rates would therefore
barely increase at all. Instead, the downturn in economic activity would cloud the outlook for
Swiss companies - with adverse consequences for share prices as well. So you see, under
current circumstances the earnings outlook for the pension funds would not improve
significantly if the negative interest rate were to be abolished. On the contrary. Higher
unemployment would impact on the economy and the pension system, as it would have the
effect of reducing value added and hence the contribution base. At present, it would therefore
not be in the pension funds' interest to abolish the negative interest rate.
So if it is not possible in the current situation for the SNB to abolish the negative interest rate,
could it not at least use the income derived from it to alleviate some of the pressure on the
pension system - for example by distributing this income to the pension funds as
'compensation'? In our view, this would not be a good idea either. Any linking of monetary
policy to social policy raises the issue of potential conflicts of interest with the SNB's actual
mandate. That would also be the case if income were committed in this way. To ensure that
the SNB can fulfil its mandate, our decisions must be based solely on monetary policy
considerations.
The current arrangements for determining and distributing profits take due account of the
individual stakeholders' responsibilities: the SNB's responsibility for monetary policy, and
that of the Confederation and cantons for fiscal and social policy. The law stipulates that the
SNB's profits be allocated to the Confederation and cantons, which can dispose of them as
they see fit. Transferring the income derived from the negative interest rate to the pension
funds would not only result in a questionable mingling of monetary and social policy, it
would also reduce the volume of funds available for ordinary distributions to the public
sector. Ultimately, it would be a zero-sum game.
For the negative interest rate to have the desired monetary policy effect, it must be applied
across all sight deposit accounts held at the SNB as far as possible. Making an exception for
such an important investor category as the pension funds would severely impair this effect.
Moreover, it is likely that other players which also perform economically relevant and
socially useful functions - such as charitable foundations - would promptly demand the right
to be treated equally. It was for similar reasons that we already had to turn down a request
from your industry association in 2015 to operate non-interest-bearing sight deposit accounts
for the pension funds.7 Quite fundamentally, the introduction of a 'fourth contributor' in the
form of the SNB would seem to depart from the rationale on which the occupational pension
system is founded.
So how can the SNB make any contribution to the health of the pension system? By
consistently and credibly pursuing a policy geared to price stability, the SNB is contributing
significantly to a solid foundation. In the long term this will facilitate economic growth and
prosperity in Switzerland and, in particular, also safeguard purchasing power. Ultimately, this
is one of the decisive factors in ensuring that our country can afford a social security network
that is resilient and remains fundable. Stable prices are thus very important for pension fund
members. However, price stability is also of utmost importance for the socially disadvantaged
and pensioners, as they are scarcely able to protect themselves against an inflation-related loss
of purchasing power. Like the pension system, price stability plays a key role in the Swiss
success story. It is an accomplishment that is greatly valued - and today almost taken for
granted - by the general public.
Pension funds - reacting with moderation and flexibility
Ladies and gentlemen, the pension funds have not been idle in the last few years with regard
to the challenges mentioned. As pension fund managers, you have shown moderation and
great flexibility in initiating various measures to bring your pension funds' income and
expenditure into equilibrium over the long term as well. On the investment side, the exposure
to fixed-income instruments has been reduced - given the persistently low interest rates - in
favour of equities and real estate (cf. chart 4). Furthermore, the pension funds have again
become more active abroad, and are keeping their liquid assets to a minimum. Indeed,
liquidity as a share of total investment assets is currently at a historic low (cf. chart 5).
You have also had to take action on the benefits side in order to balance income and
expenditure over the longer term. These cuts are painful and have been directly reflected in
people's insurance certificates. One example is the sharp reduction in the conversion rate for
non-mandatory cover.8 Moreover, the technical interest rate9 has been lowered by 40% in the
last ten years. This took account of the probability that income from the 'third contributor'
would also be greatly limited in future.
Thanks to these measures, together with the favourable trend on the equity and real estate
markets, the coverage ratio of the pension funds of private-sector employers has remained
stable since 2015 - despite the aforementioned correction to the technical interest rate, which
has the effect of reducing this ratio. These efforts are approaching their limits, however. As
the adaptation of the portfolio structure is associated with increasing investment risks, larger
fluctuations in value are to be expected in future. In addition, the measures implemented to
date are not sufficient given the rise in life expectancy. All other things being equal, the
longer average duration of pension payments calls for increased retirement assets.
What can be done about this? Only a limited number of adjustment mechanisms can be used
to restore the equilibrium of a pension system. The first such mechanism relates to the
pension funds' income - in other words, the contributions paid into these funds. Higher
contributions by employees and employers would make it possible to accumulate more
capital. The other adjustment mechanisms relate to pension funds' expenditures. To reduce
these outgoings, either benefits could be decreased or the period of benefit payments could be
shortened. We do not express any preference as to which of these mechanisms is used.
Making such a choice always involves a delicate balancing of interests, which is a matter for
political circles rather than the SNB.
Under these circumstances, however, it is clear that there is unfortunately no easy, universal
solution. Adjusting to the realities of the investment world and demographic change comes at
a price. And something else is also clear: in a pension system like ours, in which the key
parameters are defined in nominal terms, this price will keep rising until such time as the
problems are tackled. But holding on to the status quo also comes at a price. For example, we
are seeing a rise in redistributions from young to older insureds, which was never intended by
the system. This is also why the term 'lifestyle', as used in the relevant article of the Federal
Constitution, targets purchasing power rather than any nominal quantity.
Workable solutions can be found
At the start of my talk I drew your attention to an international ranking of pension systems (cf.
chart 6). In other countries, too, the population enjoys rising life expectancy while savers
bemoan the low interest rates. Denmark and Sweden, for example, which are now ranked
several places ahead of our country, have implemented far-reaching and thus painful measures
to stabilise and modernise their pension systems. Denmark has linked the retirement age to
life expectancy, and Sweden is making the level of pension payments directly dependent on
demographic and economic developments. These two examples show that it is possible, even
in this politically fraught area, to find workable solutions.
Ladies and gentlemen, the SNB is not responsible for social policy. But allow me to finish by
stressing once again how important it is to us that Switzerland's pension system should
continue to perform its pivotal economic and social function as well as possible. We are also
aware of how critical the situation is for the pension funds, given the persistently low interest
rates. At the same time, we cannot say when the negative interest rate will no longer be
necessary. The SNB's contribution to a strong pension system is maintaining price stability in
our country.
Adapting the parameters to economic and actuarial realities is an ongoing task of both pension
fund managers and political bodies - in normal as well as exceptional times. As pension fund
managers, you have fulfilled your obligations and have taken action in the very challenging
environment of the past few years. Switzerland's political bodies, too, recognised some time
ago that the pension system must take account of the economic realities. Some initial steps
have already been taken along this rocky road. But there is still a way to go.
Challenges confronting the pension system -
options and limitations of monetary policy
Thomas J. Jordan
Chairman of the Governing Board
Swiss National Bank
PK-Netz conference,
Berne, 31 October 2019
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31.10.2019 Challenges confronting the pension system - options and limitations of monetary policy | Thomas J. Jordan | © Swiss National Bank
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31.10.2019 Challenges confronting the pension system - options and limitations of monetary policy | Thomas J. Jordan | © Swiss National Bank
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31.10.2019 Challenges confronting the pension system - options and limitations of monetary policy | Thomas J. Jordan | © Swiss National Bank
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31.10.2019 Challenges confronting the pension system - options and limitations of monetary policy | Thomas J. Jordan | © Swiss National Bank
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31.10.2019 Challenges confronting the pension system - options and limitations of monetary policy | Thomas J. Jordan | © Swiss National Bank