Earlier this year, the Swiss subsidiairy of France’s giant Axa insurance group shocked its peers by pulling out of the comprehensive insurance sector. From 2019, its activities will be converted into semi-autonomous foundations. While Axa will continue to cover disability and death risks, any financial gains or losses on investments will be borne by the foundations or insured individuals.
The step is not entirely new. About 15 years ago, Zurich Insurance reached a similar conclusion. The reason was the framework of regulatory and political risks in the comprehensive insurance business.
Understanding the implication of these moves requires a bref explanation of Switzerland’s retirement pension system. The coutry relies on its so called “Three Pillars”: – comprising, respectively; compulsory state cover; occupational pensions (best known under their German abbreviation of BVG); and voluntary private pension contributions. Most contentiously, BVG contributions are converted, on retirement, into pension payments, with the conversion rate being set by the law.
As interest rates have fallen steadily, the conversion rate has been increasingly uneconomic for insurers, prompting sharp criticism from practioners and independent economists and even withdrawals from the market. However, the political sensitivity of the conversion rate has meant politicians have been extremely cautious about reductions.
Axa’s and Zurich’s decisions were not just reactions to changing customer needs, but also to ever stricter regulatory constraints. Independent funds offering occupational pensions under the BVG scheme are subject to cantonal supervision, whereas insurers have to answer to Finma, Switzerland’s Financial Supervisory Authority. The two supervisory regimes have disparate requirements. Finma demands the use of lower technical interest rates than do the cantons for the semi-autonomous funds they oversee.
That means future liabilities weigh heavier on the insurers’ balance sheets and must be covered by additional capital. In addition, Finma formulates strict capital requirements that do not apply to the semi-autonomous funds. This increases the cost of insurers’ investment strategies. It remains to be seen whether Finma is too strict or the cantons too lax. In any event, the result has been to create an unlevel playing field.
No free lunch in the retirement provision sector
Switching to the semi-autonomous system can ease regulatory pressures. Axa referred explicitly to the lower risk premiums resulting from the change.
Trade unions, which have long opposed the full insurance model, will be pleased with Axa’s withdrawal. But it s is only a Pyrrhic victory. Many small and medium sized companies still need to protect their company pension plans against big price shifts in their investment portfolios . If insurers do not offer suitable protection, companies will have to build up potentially costly “worst case” reserves.
There is no right or wrong. Both models (comprehensive insurance and semi-autonomous solutions) offer advantages and meet different needs. But it is a pity if customers no longer have the choice, since the regulatory framework no longer facilitates product diversity.
The whole industry – including semi-autonomous insurance companies – is affected
Axa’s withdrawal has an impact on the entire industry, removing at a stroke Switzerland’s second largest provider of comprehensive insurance. Affected customers who still want a full insurance solution will have to switch to Allianz, Bâloise, Helvetia, Pax and Swiss Life, the remaining providers. But not everyone will receive an offer. The other insurers are also struggling with the same regulatory constraints as Axa and have in recent years become more selective in accepting new customers.
In the semi-autonomous environment, Axa will now be the largest player and will have its own sales force. In addition, Axa has promised to reduce its risk premiums by 30 per cent. So far, semi-autonomous collective foundations have been able to rely on the “protective shield” of large insurers when setting prices for these risk premiums. The latter have to keep premiums high to compensate for losses when new pensioners retire. Semi-autonomous insurers also benefited from these higher prices and were thus able to compensate for pension losses. This protection is now partially removed. The competition for semi-autonomous collective foundations will become harsher.
Basic problems remain unsolved
The increasing importance of semi-autonomous solutions cannot hide the causes of this malaise in the second pillar. It is currently accentuated by Axa’s withdrawal. The pension promises for occupational benefits are too high due to the legally set minimum conversion rate. The current rate is still based on life expectancy as measured at the end of the 1980s and on nominal returns of over 4 per cent. Both criteria are completely out of date. However, the trade unions and many left-wing politicians have erected obstacles to any adjustment of the conversion rate. As a result, billions of francs are redistributed every year from young to old, regardless of the role insurers play in this business.
The deadlock is poisonous for the occupational pensions system and every day puts further strain on the relatinship between younger earners and older pensioners. It is finally time now for policymakers and the people to react.