Profond: is recapitalization necessary?

Impressum: Herbert Brändli, Pension expert, president of foundation council of Profond Pension Fund, 8800 Thalwil

No cuts in benefits

In spite of the financial crisis, persons insured with Profond won’t lose a single cent. Pensions currently being paid will not be cut, and the accumulated retirement capital of members who are still working will be maintained until they retire, when it will generate annuities at the annual conversion rate of 7.2 %. In the next few years, however, retirement capital will not generate as high a return as it has in the recent past – if the stock markets recover as slowly as eminent economists currently expect, that is.

Pension funds are generally highly resistant to market fluctuations. In the current environment, they can and should act as a stabilizing influence. They have no debts, and their current income is usually greater than the sums they pay out in benefits, as is the case at Profond. To extract additional funds from the real economy – slack as it is – in recapitalization payments to cover shortfalls caused by ailing stock markets is economically and actuarially absurd.

Recapitalization measures

From both an economic and actuarial point of view, recapitalization measures are unnecessary. Even so, the regulator will compel individual pension funds to take these measures, as it is too fixated on a constant cover ratio of 100 %. Whether any action will be taken at Profond, and what it might be, has not yet been decided. Under certain circumstances, the rate of interest credited in 2009 may be no more than the legal minimum. This would not be a serious burden on active members, and nor – taking account of the past – would it last long. Persons who have been insured with Profond for an extended period would still enjoy average returns superior to those of most other pension funds.

A zero interest credit was ordered in 2002, for example. What happened? In subsequent years, Profond was able to credit interest as follows:
2003 4 %
2004 4 %
2005 6 %
2006 5 %
2007 4 %.

If Profond had always paid out only the legal minimum interest, fluctuation reserves would have been built up instead of benefits – and today, we would have hardly any cover shortfall. However, Profond prefers to distribute profits to members in good years, suspending credits when times are hard.

Bridging versus recapitalization payments

In the event that the regulator insists on recapitalization payments, Profond plans to arrange bridging finance to meet the cover shortfall on a temporary basis. This is what we did in 2002. The “recapitalization payments” were calculated so that their net present value would restore the balance sheet to equilibrium. The additional contributions were credited to individual insured persons and made available to them again once the stock market had recovered. This meant that younger members did not have to stump up for the stock-market collapse to support the older generation, and there was no redistribution between the generations.

In the present case, Profond will again calculate the additional contribution so that its net present value will provide the cover required for a temporary technical deficit. The additional contributions are hard to estimate. However, given the current volatility of the cover ratio, they will probably be somewhere between 0 and 2 per cent of payroll. Once again, younger members will not have to fork out for this bridging finance. The recapitalization payments would again be treated as contribution reserves. Later, once the storm had passed, they would be converted to retirement credits or used to fund normal contributions.

In long-term equilibrium

Profond prepares an actuarial balance sheet as a constant check on its security. Taking a long-term view, this compares future income (contributions and investment returns) with future outgoings (benefits and costs). There is no point in updating this balance sheet every day, or even every month. It is distorted by the currently high levels of market volatility, making it useless for its intended purpose of providing a long-term perspective. Turbulence on the stock markets resulted in Profond posting a drop in performance of 13.8 % in October, while the cumulative fall from the start of the year to 31 October was 24.2 %. It’s not difficult to work out that our cover ratio at that point was below 90%, meaning Profond suddenly finds itself substantially in deficit. Nonetheless, there is no threat to our capacity to pay benefits or to withstand risk.

Investing in production factors

Profond is in a position to meet its benefit obligations seamlessly. Any further temporary deterioration in the cover ratio will make no difference to this, because we take in much more in contributions than we pay out in benefits – and that will continue to be the case for decades to come. Profond thus has a constant flow of new funds to invest. The fact that Profond concentrates most of its investment throughout the world in production factors restores our capital holdings, which both generate our income and act as a cushion for benefit obligations in the remote future, to equilibrium. Profond’s benchmark is not the stock market. We want our investments to track the performance of the global economy (6 to 8%). Accordingly, we abandoned unproductive – allegedly “safe” – investment vehicles a long time ago, thus avoiding total losses. There are therefore excellent prospects that book losses on equities will correct themselves, and the cover ratio rise, long before there is any need to break into our growing capital.

No weakening of the “third contributor”

Occupational pensions are proving highly resistant to the financial crisis, as long as they base themselves on the real economy. The question of whether the real economy – slack as it is – will have additional funds extracted from it in recapitalization payments, which will subsequently lie idle in pension funds, is becoming a matter of survival. Profond’s answer to this question is a resounding no. We are sticking to the investment strategy we have adopted, constantly adding to our holdings in promising companies as the stock market falls. This strategy is the heart of our actuarial balance sheet. It forms the foundation of the “third contributor” – our capital – which is what justifies the very existence of pension funds. This third contributor must not be weakened without extremely good reason.

The long-term orientation of the pensions field gives us our risk capacity. The only factor that restricts it is a liquidity bottleneck, which can force investments to be realized at the wrong time. If the long-term character of investments and liabilities is compromised for no good reason, this may lead to financial difficulties on the liability side, namely on switching pension foundations. This risk cannot be effectively countered with recapitalization payments. There are grave systemic defects in the legal provisions relating to vested benefits that must be stamped out. We have the financial crisis to thank for bringing these to light. Now is the time to put an end to them once and for all.

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