Lump-sum withdrawals undermine the Federal Constitution, Andreas Dummermuth
echo-Interview, February 2017

Lump-sum withdrawals undermine the Federal Constitution


Lump-sum withdrawals undermine the Federal Constitution

echo interview with Andreas Dummermuth, Director of the Social Security Authority/Invalidity Office of Canton Schwyz and President of the Conference of the Social Security Authorities of the Swiss Cantons

elipsLife echo: In a recently published analysis, the OECD estimates a total shortfall of USD 78 trillion in the pension systems of its member countries. What's the situation in Switzerland?

Andreas Dummermuth: You need to approach this question in a different way. Social security systems were established in order to deliver on promises of future benefit payments. That being said, social insurers - from an accounting point-of-view - do not enter into their books benefit payments to be made at some future date. Let me provide an historical example: In 1532, the authorities in the German town of Goslar introduced the so-called "Büchsenpfennig" for coal miners. Before descending into the mine, each miner was required to place a penny into a collection box in order to mitigate fatality, accident and invalidity risks. In the event of these risks actually materializing, the money collected was used accordingly. So even back in the 16th century, there was no individually-based calculable risk that could be projected in to the future. My point is that this USD 78 trillion gap in a pay-as-you-go process is actually a piece of accounting fiction. Social security systems nowadays are mandatory and society requires that fatality, accident and invalidity risks are properly covered, just as they were back then in Goslar.

The same OECD paper mentions that many countries have made substantial progress in strengthening their funded social security systems. Do you see a need to extend capital-based schemes?

The OECD's recommendation applies to countries such as Germany, France and Italy that operate largely pay-as-you-go pension systems. It doesn't however apply to Switzerland since we have the three-pillar system. The pay-as-you-go old-age pension system (AHV) making up the first pillar, the funded occupational pension schemes represented by the second pillar and the private plans in the third pillar mean that Switzerland has long since implemented the OECD proposal. I don't therefore see any additional need for action in this connection.

echo-Interview, February 2017

What are the major challenges for occupational pension schemes in your view?

These have to do with demographic change and our ageing populations. They are the two biggest problems both in the first and second pillars. In addition, the second pillar is characterized by an enormous capital accumulation. In my view, this fact obviates any need for its further expansion. In fact, the second pillar contains a capital reservoir equal to 125% of our Gross Domestic Product, in other words 1 ¼ of Switzerland's total annual income. In addition, this fully funded pension system highlights the problem with the so-called "third contributor," i.e. the return on capital from the financial markets. The global hoarding of increasing cash amounts in the second pillar makes money progressively cheaper, in turn driving down interest rates still more. Consequently, to extend the second pillar in Switzerland would not be a sensible idea since "more of the same" does not benefit the system in this instance but rather exacerbates the risks.

Are old-age pension systems based on fixed pension rights, such as the AHV, sustainable in the long term?

Yes, I believe they are, since a pension system based on a pay-as-you-go model is extremely stable. Throughout its 69 year-old history, our AHV system has proven to be very successful. We're always hearing that the declining number of those employed versus the number of pensioners – in 1948 it was 6.5 and by 2035 it will only be 2.1 – poses an existential threat to our system. But this is not the relevant question in my opinion. Far more important are the contributions being paid in. When an economy is working and flourishing, the pay-as-you-go model generates sufficient funds to keep the ship afloat. The crucial factor is that our economy and our society actually support a flexible and stable old-age provisioning. It also has to be a retirement system that burdens the economy in a gradual, not an abrupt fashion. And we've achieved this: the current AHV contribution rate is at 8.4% of total wage. This has been the case since July 1st 1975! The only thing added was one percent value-added tax in 1999. The AHV has been working smoothly with the same contribution rate for 42 years – proof enough of the system's reliability.

echo-Interview, February 2017

Demographics, longevity and very low interest rates are threatening to throw social security schemes out of sync. What can be done to prevent this happening?

A retirement benefit system can be kept on an even keel by reducing pensions, raising the retirement age or increasing premiums. Since our Federal Constitution guarantees pensions that enable a decent standard of living, cutting them would be politically unworkable. Raising the retirement age, on the other hand, is a totally sensible and practicable solution. Switzerland has the most expensive healthcare system in Europe with very high medical insurance premiums. What we get in return is very high life expectancy. Our public health system underpins longer life, but also ensures that at age 65 we we're not necessarily worn out and unable to carry on working. With regards to hoisting premiums, it stands to reason that raising the percentage of value-added tax would make more economic sense than increasing the percentage from employees' pay. This is because it would affect everybody and not just those in employment.

And which of the three possibilities would you prefer?

Surveys show that Swiss citizens are clearly in favour of raising premiums. The 2020 pension reform proposals, by the way, recommend a mix of the three parameters: raising the retirement age for women from 64 to 65 years, additional financing via value-added tax and a reduction of pensions through a lower conversion rate in the second pillar.

Apart from raising deductions from wages and salaries or value added tax, are there other financing possibilities?

I see the danger of a shift from the second to the third pillar. Companies could conclude in future to no longer provide generous support to occupational pensions above the obligatory level and to withdraw financing for, say, salaries over CHF 150,000. Employees would have to rely more on private schemes via the third pillar. This would be tantamount to "risk shifting," with employers transferring portions of the age risk, especially longevity, to their employees.

Andreas Dummermuth, Director of the Social Security Authority/Invalidity Office of Canton Schwyz and President of the Conference of the Social Security Authorities of the Swiss Cantons

The AHV has survived very well up to now. To what extent has this been attributable to immigration, in other words to the influx of new contributors?

The basis for the AHV's success is a smoothly functioning economy. When it's firing on all cylinders, a lot of people find work. And because all these employees pay their AHV dues and because of the rising participation in the labour market of women, of second-generation children of immigrants and also of the over 65s, we're seeing an ongoing upturn in contributions. Switzerland is an employment miracle – and to keep its economy running well, it needs both skilled and semi-skilled workers that it can also source from abroad. Up to now, the thriving economy has been able to shoulder the demographic burden without raising the contribution rate. Should the economy collapse in the wake of rising unemployment, an exodus of foreign skilled workers, wage dumping and other factors, the AHV would suffer a double blow. Firstly, contributions would slump and, secondly, the demographic factor would become far more onerous that it is at present.

So social security is dependent on the economy?

Yes, decidedly so! The economy and social security have a close inter-relationship. It's the job of the social security system to ensure that our highly dynamic society and performance-oriented economy remain sustainable. The economy and social security can no longer be separated. In the event that all compensation, pension, medical insurance, accident insurance and unemployment funds stop their payments, Switzerland would be paralyzed within a month.

It is well known that there are numerous different approaches to addressing the various challenges facing the AHV. What would happen if the political decision-makers decided to cut AHV benefits across the board?

Should the government decide to cut AHV benefits, this would happen via a formal change in AHV legislation which, in turn, would be dependent on an optional referendum. I have no doubt at all that such proposal to reduce benefits would be voted down. Politically, it would be a non-starter. People want security. The only possibility would be a reduction focused on today's unnecessary benefits, for example high supplementary pensions paid to AHV retirees for their children.

What role do supplementary benefits play in the pension system?

 The supplementary benefits offered by the AHV and Disability insurance systems were introduced in 1966. They provide coverage for basic necessities and are intended to safeguard the livelihoods of all pensioners. They come into play for pensioners should the benefits they receive from the other social insurance plans fall short of a defined income minimum. For example, Canton Schwyz currently guarantees a minimum of CHF 37,230 for an AHV pensioner. While over the years, the AHV and second pillar have been steadily strengthened, current expenditure on supplementary benefits is alarmingly high. At around CHF 5 billion, it is approximately equivalent to Switzerland's defence budget and is likely to go on rising.

How could such a situation arise given the thoroughly robust 3-pillar system?

The soaring expenditure on supplementary benefits is attributable to several factors, such as longevity, the rising cost of nursing care, the politically endorsed expansion of benefit payments or the strong privilege accruing from the possession of significant assets. For example, in Canton Schwyz it is still possible to claim supplementary benefits even with taxable assets of CHF 1 million, provided the adjusted gross income in question does not exceed a defined level. With respect to the second pillar, another important reason for the hike in expenditure is the widespread use of lump-sum withdrawals in lieu of a pension. We've calculated that in Canton Schwyz in 2015, 44% of all recipients of supplementary benefits had previously withdrawn capital from the second pillar. For the whole of Switzerland, this figure was around 33%.

But can't people do what they want with their money?

In principle, yes. But the second pillar was established to ensure a secure retirement for people in the long term. For this reason, the employer is required by law to subsidize contributions and, at the same time, the state is obliged to forgo tax revenue which would otherwise accrue to it. When capital is withdrawn, not to secure a livelihood but rather to finance a luxury lifestyle for example, the pension fund cannot achieve its intended purpose. In my view, lump-sum withdrawals from the second pillar are not in the spirit of our Federal Constitution.

What concrete measures can be undertaken to stem the soaring costs of supplementary benefits?

In the next amendment to the federal law on supplementary benefits, Parliament needs to decide on restrictions. A sensible move would be to limit access to such benefits instead of just making savings around the system's basic parameters.

elipsLife echo-interview with Andreas Dummermuth

Are you also against lump-sum withdrawals in order to purchase residential property?

This could be the exception that proves the rule, since the Federal Constitution also has a mandate to promote residential building. We need to ensure that no one who really needs supplementary benefits has to suffer cuts in such payments. On the other hand, we can't allow the system to deteriorate into a tax-subsidized safety net for the middle class or for people with substantial assets. That would be absurd.

What do you think about flexible retirement age?

I think the flexibility and individualization proposed by the 2020 old-age pension reform is very important. The people want it. Whether in the first or second pillars, we really need to get to grips with these social security topics, even when they're administratively time-consuming. I believe that actually introducing flexibility between 62 and 70 is the best way to prepare for gradually raising the official retirement age.

Should pensioners also be called upon to help recapitalize the social security system – or are previously earned pension rights a taboo topic?

Pension rights are not taboo. If the economy collapses, then this also has to have an impact on pensions. But this is pure fiction. The reality right now is that we have continuity. AHV pensions are adjusted every two years for wage and price development. At the beginning of this year, there was no adjustment because wages and prices had not risen.

Many people assume that when they reach retirement age, they’re not going to see much of either their AHV money or of their other pension savings. How can people’s trust in our social security systems be strengthened?

I don’t see it that way. I believe, on the contrary, that the Swiss have great confidence in the AHV. The scepticism in your question, by the way, has been around since 1947 when there was a campaign to prevent the introduction of the AHV. But every month we’re proving to the Swiss people that the system works very well.

Personal Profile
Andreas Dummermuth
Director of the Social Security Authority/Invalidity Office of Canton Schwyz and President of the Conference of the Social Security Authorities of the Swiss Cantons

Born in 1961, Andreas Dummermuth, from Goldau Schwyz, gained a law degree from Zurich University. He later gained a Masters Degree in Public Administration from the Institut de Hautes Etudes en Administration Publique in Lausanne. He began his professional career at the Schwyz Canton Court, subsequently moving to the legal department of the Schwyz Ministry of Education. Following this position, he spent 13 years as Director of the Social Security Authority/Invalidity Office for Nidwalden before becoming Managing Director of the Social Security Authority/Invalidity Office in Canton Schwyz in 2007. Dummermuth is also President of the Conference of the Social Security Authorities of the Swiss Cantons (professional association for the first pillar).

echo-Interview with Andreas Dummermuth