How does the group life business work? How are the benefits funded? How can insurance companies operate profitably?
The Swiss system of provision for retirement is based on three ‘pillars’: occupational, private and state-run pension schemes. Group life insurance is used to provide occupational pensions – so-called Pillar 2.
Employees who are at least 17 years old and earn a certain minimum wage from an employer are required by law to be registered in an occupational pension scheme.
Employers who employ workers who are required to be registered in such a scheme must either set up their own statutory pension system or join an existing scheme.
The collective foundations run by Baloise Life Ltd offer such existing pension schemes in Switzerland. Roughly one-third of employees in Switzerland are now covered by this type of pension solution from a private Swiss insurer.
Pillar 2 supplements the state-run pension scheme (Pillar 1) and aims – within reasonable limits – to enable policyholders to maintain the standard of living to which they are accustomed. It generally achieves this objective by providing benefits amounting to 60 per cent of final salary. Occupational pension benefits are financed as part of a fully funded plan, with employer and employee paying contributions into the pension fund throughout the term of the policy. These contributions consist of a savings component, a risk component and a cost component. The risk component is used to finance death and disability benefits prior to retirement, while the cost component covers the administrative expenses incurred. The savings component contributions paid in are held in an individual pension account and earn interest. This builds up individual pension assets – amounting to 1 million in the above example (A2) – which, when the policyholder retires, are paid out as pension benefits in the form of an annuity or a lump sum. These benefits would come to 68,000 per year in this example (B2).
The key parameters used to calculate the level of pension benefits are the minimum rate of return on these pension assets and the conversion rate at which the pension assets are converted into an annuity at the retirement date. Both of these parameters are institutionally fixed for the purposes of Swiss statutory pension schemes: the conversion rate (currently 6.8 per cent, B2) is stipulated by law, while the minimum rate of return (currently 1.25 per cent, A3) is set by the government.
The contributions paid to the insurance company are invested in the capital markets. At least 90 per cent of the income (D3 / D4) generated by the three business processes must accrue to the policyholders.
Insurers make sure that this is the case by paying insurance benefits, strengthening their reserves and allocating capital to the surplus fund. The remaining income of no more than 10 per cent stays with the insurance company (D4). The rule of thumb – which equally applies to the insurance industry as a whole – is that an insurer’s profitability is closely linked to its risk selection processes and cost effectiveness.