The two big public pension plans in Geneva are in dire straits. The local legislature is considering a bill this week that would merge them and would also provide a capital injection of almost a billion Swiss francs. The funds have pursued what is euphemistically called a mixed financing strategy. Their assets cover less than sixty percent of their liabilities with the remainder guaranteed by the local government, i.e., the taxpayers of Geneva. (This is where I should perhaps declare an interest: I am one of them.) The bill also proposes higher contributions by members and employers to raise the fund’s coverage ratio to eighty percent over the next forty years as required by federal law. To keep the required capital injection and contribution levels at a politically palatable level, the assumptions underlying these changes are rather optimistic. Consequently, I fear that Geneva taxpayers may well be asked to refinance their public pension plan at regular intervals over the foreseeable future.
The asset cover of the two funds had gradually eroded over the years due to a combination of benefit promises that were too generous (the funds are and will remain defined benefit plans and used to promise full indexation of benefits), contributions that were substantially lower than those of comparable funds elsewhere and disappointing investment returns. No serious measures were ever taken to stop the erosion until now.
There are two issues in this local saga that are perhaps of broader interest. One is the fact that a government guarantee may provide perverse incentives to the boards running such funds, and the other is the policy of the funds to invest exclusively in socially responsible investment strategies despite being seriously underfunded.
The merged fund will continue to benefit from a government guarantee. Benefits will also continue to be indexed to inflation if the fund’s financial situation is sound. The local government will set the level of contributions. But the level of benefits and the investment strategy will be determined by the board of the new fund. According to Swiss law, the board will consist of equal numbers of employer and employee representatives. But, given the political sympathies of some employer representatives – chosen from among the political parties represented in the legislature – the board will likely have an open ear for the viewpoint of the employees. This would not be an issue if it were not for the guarantee. There is no plan sponsor in the Anglo-Saxon sense under Swiss rules, so that pension funds without such a guarantee must keep their books balanced or the members will suffer the full consequences. But thanks to the government guarantee, the board of the new fund will have a free option (or at least a very cheap option). If they choose a overly risky investment strategy and happen to be lucky, they will be able to index member benefits to inflation. If the strategy fails, they will go back to the government and ask for a further cash injection (active members would have to participate in the refinancing but pensioners would escape any consequences). The experience of the two funds over the past decades suggests that this is not a theoretical concern. Despite a deteriorating coverage ratio, business was conducted as if the situation was sustainable, which it was clearly not. Governance arrangements for seriously underfunded pension funds that benefit from a government guarantee ought to be reconsidered. It is not just greedy bankers that respond to perverse incentives but members of pension fund boards as well.
The two funds are proud to have been among the pioneers in the pursuit of socially responsible investment (SRI) strategies. Unsuitable issuers are systematically excluded in all asset classes. There is nothing wrong with SRI strategies. They are obviously a sensible long-term approach: we have to manage the finite resources of our planet in a responsible, sustainable way. But most SRI strategies appear to underperform traditional approaches. Over the past decade, the performance penalty in most markets has been substantial. In addition, the exclusions may lead to a less broadly diversified portfolio. Thus, SRI makes sense only if investors are motivated by wanting to do good and feel good with their investments to compensate them for the fact that they are likely to do less well than with a traditional approach.
But in the case of the Geneva pension plans, while the board gets to feel good and do good, it is the Geneva tax payers who pick up the tab for the performance penalty. Is it really socially responsible or ethical for seriously underfunded pension plans that benefit from a government guarantee to pursue a strategy that is highly likely to reduce their expected performance or forces them to take on more risk to achieve the same potential performance? I wonder.
I do not begrudge the civil servants of Geneva their generous pension arrangements. I do wonder, however, about the governance arrangements of their new fund and their definition of ethical and socially responsible behavior.