Swiss Institutional Investors

Abstract

Institutional Investors, such as insurance companies, pension funds, real estate funds, and mutual funds, have become critically important players in the Swiss financial market. They channel capital from a multitude of investors, such as households, businesses, and the government, into asset classes like equities, debt, commodities, and real estate. The social security system plays a key role in this, together with the state-run basic benefit plan, the mandatory occupational pension scheme, and private savings. Insurance companies, comprising life insurance, non-life insurance, and reinsurance business activities, along with the growing class of collective investment schemes, have become enormous sources of investment capital, deciding about their allocation—unfortunately not in the best interest of their contributors’ future, also because of increasingly comprehensive regulations.

Introduction

Financial intermediaries exist because they perform valuable services for savers and borrowers.¹ Savers use them for the efficient and effective ways they offer to invest and withdraw funds in different amounts. Borrowers use them for their lending flexibility, power to lower search costs, and access to broad and deep pools of funds . Generally speaking, financial intermediaries moderate the risk -to-reward tradeoff by pooling funds , specializing in risk evaluation (i.e., credit, liquidity, and market risks ), and engaging in measured risk-taking activities.

The similarities among financial institutions, such as banks, insurance companies, and mutual funds, are strong. To be sure, part of this similarity is legal because most financial institutions need licenses to operate. Nevertheless, far beyond this legal commonality are economic resemblances grounded in human resource competencies, fund transfer goals, and an ability to engage in risk and maturity transformation. It is for these reasons that competition in the financial markets has intensified.

This chapter focuses on Switzerland’s institutional investors. These organizations conduct investments using a pool of funds they obtained from a multitude of investors. Typical institutional investors are insurance companies and related financial intermediaries, such as pension funds and mutual funds. It is fair to say that historic lines of competition are blurring in the Swiss financial markets, and the nation’s financial landscape is transitioning. Therefore, focusing solely on the narrowly defined insurance industry risks overlooking a landslide transformation in competition.

Investment Market Intermediaries

Figure 6.1 provides an overview of the ultimate suppliers of funds in the financial markets. In broad terms, funds flow from surplus units in the household, business, government, and foreign sectors to deficit units, such as consumers, businesses, governments, and foreign borrowers. Households supply funds by saving from annual incomes and reallocating existing portfolios. Businesses supply funds from non-operating assets fed (or drained) each year by retained earnings. Governments could supply funds if they ran surpluses, but few of them do, and, finally, foreigners are active suppliers of funds, which can flow internationally at the blink of an eye.

Fig. 6.1

(Source Authors’ representation)

Investment market intermediaries in Switzerland

Households, businesses, governments, and foreigners are also active users of funds. The debt crises of 2010 and 2011 pointed to the unpleasant side effects of unrestrained debt accumulation in nations such as Greece, Ireland, Italy, Portugal, and Spain. Excessive deficits in Latin America and Russia are also well known. The Covid-19 assistance programs in many countries in 2020, also Switzerland, have led to another rise in government indebtedness.

Insurance Sector

Insurance companies occupy a special place in the financial markets among institutional investors. The key principle of insurance is risk pooling. Ideally, these risks are uncorrelated (i.e., diversified across broad pools of risks), and if they are, potential insurance claims can be financed with reserves, which are accumulated and invested to meet future needs. In addition to the reserves that insurance companies accumulate to meet actuarially predicted claims, extra (i.e., buffer) reserves are also needed because premiums, accumulations, and indemnifications are not perfectly timed. Black swan events with regard to risks or investments can (and do) occur, causing insurance companies with seemingly well-diversified portfolios and risks to come under considerable pressure. Finally, insurance companies accumulate investable funds by offering policies that encourage private savings. For these reasons, they have become significant investors in global capital markets.

Switzerland’s insurance industry has a long history, dating back to the foundation of Mobiliar in 1826, followed by Rentenanstalt (today Swiss Life, 1857), Helvetia (1858), Bâloise (1863), Schweizer Rück (today Swiss Re, 1863), Zurich (1872), Winterthur Versicherung (1875), Pax (1876), and Vaudoise Assurances (1895).

As in most countries, Switzerland’s insurance industry has both a private and a public sector. Public insurance prevails mainly in social security and protection against natural disasters. For social security, the objective is mainly to redistribute income and address problems connected to moral hazard and adverse selection.² Natural disaster insurance covers risks that are relatively large but have trifling probabilities of occurring. By contrast, private insurance tends to focus on the areas of life and health, as well as liability and damage (e.g., automobile insurance).

Pension Funds and Other Institutional Investors

The Swiss social security scheme consists of three pillars: The first pillar is the mandatory state-run pension and disability insurance, the second pillar comprises the occupational pension scheme, and the third pillar represents the individual and optional retirement savings plans. We will discuss the pillars in further detail later in this chapter.

Among the related institutions of the second pillar, pension funds are, by far, the most important, basing their operations on the funding principle (i.e., benefits are met from policyholders’ premiums paid during their working years, and from accumulations from invested reserves). Accordingly, pension funds have vast amounts of assets to manage.

The other components of the private insurance sector are health insurance, non-life insurance, and reinsurance. Except for health insurers, all the financial institutions connected to these services have relatively large pools of investable assets, potentially exposing these investors to substantial one-off risks (e.g., natural disasters).

Institutional Investing

Table 6.1 provides an overview of the leading players in the Swiss insurance market, as well as the financial intermediaries related to the nation’s social security services and their investments, separated by asset classes. Columns 2, 3, and 4 of this matrix are the pillars of Switzerland’s social security system. The first pillar (column 2) is the state social security pension scheme, which has six components. Its primary purpose is to guarantee a minimum level of benefits for retired individuals and those with physical or social disabilities. Because these insurance schemes are on a pay-as-you-go basis, the assets invested by their respective institutions are relatively small.

Table 6.1 Summary matrix: Swiss financial security system and financial intermediaries

The investments of all these institutions mainly focus on government bonds, listed equities, and real estate, but their incentive structures are such that only marginal investments are made in non-listed equities and venture capital opportunities. Hence, although social security institutions and insurance companies are enormous collectors of capital, their financial resources barely flow into the financing of start-ups. The impact of investment policies on economic growth has only recently gained attention in the respective political debates.

Table 6.1 also provides a convenient outline for the remaining sections of this chapter, which starts with the three-pillar system, moves to the Swiss insurance market, and, finally, provides an overview of the nation’s collective investment schemes.

Swiss Social Security: The Three Pillars

The Swiss social security system builds on three highly interdependent financing pillars:

• 1. The state-run, basic benefit plan is extended to all residents.³

• 2. The mandatory occupation pension scheme.

• 3. Private savings (see Fig. 6.2).

Fig. 6.2

(Note EL = Supplementary benefits that cover the minimum costs of living where OASI and DI are not sufficient; AHV = Old Age and Survivors Insurance (OASI); IV = Disability Insurance (DI); EO = Loss of earnings insurance; ALV = Unemployment insurance; FZ = Family allowances; BVG = Law on Occupational Benefit (LOB); ZGB = Swiss Civil Code ; OR = Swiss Code of Obligations . Source Authors’ representation)

Three-Pillar Concept of Social Security in Switzerland

Before the introduction of these types of compulsory savings, corporations directly used the funds for productive investments. Since then, to channel savings from these three retirement-financing sources to investment assets, a labyrinth of financial intermediaries has evolved in Switzerland. For large companies with significant pension assets, in-house pension management is possible, but pooling arrangements must be made for most companies. At the end of 2020, there were 4.4 million (2010: 3.7 million) members of 1,434 (2010: 2,265) Swiss pension funds.⁴ Most of these pension funds relied on the financial skills of investment fund managers, collective or pooled foundations, and Swiss life insurance companies to manage their retirement savings.

The First Pillar: Mandatory State-Run Pension and Disability Insurance

The Swiss social security scheme (OASI/DI) guarantees a minimum level of benefits to pensioners and is the first line of defense against poverty or undue social hardship. Minimum compensation is fixed by the government and is not based on either salary levels prior to retirement or years of contribution, but, for every year of missed contributions, a reduction in the maximum insurance proceeds of about 2.3% is applied.⁵ Furthermore, above the minimum level, benefits are adjusted by pre-retirement income, but they are capped far below levels sufficient for all but the lowest income earners to maintain their standards of living. Hence, the system is highly redistributive, funneling contributions from high to low-income earners. For higher-income earners, the contribution has the character of a tax. In addition to OASI/DI, occupational pensions and private savings play an essential role in making the difference in the Swiss retirement equation. Still, revenues from these sources are taxed at progressive rates that make them redistributive, as well.

In an ideal world, OASI/DI’s current benefits would be financed by current contributions with zero annual surpluses or deficits. In practice, the timing and flow of both contributions and payments are not exactly matched, creating an investment pool that has needed administering (see Fig. 6.3). The surpluses have created three equalization funds (i.e., one each for OASI, DI, and EO),⁶ which are managed by a common administrative council.⁷ It is responsible for investment, liquidity management, and financial and annual reporting. Capital investing takes place according to safety, profitability , and liquidity requirements .

Fig. 6.3

(Source Authors’ caltulations based on data from Bundesamt für Sozialversicherungen, Schweizerische Sozialversicherungsstatistik 2021, https://www.bsv.admin.ch/bsv/de/home/sozialversicherungen/ueberblick/grsv/statistik.html; Schweizerische Sozialversicherungsstatistik 2022, [Accessed on October 3, 2022])

Net Assets of OASI, DI, and EO: 2005–2020 (Billions of Swiss Francs )

During the post-World War II period until 2021, the average return on funds invested by the former Swiss Central Compensation Fund was slightly above four percent per annum.⁸ This low rate of return was due largely to restrictions placed on the range of allowable investments due to high liquidity requirements . As a result, the return was insufficient to finance benefit liabilities , but the deficit (until 1985) was filled by surpluses that arose from Swiss workers changing jobs. Before 1985, pension-vesting rules decreased workers’ benefits when they changed employment. Since 1985, the pension-vesting rules have been modified for the benefit of Swiss workers and increased labor mobility.⁹

In 2020, OASI had a surplus capital position totaling CHF 47.2 billion, and DI was in debt by approximately CHF 5.8 billion (see Fig. 6.3). Although the OASI capital stock was relatively stable over the past decade (2010: 44.2 billion), and DI reduced its indebtedness (2010: −14.9 billion), most forecasts predict declining surpluses and significant deficits. The rate at which current surpluses decline will depend on factors such as increases in benefits, real wages growth, inflation rates, returns on invested capital, and the net size of the workforce. Immigration levels, female participation rates, longevity, fertility rates, and average retirement age will also play significant roles.

The Second Pillar : Occupational Pensions

In 1985, the Swiss Parliament made occupational pension plans mandatory for virtually all Swiss businesses, based on the Law on Occupational Benefit (LOB).¹⁰ LOB pension programs are financed by direct payroll deductions and contributions from employers. In its early years, there was a predominance of defined-benefit schemes. Workers received a share of their income based on a sliding scale, with low-income earners receiving much larger percentages of their incomes (up to 90%) than high-income earners (as low as 25%). In recent years, there has been a strong trend towards defined contribution plans that base employees’ payments on their contributions.¹¹ Unlike the government plan (i.e., OASI/DI), funds are collected by these pension funds , and assets that are not distributed immediately are invested and accumulate.

Between 2005 and 2019, the assets of occupational pension funds grew at a compound annual rate of 4.3%, reaching CHF 1021 billion (see Fig. 6.4).¹² In the decade between 2010 and 2019, the share of real estate has increased more than the share of bonds. In 2019, bonds accounted for 30%, real estate for 20%, shares for 30%, alternative assets for 9%, liquid assets and short-term investments for 5%, mortgages for 2%, and other investments for 4% of the total assets. Collective investments managed 67.2% of these assets (see Fig. 6.5).¹³ Like insurance companies , this portfolio allocation provides visual evidence that pension funds ’ incentives were aligned to preserve capital rather than venture into riskier activities that contribute the most to growing economies.

Fig. 6.4

(Source Bundesamt für Sozialversicherungen, Schweizerische Sozialversicherungsstatistik 2021, p. 67, https://www.bsv.admin.ch/bsv/de/home/sozialversicherungen/ueberblick/grsv/statistik.html [Accessed on October 3, 2022])

Assets of occupational pension funds (in CHF billion)

Fig. 6.5

(Source Bundesamt für Sozialversicherungen, Schweizerische Sozialversicherungsstatistik 2021, p. 67, https://www.bsv.admin.ch/bsv/de/home/sozialversicherungen/ueberblick/grsv/statistik.html [Accessed on October 3, 2022])

Composition of occupational pension assets: 2005–2019 (in %)

Swiss pension funds have significantly increased their equity allocations during the past 30 years, from 9.8% in 1992 to 27% in 2010 and 30% in 2019. However, they are still considerably below the 50% limit. The superior return on Swiss equities has been a significant stimulus for this change. Professional and nonprofessional investors have a growing understanding that marginal differences in asset performance are important. Studies have shown that, in the long term, Swiss equity portfolios have outperformed debt portfolios. For instance, between 1995 and 2010, the annual return on Swiss equities (6.92%) was above the return on Swiss domestic bonds (3.96%). Between 1995 and 2021, the difference was even more prominent, with an average return of 8.19% on Swiss equities, compared to just 2.93% on Swiss bonds.¹⁴ Small yearly performance differences accumulate over time to significant performance differences due to the math of compound interest.

As a result, there has been a discernible movement toward equity investments and international diversification during the past 30 years. Moreover, some legal restrictions on equity investments ceased to apply. For instance, since January 1993, Swiss investment rules governing pension funds have permitted them to hold up to 50% of their portfolio in equities. Furthermore, a maximum of 30% of the entire portfolio may be invested in unhedged foreign currencies.¹⁵

Size of OASI and LOB Assets

Figure 6.6 summarizes the investment assets of Switzerland’s social security system and private occupational pension plans from 2010 to 2020. The healthy net surpluses during this period are deceiving and mask a looming problem of the state-run old age and survivors’ insurance scheme. The problem is that its capital and expected future contributions from the working population are unlikely to cover future retirement payments. These financing difficulties are well known and will continue to be the source of wide-ranging policy debates.

Fig. 6.6

(Source Authors’ calculations based on data from: Bundesamt für Sozialversicherungen, Schweizerische Sozialversicherungsstatistik 2021, p. 28 https://www.bsv.admin.ch/bsv/de/home/sozialversicherungen/ueberblick/grsv/statistik.html [Accessed on July 8, 2022])

Total capital of Swiss state-run pensions

The Third Pillar : Individual Savings

In contrast to Switzerland’s second pillar, which is mandatory for employees, the third pillar is entirely optional. It consists of supplementary individual savings, some of which enjoy various tax privileges. The tax-privileged plans are called “3a” solutions and come with a capital lockup. These savings plans are often connected to insurance coverage, such as life insurance policies, which are listed and described later in this chapter. On the other hand, “3b” saving refers to unrestricted individual saving.

Swiss Insurance Companies

Apart from pension funds, private insurance companies are the most prominent collectors of financial resources in the Swiss capital markets. In 2020, the capital investments of private insurance institutions amounted to CHF 712.6 billion.¹⁶ Even though Switzerland is a small part of the world insurance market, comprising just over 1%, insurance plays a vital role in the Swiss economy relative to most developed countries: Among all nations in 2020, Switzerland ranked fourth in terms of insurance per capita and fourth, behind Luxembourg, Denmark, and United Kingdom, in the proportion of its GDP devoted to insurance (Table 6.2).

Table 6.2 Insurance : International comparisons of premiums per capita: 2020

As Tables 6.3 and 6.4 show, the importance of Swiss insurance companies depends on the market segment. In the life insurance business, they no longer ranked among the top 12 in 2022, but, despite the relatively small size of their domestic market, Swiss insurance companies were among the world leaders in the nonlife market, with Zurich Insurance ranking sixth behind U.S. and German competitors. In contrast to the typical Swiss multinational company, which conducts more than 95% of its business abroad, Swiss insurance companies led a large part (but not the majority) of their business in Switzerland.

Table 6.3 Largest life insurance companies in the world 2022 (Ranked by market capitalization)

Table 6.4 Largest nonlife insurance companies and reinsurers in the world 2022 (Ranked by market capitalization)

Swiss Insurance Market Structure

The Swiss insurance industry has three major segments:

• 1. Life.

• 2. Non-life (i.e., property and casualty, as well as supplementary health insurance).

• 3. Reinsurance.

Although competition in the life and non-life segments used to be nationally or regionally oriented, international competition has increased during the past two decades. The same has been valid in the reinsurance industry but on a different scale. Traditionally, reinsurance’s scope was international to enjoy economies of scale from having large customers, such as international insurance companies and corporations.¹⁷ In 2020, the Swiss insurance industry earned CHF 99.3 billion in domestic gross premiums, of which 25%, 29%, and 46% were for life, non-life, and reinsurance coverage, respectively (Table 6.5).

Table 6.5 Premiums in the Swiss insurance market 2021

Since 2000, the premium income has increased overall by 36%. Thereby, premium income in the non-life segment has grown by 56%, whereas in life insurance, it has decreased by 26%. In reinsurance, it has more than doubled during the same period. Premium growth in the non-life insurance market experienced an increase of insured values, such as motor vehicles and assets insured against fire and natural hazards, rising healthcare costs, and rising accident insurance premia due to the growth of aggregate salaries. In contrast, life insurance premia have declined in the same period because of competition and because some insurance companies have withdrawn wholly or partly from the full insurance market that provided guarantees not only for the insurance-related risks but also for investment risks. Due to the low interest rates, it became increasingly challenging for life insurance companies to issue these guarantees. Without full insurance, however, clients face higher exposure to the ups and downs of the financial markets. This has led to a shift into other investment products. In the year 2021, part of the reduction was due to a highly stable labor market leading to fewer job changes.¹⁸

Tables 6.6, 6.7, and 6.8 show the premium volume for the top six companies of each market segment. Their size is highly variable. In 2021, the three largest life insurance companies (Swiss Life, Helvetia, and Basler) accounted for 65.5% of the Swiss market. The three largest non-life insurance companies (AXA, Mobiliar, and Zurich Insurance) comprised 30.5% of their segment. And in the reinsurance sector, the three largest reinsurers (Schweizerische Rückversicherungs-Gesellschaft AG, New Reinsurance Company Ltd., and Swiss Re Nexus Reinsurance Gesellschaft AG) accounted for 73.9% of their market.

Table 6.6 The largest life insurance companies in Switzerland, 2021 vs. 2010 (Ranked by gross premium income)

Table 6.7 The largest non-life insurance companies in Switzerland: 2021 vs. 2010 (Ranked by gross premium income)

Table 6.8 The largest Swiss reinsurance companies: 2021 (Ranked by gross premium income)

For more than 30 years, the Swiss insurance industry has been in a state of accelerated transition. The business environment was characterized by high government regulation, cartel-like price agreements, lack of efficiency-enhancing innovation, and very little foreign competition. The transition began in 1988 when the Swiss government initiated a cartel inquiry into the non-life insurance industry. This effort led to the gradual liberalization of Switzerland’s insurance industry, increasing competition and concentration. Another critical effect of liberalization was a substantial increase in foreign insurance companies’ market shares. After membership in the European Economic Area (EEA)¹⁹ was rejected by a popular referendum in 1992, the Swiss government enacted legislation that forced Swiss insurance companies to compete as if the nation had joined the European Union (EU), and, after that, the EU has moved quickly to deregulate all segments of its insurance industry.²⁰

Deregulation has forced Swiss insurance companies to become more sensitive to costs by rationalizing their sales organizations, pruning bad policies, introducing new products, and using better methods to measure and transfer risk. The shift came when Swiss insurance companies were already under considerable competitive pressure, which caused premium growth to stagnate and commissions to fall. Among the most aggressive new competitors have been foreign insurance companies and banks.

Since 1995, there has been great anticipation of intensified integration between banking and insurance (services) companies in Switzerland, but integration efforts (called the Allfinanz strategy) have stalled. Only recently, they have shown signs of revival. Some of the early bank takeovers of Swiss insurance companies, such as Credit Suisse Group’s takeover of Winterthur insurance company (today part of AXA Winterthur), have already been unwound. Similarly, bank acquisitions of insurance companies, such as Zurich Insurance Company’s purchase of the private bank Rüd Blass in 1994, were unsuccessful due to a lack of substantive lines of integration. In general, integration efforts have been frustrated by significant differences in underlying products and a lack of mutual understanding of the pertinent business models. Another major factor was the dissimilarity in regulators, but this obstacle has changed. Since January 2009, the banking and insurance regulators have been under the single roof of the Swiss Financial Market Supervisory Authority (FINMA). Between 2009 and 2022, there were no major acquisitions anymore in either direction. Still, banks and insurance companies embarked on manifold ways of partnering with each other and setting up common platforms and so-called ecosystems.

Level of Internationalization

Switzerland’s insurance companies entered the international arena at a very early stage, forced mainly by the relatively small national market and the necessity to achieve sufficient levels of risk diversification. By contrast, fewer compelling reasons prompted foreign insurance companies to tap the Swiss market. Mild changes in this pattern began in the mid-1990s, and since then, the level of foreign participation in Switzerland has increased substantially. In 1992, there were only 24 insurance companies (all non-life) in Switzerland, with a market share of two percent.

Since then, the level of international participation has increased significantly. By 2001, 37 foreign insurance companies (35 of them non-life) had entered Switzerland, with a market share of 20%, and, at year-end 2010, the number had increased to 51. With 48 companies in 2021, there was almost the same number of foreign insurers active in Switzerland compared to ten years earlier. This surge in foreign competition has been primarily due to the liberalization of the Swiss domestic market (Table 6.9).

Table 6.9 Swiss insurance segments and international distribution 2021

In contrast, foreign players have been largely absent from Switzerland’s reinsurance market segment due largely to regulations regarding market access. This was a consequence of the limited supervision of Swiss reinsurance companies in the EU and of EU-based reinsurance companies in Switzerland. Since 2010, based on Article 175 of the Directive 2009/138/EC, the EU has declared that supervision of Switzerland’s reinsurance market complies with the EU Reinsurance Directive. In the following, foreign reinsurance companies relocated some of their operations to Switzerland.

The sources of premium payments and the number of jobs created reflect the international profile of Switzerland’s insurance industry. Of the CHF 226.5 billion earned during 2021, CHF 171 billion (75.4%) was from foreign sources (see Table 6.10).

Table 6.10 Domestic and foreign premiums of Swiss insurance companies by source: 2010 and 2021 (Figures in billions of Swiss Francs)

Swiss insurance companies have had some important foreign acquisitions during the past three decades. As early as 1994, the German insurance company Allianz bought from Swiss Re a majority share of Elvia, the fifth-largest Swiss direct insurer at the time, and a 31% share of Berner Insurance Group.²¹ In 1995, Allianz increased its share in Elvia to nearly 100% through a public offering,²² and, in 2001, the company’s share in Berner Insurance Group and its affiliate, CAP (which offers legal protection insurance ), increased to 97%. In this context, the company also changed its name to Allianz Suisse, which communicated the combination of Allianz’s activities in the Swiss insurance market.

The French global insurance group, AXA, followed suit in 2006 by acquiring, for CHF 12.3 billion, 100% of the leading Swiss insurance company, Winterthur Group, a former affiliate of Credit Suisse Group. Through this acquisition, AXA significantly advanced its position in the Swiss non-life market, strengthened its leading position in Europe, and increased AXA’s presence in high-growth markets in Central and Eastern Europe and Asia. As a national transaction, Helvetia acquired Nationale Suisse in 2014.

Competition with Banks

During the mid-1990s, banks and insurance companies increasingly became vigorous competitors, but they also formed numerous strategic alliances.²³ Given the similarity in some of their functions, the fight for financial turf and a web of operating alliances were logical consequences of this competitive environment. Both financial institutions issue liabilities (policies or deposits ), invest the proceeds, compete in the labor markets for the same qualified investment managers, and vie for customers interested in managing their risk levels.

Despite competition in several fields, it is helpful to remember that banks’ and insurance companies’ business models are substantially different. While banks generate, finance, and service loans, insurance companies gradually build reserve assets based on client premiums plus the market returns on invested funds minus claims. Furthermore, banks engage in maturity transformation activities, making them inherently risky, which is not the case for insurance companies. Although insurance companies face redemptions, penalties for early withdrawals significantly reduce these risks. Generally, banks are driven mainly by the asset side of their balance sheets, while insurance businesses tend to focus more on the liability side.

Insurance companies and banks are specialists at shifting risk from individual customers to a diversified pool of assets. However, insurance companies’ debt instruments are contingent liabilities, and their investments mirror, as closely as possible, the term structure of their liabilities—which is relatively long-term for life insurance companies and short-term for property and casualty companies.

Banks commonly offer off-balance sheet contracts, such as forward exchange, forward interest, swap, and option transactions, to modify customers’ and their own risk levels. In the competition between banks and insurance companies, Swiss banks have used their extensive branch networks and frequent contacts with potential insurance customers to make inroads into the life insurance segment of the industry.²⁴ It is only natural that these similarities would forge significant levels of integration between banking and insurance services, but, as previously mentioned, this Allfinanz or Bancassurance strategy has been challenging to implement and, therefore, less prolific than expected.

A common practical problem associated with combining a formerly independent bank with a previously independent insurance company has been the competition between existing distribution channels, which has hampered many potential synergies. Due to these problems, the market tends to favor affiliations, collaborations, and associations instead of integrating through acquisitions and mergers. In recent years, banks and insurance companies have partnered by setting up collaborative platforms and ecosystems focused on servicing clients’ needs instead of product offerings. Hence, products and services are complementary in many ways, but institutionally, the insight has grown that there are good reasons to keep banks and insurance companies as separate institutions. In particular, the digitalization of financial services has contributed to this new era of Bancassurance.

Cooperative agreements as strategic initiatives have a long history in the Swiss market. In 1992, Swiss Bank Corporation (SBC, today UBS) and Zurich Insurance Group were among the first to start a joint venture to develop their life insurance businesses. In 1996, they extended their cross-selling efforts to a broader range of products. In addition to its life insurance offerings, SBC subsequently offered its customers property, liability, and accident insurance via its affiliate, Zurich Insurance. Simultaneously, Zurich Insurance started selling its clients SBC’s investments and products. In 2020, UBS and Zurich Insurance Group announced their launch of Bancassurance products for entrepreneurs and followed up in 2022 with a joint offering for leasing products.²⁵

In 1994, Credit Suisse Holding (today, Credit Suisse Group) and Swiss Re announced a new agreement to cooperate in ways that would expand Swiss Re’s geographic range and product offerings. The agreement grew Swiss Re’s activities in the financial reinsurance business,²⁶ created an investment fund to promote new insurance companies in Asia and gave Swiss Re 20% control over Credit Suisse Financial Products (CSFP), a London -based financial derivatives specialist. Participation in CSFP should help develop new financial derivatives for the reinsurance industry. The cooperation lasted until 2002 when Credit Suisse Group sold its shares .

In 1999, Helvetia Insurance signed a distribution cooperation agreement with Raiffeisen Group for its products, which also included capital participation in Raiffeisen Group. The parties renewed this agreement in 2009. In the context of this agreement, Raiffeisen had agreed to distribute the insurance products of Helvetia, while the deal also allowed Helvetia to offer Raiffeisen/Vontobel funds to its customers. In 2021, the cooperation ended, and Raiffeisen Group entered a new partnership with Mobiliar.

In the life insurance segment of the market, Credit Suisse and Zurich Life Insurance Company established a partnership in 2010.²⁷ Since October 2010, life insurance products from Zurich Life have been available to the bank’s clients in Switzerland, which supplement the bank’s existing range of products and services in the fields of pension provisions , retirement solutions, and risk coverage. Other examples of cooperative agreements between insurance companies and banks have been agreements between AXA Winterthur and Postfinance , as well as the affiliation between Bâloise Group and Bâloise Bank SoBa (the latter being a subsidiary of the Bâloise Group). A more recent example is the cooperation of Smile, an online insurance company and subsidiary of Helvetia, and the digital bank Neon, targeted at providing joint mobile Bancassurance solutions.

Asset Structure of Insurance Companies

Table 6.11 shows the investments and the security composition of Switzerland’s life, non-life, and reinsurance companies. The assets of life insurance companies are mainly long-term and conservative, including bonds, mortgages, loans, shares, real estate, and liquid funds. The industry’s investment yield of about 4.5 to 5.5% reflects this safety consciousness during the past 80 years. Average investment yields were only about 3.5% from 2010 to 2020 (Fig. 6.7). Non-life and reinsurance companies invest heavily in government securities and mortgage bonds.

Table 6.11 Investments of life, non-life, and reinsurance companies 2021 vs. 2010 (CHF billion)

Fig. 6.7

(Source FINMA, annual issues of Bericht über den Versicherungsmarkt [2008–2021], for 2021: https://www.finma.ch/de/~/media/finma/dokumente/dokumentencenter/myfinma/finma-publikationen/versicherungsbericht/20220909-versicherungsmarktbericht-2021.pdf [Accessed on October 3, 2022])

Investment returns of life, non-life, and reinsurance companies 2008–2021

Due to Swiss insurance companies’ tight investment prescriptions, which favor domestic government bonds and other safe Swiss securities, foreign borrowers have not found the private Swiss insurance sector to be a significant source of funds. Switzerland’s social security system, private pension funds, and the private insurance sector are the financiers of Swiss federal, cantonal, and municipal government deficits. This funding source is reflected in the very high proportion of assets invested in bonds, among which government bonds dominate, as shown in Fig. 6.8.

Fig. 6.8

(Note Major shareholdings denote long-term equity holdings in other companies. Source Schweizerischer Versicherungsverband, Prämienvolumen und Kennzahlen, https://www.svv.ch/de/der-svv/svv-publikationen/zahlen-und-fakten/zahlen-und-fakten/praemienvolumen-und-kennzahlen [Accessed on October 3, 2022]; FINMA, Bericht über den Versicherungsmarkt 2021, https://www.finma.ch/de/~/media/finma/dokumente/dokumentencenter/myfinma/finma-publikationen/versicherungsbericht/20220909-versicherungsmarktbericht-2021.pdf [Accessed on October 3, 2022]. For 2010: FINMA, Bericht über den Versicherungsmarkt 2010, https://www.finma.ch/~/media/finma/dokumente/dokumentencenter/myfinma/finma-publikationen/versicherungsbericht/versicherungsreport-2010-d.pdf?sc_lang=de [Accessed on October 3, 2022])

Structure of Swiss insurance companies’ investments: 2021 vs. 2010

Regulation

There have been waves of deregulation in the Swiss insurance sector during the past 30 years, each designed, in its way, to increase competition. Still, there have also been undercurrents of increased regulations in areas such as customer protection and system stability. Today’s foundation for Switzerland’s insurance regulation is the 2004 law on the supervision of insurance companies,²⁸ which defines the responsibilities and basic requirements for licensure, risk management, reporting, brokerage, and default procedures of insurance companies .²⁹

On a contractual level, the 1908 law on insurance contracts regulates the legal relationship between an insurance company and the insured.³⁰ In the field of social insurance , the law on retirement and disability insurance ³¹ has defined, since 1946, the basis for Switzerland’s first pillar of the social security system (see above), whereas its second pillar was founded on the 1982 law on occupational retirement.³² In addition to the laws mentioned earlier, there are insurance laws pertaining to particular risks , such as the 1981 Law on Accident Insurance³³ and the 1994 Law on Health Care Insurance.³⁴

Since the heavy portfolio losses suffered by Swiss insurance companies in the wake of the 2001 to 2002 stock market downturn, there have been continuous regulatory efforts to increase system stability. In the EU, these activities have focused on solvency. The first wave of EU regulation, called Solvency I, was enacted in 2002 and followed, in 2016, by Solvency II rules. Similarly, since January 2011, Swiss insurers have been obliged to apply the Swiss Solvency Test (SST) to their portfolios. SST grounds on three basic principles³⁵:

• 1. Positions should be valued at market prices and closely mirror current market conditions. Valuation models may be applied if market prices are unavailable. This principle starkly contrasts Solvency I requirements, which were based on historic costs.

• 2. Capital requirements should be risk-based and focused broadly on market, credit, and technical insurance risks.

• 3. Risk management should use the total balance sheet approach, which requires on-balance-sheet reporting of all relevant positions. This framework forces insurance companies to value all their contingent assets and liabilities (e.g., embedded options).

Based on the assets and liabilities of a typical insurance company, the SST provides a methodology for determining the required capital (target capital). The solvency ratio then measures the available capital relative to the target capital required by the SST. As Fig. 6.9 shows, the solvency ratios of Swiss insurance companies have consistently been above 200% on average from 2016 to 2020. That means, in total, surplus capital has been even larger than the required capital. 98 out of the 133 insurance companies supervised by FINMA in 2021 used the standard model approach of the SST. By contrast, 35 insurance companies either used an internal model (19) or a standard model with some internal modules (16).³⁶

Fig. 6.9

(Source Schweizerischer Versicherungsverband, Prämienvolumen und Kennzahlen, https://www.svv.ch/de/der-svv/svv-publikationen/zahlen-und-fakten/zahlen-und-fakten/praemienvolumen-und-kennzahlen [Accessed on October 3, 2022]; FINMA, Bericht über den Versicherungsmarkt 2021, https://www.finma.ch/de/~/media/finma/dokumente/dokumentencenter/myfinma/finma-publikationen/versicherungsbericht/20220909-versicherungsmarktbericht-2021.pdf [Accessed on October 3, 2022])

Solvency ratios of Swiss insurance companies

The SST comprehensively integrates relevant risk categories into the calculation of target capital and provides a breakdown of the risks driving it. Therefore, it is a modern instrument for regulators and the insurance sector to measure the financial health of this industry. One major problem with the SST and Solvency II frameworks is that positions are more volatile and procyclical than under Solvency I.

Influence of Pension Funds and Social Security System on Swiss Capital Markets

Like other developed nations, Switzerland has an aging population, and this demographic change has important implications for domestic and international capital markets. Many members of the post-World War II baby-boom generation have either retired or will have retired by (about) 2030. Because of their numbers, the volume of accumulated savings, investments, and pension liabilities has grown at unprecedented rates and to unprecedented levels. A reflection of this growth has been the steady increase in Swiss pension fund assets, which reached, in 2019, CHF 1,021 billion,³⁷ a sum equal to 140% of the nation’s GDP .

Between 2018 and 2050, the proportion of Switzerland’s population receiving pensions is expected to rise from 18 to 26%.³⁸ Financing these retirements and determining the role government will play in supporting them are issues that relate directly to Switzerland’s interest rates , economic growth, and income distribution. To the extent that the Swiss government finances these needs, inter-generational conflicts could arise. The federal social security program (OASI) contemporaneously taxes the current workforce to provide for current pensioners. Any surpluses or deficits that arise are unintended and not based on a conscious policy of asset accumulation. Given that insufficient assets exist to support future pension liabilities , the arithmetic is disconcerting. In 1970, 4.6 Swiss workers supported the average Swiss pensioner, in 2021, the ratio was 2.8, and by 2050, this ratio is expected to fall further to 1.9.³⁹

Occupational pension programs and personal savings are two alternative sources of financing for future retirement needs. The extent to which they are used raises essential issues concerning the proper composition of investment assets (e.g., bonds versus equities versus real estate versus commodities), their geographic distribution, currency diversification, level of risk, and duration. Most nations severely restrict the portfolio decisions of pension portfolio managers, erring on the side of safety over a return, but this safety comes with a high cost. A mere one percent lower return compounded over 45 years of one’s working life has substantial implications for future living standards.

Suppose an individual retired in 2022 after working for 45 years. His base salary in 1977 was CHF 10,000, and, over the years, he earned annual pay raises that averaged four percent. If he contributed 13% of his salary each year toward retirement and his pension fund made 4%, he would be able to retire with a pension equal to roughly CHF 1,700 per month, 20% of his final year’s monthly pay. Had the pension fund earned 5% rather than 4%, his monthly pension would have increased to CHF 2,150, 26% of his final year’s monthly pay.⁴⁰

Investment Funds

Investment funds organized as mutual funds are an essential part of the Swiss capital markets and are subject to rigid legal regulations and supervision by FINMA. Of the 10,385 admitted funds as of July 2022, 1,879 were Swiss with combined assets of CHF 1,334 billion (as of the end of June 2022).⁴¹ Unlike mutual funds that are regulated by several foreign countries, Swiss investment funds do not necessarily have the status of a legal entity. They can also represent separate assets based on a collective investment contract instead. Foreign investment funds may be distributed in Switzerland, which brings them under the regulatory umbrella of Swiss laws and the supervisory powers of Swiss authorities.

The main growth period for Swiss investment funds was during the late 1960s and early 1970s. However, some of these funds have existed in Switzerland since the 1930s. For example, America Canada Trust Fund (AMCA, today part of UBS Equity USA), founded in 1938 by Schweizerische Bankgesellschaft (SBC, which is today UBS), had the distinction of being the first fund of that kind in Switzerland. The launch of the first Swiss real estate fund also occurred in 1938.

An important peculiarity of the Swiss investment fund business is that it is part of the domestic banking system. By law, open-end collective investment schemes must be managed by a separate company whose sole business is to manage the investment fund. Each fund must have a bank as custodian (depot bank) that is responsible for asset management, which includes safeguarding investments in these funds, executing all payments, and assuring that the open-end collective scheme is compliant with the law and fund regulations. The management of the scheme must be completely separated from its custodial functions. More important than these legal obligations is the moral responsibility, which derives from the public’s identification of each scheme with the custodian’s name. Custodians often advertise investment schemes under their names, virtually guaranteeing their custodial function.

Tapping the EU markets has been a challenge for Swiss investment funds due to domestic taxes (e.g., stamp duties), restrictive investment policies, and other regulations. As a result of these disincentives, Swiss banks that wanted to maintain an international presence in this industry responded by establishing investment fund operations in Luxembourg. As of June 30, 2022, Switzerland was the fourth largest promoter of collective investment schemes, also known as Undertakings for Collective Investment (UCI), behind Germany, U.K., and the United States with a market share (in net assets) of 13.9%.⁴² At the same time, most collective investment schemes distributed in Switzerland are domiciled in Luxembourg (Fig. 6.10).

Fig. 6.10

(Source Staatssekretariat für Internationale Finanzfragen SIF, Finanzstandort Schweiz―Kennzahlen April 2022, https://www.sif.admin.ch/sif/de/home/dokumentation/finanzstandort-schweiz-kennzahlen.html [Accessed on July 25, 2022])

Domiciles of collective investment schemes (April 2022)

FINMA must officially permit the distribution of foreign collective investment schemes in or from Switzerland, but it does not supervise admitted foreign collective investment schemes. Instead, supervision is in the hands of investor-protection laws of their respective home countries. The organization, investment rules, and policies must be on par with Switzerland’s Federal Act on Collective Investment Schemes. In addition, the scheme’s name must not give rise to confusion or fraud, and, according to Swiss banking law, a bank must act as the representative and paying agent. This representative bank’s principal task is to represent the foreign collective investment schemes for investors and FINMA and to ensure compliance with Swiss regulations and the self-regulatory rules of the Swiss Funds Association.

Figure 6.11 shows that at the end of the first quarter of 2021, shares accounted for 34.1% of the assets in all Swiss collective investment vehicles. Bond issues shrank from 33.4% in 2005 to 26.5% in 2022. Until 2007, these statistics comprised only mutual funds. However, due to the enactment of the Federal Act on Collective Investment Schemes (KAG) in 2008, they now include other collective investments, such as investment companies.

Fig. 6.11

(Source Swiss National Bank, Swiss open collective capital investments―By investment category, https://data.snb.ch/en/topics/finma/cube/capcollcat [Accessed on July 25, 2022])

Open collective capital investments (Mutual funds and investment companies) according to the federal act on collective investment schemes, 2005–2022 (CHF million)

Real Estate Funds and Real Estate Investment Companies

Investments in real estate funds are attractive to foreign investors, who cannot buy Swiss real estate directly because of the still-existent restrictions under Swiss law (Lex Koller, formerly Lex Friedrich). Despite restrictions regarding the purchase of real estate by non-Swiss investors, foreigners without permission can purchase certificates of listed real estate funds. However, this is not the case for unlisted forms of indirect real estate investments.⁴³ Unlike some Anglo-Saxon funds , Swiss real estate funds do not participate in household mortgages but, rather, invest in revenue-earning properties. Although most real estate funds spread their risks by investing throughout Switzerland, substantial parts of their portfolios are concentrated in larger cities. In 2022, Swiss real estate funds and real estate investment companies invested about CHF 85.5 billion in Swiss real estate.⁴⁴

Diversification of Investment Funds

In total, 14.9% of Switzerland’s open collective investment schemes are mixed funds that invest in a combination of shares and bonds. A few smaller funds specialize in either one country or one economic sector, where the risk-reward potential seems to be higher due to the lack of diversification. Another difference between the various funds is their emphasis on dividend yield versus capital appreciation (growth funds). While many Swiss funds are distributive, most foreign funds sold in Switzerland are accumulative, which means they reinvest most of their revenues. These funds perform valuable services for investors by lowering risk and increasing opportunities, usually through their research departments, which help to identify profit opportunities worldwide. For these services, the funds are paid commissions calculated as a percentage of assets under management. Fund certificates can be purchased either on the stock exchange or over-the-counter, where the major funds and their banks maintain a market in the certificates. At the end of Q1 2022, 265 of 1810 open Swiss collective capital investment schemes were mixed funds.

Industry Concentration

The two big banks dominate Switzerland’s investment fund industry. Figure 6.12 shows that UBS and Credit Suisse accounted for 41% of the domestic market as of June 30, 2022. Neither foreign competitors nor insurance companies have gained significant shares of the Swiss market, even though the intensity of competition has increased as banks and insurance companies (both domestic and foreign) have continued to find overlapping business interests. Nevertheless, increased competition in the asset management sector has caused Swiss private banks to increase their investment fund alternatives. The largest foreign competitors are Black Rock (7.4%) and JP Morgan (2%), but Swiss banks have responded by setting up operations in other nations to market their Luxembourg-based investment funds.

Fig. 6.12

(Source AMAS Marktkommentar/Swiss Fund Data AG, Market Comments [June 2022], https://www.swissfunddata.ch/sfdpub/fundmarket-statistics [Accessed on July 25, 2022])

Concentration of Swiss investment fund industry, June 30, 2022

Regulation of Collective Investment Schemes

Switzerland has undertaken significant steps to improve the regulatory framework of institutional investing. The main pillars are the Collective Investment Schemes Act (CISA, in force since January 1, 2007),⁴⁵ the Financial Market Infrastructure Act (FinMIA, in force since January 1, 2016),⁴⁶ the Financial Institutions Act (FinIA, in force since January 1, 2020),⁴⁷ and the Financial Services Act (FinSA, in force since January 1, 2020).⁴⁸

On January 1, 2007, Switzerland’s new Federal Act on Collective Investment Schemes came into force. Article 1 of the new law states that its purpose is to improve investor protection, increase transparency, and enhance the operational capability of the collective investment scheme market. According to the Act, only mutual funds established on a contractual basis or as investment companies with variable capital (SICAV)⁴⁹ are permitted as open-end collective investment schemes (Art. 8). Closed-end collective investment schemes take the form of limited partnerships for collective investments or investment companies with fixed capital (SICAF ).⁵⁰

The Collective Investment Schemes Act has brought Switzerland’s regulations in line with the EU funds directive (Undertakings for Collective Investments in Transferable Securities—UCITS). It also goes a long way toward freeing Swiss fund managers to compete in the international markets by enabling (with limitations) the use of many of the financial instruments that once were restricted, such as derivatives and book entry instruments. Consequently, many of the advantages other countries (especially Luxembourg) have enjoyed relative to Switzerland during the past years have decreased.

Swiss law further mandates that the fund manager of an open-end collective investment scheme be a Swiss public limited company with a minimum capital of CHF 200,000 and the management of the scheme be independent from the custodian bank.⁵¹ Investors are protected by transparency requirements for open-end investment schemes, which stipulate both semi-annual and annual reporting. The law also defines the form these financial reports need to take. A disadvantage of the liquidity provided to investors is that mandatory redemptions often force funds to sell certain positions, which may cause increased stock market volatility .

There are organizational restrictions for closed-end investment schemes,⁵² such as limited partnerships and SICAF , as well as articles of incorporation (e.g., regarding the legal form), investments, and publication requirements. Still, they are not as far-reaching as those for open-end structures. Investment regulations mandate adherence to investment policies, which must conform contemporaneously to the defined investment character of the investment scheme. The law identifies FINMA as the supervisory authority of collective investment schemes. It also explains the duties of managers, sales agents, representatives of foreign investment schemes, custodians , auditors, valuation experts, and supervisory authorities.

In light of the EU Directive on Alternative Investment Fund Managers (AIFM Directive or AIFMD), which came into force in the EU in 2011, the Swiss Federal Council decided to revise the Federal Collective Investment Schemes Act (CISA). With the Financial Services Act (FinSA) and the Financial Institutions Act (FinIA) that came into force on January 1, 2020, the CISA was fundamentally revised. While the FinIA regulates the admission and conduct of financial intermediaries, the FinSA aims to protect clients and regulate documentation and the distribution of financial products. This last point includes significant changes regarding the distribution concept and the definition of qualified investors. Hence, the CISA now focuses mainly on products and investment schemes. The revised act is supposed to come into force in 2023. In addition, with the Limited Qualified Investor Fund (L-QIF), there will be a new and less regulated investment scheme for qualified investors which will also facilitate venture capital investments.⁵³ For Swiss fund managers, compatibility with the new regulations is a prerequisite to managing and distributing funds registered in the EU . The AIFMD (Alternative Fund Managers Directive) will allow the distribution of funds in the entire EU for fund managers benefitting from an EU Passport after obtaining permission from one member country.

The Financial Market Infrastructure Act (FinMIA) regulates financial market infrastructures and the conduct of financial market participants to guarantee transparent and functioning markets for securities and derivatives trading. Large parts of the Stock Exchange Act were integrated into FinMIA, such as regulations on public takeover offers, insider trading, and market manipulation.

Conclusion

Since 2000, regulation changes have led to massive shifts in Switzerland’s insurance and collective-investment sectors. Many adjustments were motivated mainly by alignments of Swiss and foreign rules, like those of the European Commission. Pension funds have become the most prominent players in the Swiss capital markets. Regulators of these financial institutions have concentrated on ensuring safety, up to the potential exclusion of national economic growth, which will be needed to generate incomes sufficient to meet future debt obligations.

Similarly, adequate funding of the government’s old-age scheme will require economic growth to broaden the nation’s tax base and release it from the zero-sum game of borrowing from Peter to pay Paul. As might be expected, government regulations’ effect on economic growth has recently gotten political consideration.

The challenges facing Swiss institutional investors are manifold. Demographics, in general, and an aging population, in particular, will continue to pose serious financing problems for the nation’s social security system. Private insurance companies will face challenges of their own, with ever-tightening regulation and an increasingly competitive and complex market environment. For Switzerland’s fund industry to succeed, one of the critical factors will be its continued and unfettered access to liquid international markets. Considering recent regulatory changes in the EU, prospects for additional changes are highly likely and expected to be geared more towards safety and control rather than value creation.