A generous dose of reality
The Italian state pension scheme has been one of the most generous in Europe, and despite recent modifications it remains generous.
Retirement income is currently derived almost entirely from state benefits, as set out in figure 1. Workers over age 60 reported an average replacement ratio close to 70%, according to the most recent Bank of Italy survey. (See figure 2 for a full breakdown of individual responses.)
For instance, under the old system, a worker could retire on 80% of the average of his or her previous 10 years’ of remuneration, those earnings being revalued by the cost of living index plus 1% although subject to a ceiling (in the range e30-35,000, depending on year). Benefits for spouses and orphans are also available, with spouses receiving 60% of the original pension, and orphans receiving 20% up to age 18.
As at the end of 2002, there were 22.1m state pensions being disbursed, averaging e8,500.
Currently, retirement income is primarily taken in an annuity form, in the sense of an income stream payable over the life of the recipient (and often the recipient’s spouse).
The amount of retirement income at present provided by annuities (in the sense of individually allocated life-contingent insurance policies) is not significant. Such insurance policies do exist, but for tax reasons there has been little reason to buy annuities. Because of recent reforms and reforms in progress, annuities are likely to become much more common as pension savings vehicles (whether pension funds or individual personal pension life insurance policies) come to maturity, at which point at least 50% of the maturity value must be converted into an annuity. The remaining 50% may be taken as a lump sum, half free of tax and half taxable.
Annuities in Italy are almost invariably conventional with-profits policies. The with-profits mechanism has the effect of increasing future annuity payments by an amount corresponding to a specified proportion (typically 80-95%) of the investment income (in excess of a certain guaranteed rate) earned on the policy reserves.
The tax treatment of annuities vesting from authorised pension vehicles is:
qThe proportion of each payment considered purchased by premiums (rather than by investment income on premiums) is taxed as income at personal tax rates, reflecting recovery of reliefs given when the premiums were paid;
qThe investment income (which would otherwise increase the annuity under the with-profits mechanism) is taxed at 12.5%.
There has recently been a major development in the legislation affecting the provision of private pensions. The Maroni reform law, passed into law by the Italian Parliament on 28 July 2004, made various changes to the provision of the state pension (primarily changes concerning pensionable age and incentives to defer). Of most immediate interest is the ‘silent assent’ change for trattamento fine rapporto (TFR) – in effect, termination indemnity funds financed by 7.41% of annual earnings. The TFR monies in respect of an employee will be transferred to one of the recognised private pension vehicles unless the employee explicitly requests that this transfer should not be made.
It should be noted that the law
was passed as a ‘legge delega’, – a delegating law – requiring the government to pass laws to give effect to areas specified in considerable detail in the 12 months since approval of this law. The government will also consider moves to increase the tax advantages applying to personal pensions. In particular, an amendment to the legge delega is expected to increase the annual cap on pension contributions from the lower of e5,165 and 12% of earnings to the higher of those two amounts.
One of the main questions facing the Italian pensions sector is the extent to which private pensions are made fiscally attractive. The main tax advantage relating to ‘authorised’ pension savings is the reduction of tax on investment income from 12.5% to 11%. Although the legge delega obligates the government to improve this advantage, it is unclear how much this advantage will be increased.
The extent to which a potentially large pensions savings market turns into an equally large annuity market as it matures will depend to some extent on the attitude of the regulator to fostering attractive forms of annuity. Compared with the range of annuity products available in some other countries, the range of products in Italy is small (indeed, ‘range’ is almost too strong a word), and consumers may prefer to convert as much of their maturing money as possible (given the tax restrictions) into cash. It currently seems that the pensions regulator will adopt a conservative approach to permitting innovative annuity designs.
The Italian private pensions market has long been regarded as a ‘near take-off’ market. Although the state pension is generous, still 46% of respondents to the Bank of Italy survey think it is not sufficient to support family income needs (see figure 3). The percentage is likely to rise in the future as state pension benefits are eroded by the gradual implementation of pension reforms, which envisage long transition periods. Substantial long-term growth of the market is generally viewed as inevitable, but the short-term potential has often seemed insufficient to justify major market entry initiatives.
The legislative development outlined above represents much of the long-awaited move to take the Italian pensions market down the runway and into take-off. The shift of TFR monies is particularly significant. The amount of money expected to flow into private pensions provision as a direct result of the TFR change has been put at e6-8bn annually (Generali’s estimate). The change should also remove one of the current bottlenecks to individuals in deciding to take out private pensions. Ultimately, the annuity market will receive a major boost from the additional flow of funds.
Mike Wadsworth is a partner at Watson Wyatt in the UK