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Special Report

Impact investing


Italy: the future is DC

Italy’s first law regulating private pension plans was Law Decree 124/1993, issued on 21 April 1993.

The most significant elements are that: only DC plans are allowed for employees (with only the self-employed being able to choose DB); strict limits are placed on the amount of tax-deductible contributions that can be made to a plan; and Trattamento di Fine Rapporto (TFR - a compulsory leaving indemnity, held by companies as an internal book reserve) accruals must be contributed to the pension fund to obtain tax deductibility on additional company contributions.

Plans in existence when the law came into effect can maintain their structures, so DB plans may still operate, but with no new participants. For participants as of the date the law came into effect, contributions remain fully deductible without limit as long as they are in accordance with a plan document.

On 4 August 1995, the Italian parliament approved Law 335 containing a complete reform of social security pensions and some changes to the new legislation on private pension plans. The basic structure of Law Decree 124/1993 remains intact but the tax treatment of contributions, benefits and fund investment earnings is revised.

The main purpose of the changes are to provide users with maximum choice and protection in terms of investment and to put all the providers, ie, the fund managers, on the same footing.

However,the legislation was delayed because the approval of new pension funds was to be regulated by an application decree of the Labour Ministry.This decree was not enacted until 11 July 1997. Therefore, since 1993 no new funds have been created and new participants have often been excluded from existing plans.

Some existing DB plans are modifying their structure to allow new participants to join. These modifications are taking place in the following ways: transforming the plan from DB into DC; maintaining the DB structure for old participants” (members in April 1993) and creating a new DC section for “new participants”; creating a new DC section for new participants and allowing old participants to choose between DB and DC, and maintaining the DB plan unchanged for old participants and creating a new DC fund for new participants.

We believe that within 10-15 years DB plans will virtually disappear. The new legislation allows DB plans only for the self-employed, which from a practical standpoint is a nonsense because the benefit has to be guaranteed either by other members of a self-employed category (who would be very reluctant to accept any form of solidarity in the second pillar, because they already finance several repartition category funds of the first pillar), or by an insurance company (very unlikely to guarantee any kind of benefit other than a guarantee return).

New company plans will be financed by employees’ contributions, company contributions and TFR annual accruals. TFR accruals will undoubtedly become the main source for new plans. TFR is calculated as a career-average lump sum benefit (annual accruals correspond to about 7% of annual pay) revalued annually to an inflation-related rate (75% of cost of living plus 1.5% fixed rate).

Employees therefore regard TFR as a source of inflation-protected savings, albeit one characterised by a low return. Asset managers managing future plan assets should be very careful to provide at least the TFR “compulsory return”.

Such a constraint will probably initially favour short-term investments in Italian treasury bonds, rather than focusing portfolios on long-term growth.

This scenario could change if Italy joins the euro. It is unlikely that the new European currency would be able to guarantee the same “risk-free” rate of return as Italian bonds; therefore a more diversified approach to DC plan investments should be sought.”

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