Assets managed by pension funds in Italy equate to about 6% of its gross domestic product. In a country where the social security system provides an adequate level of coverage at retirement that would not be a concern. But in Italy, after all the recent reforms, this situation represents a relevant risk for both employees and employers. Benefits provided by the social security system have strongly decreased over the last 20 years and the retirement age raised considerably.
Italian employees have a great need of consistent additional pension coverage. But participation is on a voluntary basis and pension funds have not become popular – only 25% of workers have enrolled.
This situation is the result of two reforms of the private pension system – one in 1993 and the other in 2005. Clearly, considering these results, these reforms have not been effective, meaning that employees are running a serious risk of reaching retirement without having accrued a post retirement income in line with their needs.
The main goal of these reforms was an attempt to fund benefits provided by pension funds transferring the annual accruals companies use to finance the termination indemnity payments guaranteed by law to all employees (the so called trattamento di fine rapporto, TFR). TFR is funded through a set of annual accruals recognised by companies as book reserves in their financial statements. Annual accruals are equal to 7% of the total gross salary received by employees.
The final benefit is equal to the annual accruals recognised during the period of employment, revalued each year at a rate established by law (equal to 75% of the cost of living plus 1.5% fixed). This can be received at termination of employment in its entirety as a lump sum.
The legislator has used two ways to convince employees and employers to transfer TFR annual accruals to pension funds – a favourable taxation system for benefits from pension funds and the provision in 2007 of a quasi auto-enrolment period.
At retirement, pension fund benefits are taxed at a rate that at a maximum can be equal to 15%. The rate is lower as the period of enrolment increases – 9% after 35 years of contributions. TFR, on the contrary, is taxed at a rate at least equal to 23% – around 45% for managerial staff. In addition, the government provided during the first six months of 2007 a period of silenzio-assenso (silent consent). At the end of this period, all employees who did not state otherwise were automatically enrolled in a pension fund.
Unfortunately, most employees rejected the reforms, refusing to transfer the annual accruals to a pension fund. Seven years later, the situation is more serious. The need for additional coverage, especially after the 2011 reforms of the former labour minister, Elsa Fornero, remains a highly crucial issue for employees.
To this end, TFR should be considered an important component of post retirement savings. However, it is apparent that employees do not understand the situation and continue to use it in other forms – not always connected to retirement needs. For this reason, in order to avoid future social issues, compulsory enrolment in a pension fund (with the related transfer of the TFR) could be appropriate. This would help the market to mature (the total annual accrual of TFR is equal to about €15-20bn) and would allow employees to achieve adequate retirement provision.
A related solution would consider the concerns employees currently have over pension funds. To this end, together with compulsory enrolment, pension funds would be required to provide a guarantee to participants, particularly in terms of investment returns and calculations used to convert final pension positions in annuities.
For instance, a minimum level of annual return (1-2%) can be guaranteed on benefits provided at specific events, such as retirement, death or disability. Factors to calculate annuities can obviously be changed. But when this takes place, new values should only be applied on the component of benefits accrued after the date of change. An alternative solution could be to allow the market to introduce so-called target benefit pension funds or funds of the collective defined contribution (CDC) type. These funds are increasing their presence in several countries, especially in the Netherlands and Canada, while the UK is planning to introduce them.
These are funds of the defined contribution type, but which do not transfer all the risks to the participants. A pension plan with these characteristics has fixed contributions, a target defined benefit formula and a benefit/funding policy that prescribes methods for varying benefits based on affordability, with pre-set reserve levels and a pre-determined order adjustments.
Benefits are adjusted (especially in terms of revaluation) according to a pre-established methodology to ensure the employer’s cost stays constant and that the funding level remains close to 100%. Companies do not run the risk of a significant increase of cost, while employees have a clear idea of benefits they can expect at retirement.