Arrivederci to the era of La Dolce Pensione
Italy can no longer afford a generous state pension, that left little room for private provision. But there is little appetite for a new approach following the financial and economic crises, finds George Coats
Over the last couple of years Italy's private pension system has suffered a double blow. On the one hand, it became clear that hopes employees would invest their TFR, the money employers traditionally put aside to give as a lump sum when workers leave, had been dashed; only around a fifth opted to do so. On the other hand, Italy's pension funds, like those elsewhere, were caught up in the financial and economic crises and posted negative returns.
But the TFR reform was, and is still, seen as being of vital importance. It was one of a series of measures dating back to the 1990s designed to alleviate the pressure on the state budget from an overgenerous first pillar system, the state's pay-as-you-go National Social Security Institute (INPS) pension, and a demographic situation that already seven years ago was summed up in a Watson Wyatt presentation as "Europe's biggest age problem".
A 1995 pension reform had begun the transformation of the INPS from an earnings-related DB model to a contribution-related DC system based on notional accounts. As a result, the average replacement rate of a 60-year-old pensioner will fall to 48% by 2050. Prior to the changes the maximum pension after 40 years' contributions was 80% of a retiree's last working year's earnings.
"How much people will get depends on whether they are young or closer to retirement and on the salary level," says Claudio Pinna, managing director of Hewitt in Italy. "They probably don't understand what they will get from their state pension because successive governments over recent years have introduced new measures. But while the coverage is not clear, it is evident that in future people will get less. If you are young and in middle management, the state could give you 40-50% to 60-65% of your salary.
For an average working class employee an adequate pension will depend on being in work for an entire career, for 30 or 40 years. But the new world is not like this, people have periods when they are not employed and that will reduce the coverage from the social security pension."
"The first pillar pension is linked to the GDP," notes Andrea Giradelli, the operations director at Fonchim, the industry-wide fund for the chemical and pharmaceutical sectors.
"The GDP this year is going down so the performance of the money people have put into the first pillar will be devalued. But I don't think people realise that GDP can go down as well as up."
Currently, the second pillar funds are in no shape to fill the gap. Industry-wide funds were established under 1993 legislation but their contribution level is low. "For the general category of employee it would average 1.5% of a salary from the employer, and the employee would probably pay an additional 0.5% to 1.5%," says Carl De Montigny, retirement leader at Mercer. "And sometimes there is also a cap: 1.5% up to €30. So if you exclude the TFR it's a very small amount. But if they put in their TFR as well as the basic contribution there's a decent return, but people don't see it like that."
However, the projected fall in the state system's replacement rate over the coming years makes a second pillar necessary and the TFR is the only source of new funding without increasing labour costs.
"So there is a problem of information and education," says Fabio Carniol, leader of Italian benefits team at Watson Wyatt.
Why don't more people put their money into a pension fund? "In Italy, pension funds are just not seen as something that people can use to fund their post-employment income," says Pinna. "A private pension is just a financial instrument, a savings product. People see a pension fund in the same way they see mutual funds. And then there is the Italian way of thinking. If they have the impression that they carry all the risks they will refuse to play the game, they prefer to take less money but to be sure of getting it."
In addition, first pillar contributions are high, and that is another problem for pension funds, notes Carniol.
But people may soon receive a wake-up call. "Next year the conversion factor, the rate at which the DC virtual plan of the generation that's been contributing since 1996 is converted at retirement age, will be recalculated," says De Montigny. "It will send a signal that the state system has been changed, that what was almost virtual is now becoming real and that people are having more and more vested into this DC fund. They will see that there is a drop compared with what was predicted based on the old conversion factor and that looking 20 years down the road there will certainly be other reductions. I expect that there will be considerable news coverage around that. But will it make people change? It depends on the economic climate, on whether people have a job and whether they have a secure job?"
Another factor is that many employers do not encourage their employees to pay their TFR into a pension fund. "The TFR provided credit for small companies because it is not funded and they could put the TFR contribution on the balance sheet as a form of self financing," says De Montigny. "Consequently, a lot of small employers would not implement incentives for workers to put their TFR in a pension fund."
Companies with more than 50 employees lose the money anyway, as where their employees do not join a pension fund they are required pay the TFR contributions into a special Treasury fund to assist with reducing government debt. But where employees join a pension fund, employers must also pay an additional contribution as set out by their collective agreement.
"If small firms lose the TFR they need more credit from banks and this has a cost," says Carniol. "Currently interest rates are low but they have been and will be higher. And in Italy small companies are very important, they employ more or less 50% of workers."
Usually those who join pension funds work for medium-sized or large companies where there is a trade union representation. Where a trade union is not present, and this is typically small companies, employers see an industry-wide fund as a way of expanding union membership.
But Pinna points out that industry-wide funds are not the only type of pension vehicle available. "We have some DB pension funds," he says. "They are the so-called pre-existing (pre-esisteni) - the pension funds that existed before the law on private pension funds of 1992. But since then many have converted into DC pension funds. Then we have the cassa di previdenza, which are funds for specific categories of professions that also substitute for the INPS system and that guarantee benefits equivalent to those provided by the INPS pension. Most are DB, although that for self-employed accountants is DC."
And Carniol identifies another alternative: "Typically, a national collective labour agreement specifies an industry-wide fund. But that is the default and the company is free to join an open pension fund either through a collective agreement with trade unions or, if there is not a union, then directly with its employees. A lot of multinationals and Italian corporates prefer to avoid joining an industry-wide pension fund so they can keep the scheme in the firm or can give a higher contribution than that specified for the industry-wide fund. Generally, they want to use the fund not only as a pension fund but as an employer benefit tool as part of a corporate welfare plan, and an open pension fund is a convenient way of doing this because it is possible to decide the level of contribution and create a more tailor-made plan of a company. And sometimes a company may allow its employees to join the industry-wide pension fund but offer a higher level of contribution to those that decide to join an open pension fund. Employees can pay their TFR into an open fund, the regulations with regard to the TFR are the same as industry-wide funds. The only condition is that there be a collective agreement in the firm."
However, open schemes are also useful for small companies, he adds. "Open-ended plans are sold by banks and insurance companies so there is a network of points of sale so it's probably a more effective way of promoting pension funds among small companies, that are afraid pension funds are used by trade unions to gain new members."
But given the budgetary and demographic issues, what are Italy's politicians doing to encourage further private pension provision and the commitment of employees' TFR to boost contributions to a meaningful level?
"The government has made it clear it doesn't want to discuss the pension system again, even if it should introduce some changes," says Pinna. "The prime minister said he did not want to review the social security structure with a view to reducing expenses during this period of crisis because then people would become more worried about the situation and this could have a negative impact on the economic environment. But this could really be the moment to introduce a fundamental change to the social security system, because it is difficult to make a reform just of the private pension system. The government should be able to review the entire pension system rather than just tinker with it each year."
And there are some discussions going on, fuelled by projections that the costs of the state pension could reach 16% of GDP despite the reforms undertaken so far because of negative GDP growth. Such an outcome would run counter to Italy's commitments to its EU partners.
One method could be to improve the fiscal treatment of second pillar contributions. "We have a fixed limit on the tax deductibility of contributions, equal to about €5,000 a year, which was introduced in 2001 and so in real terms it is a reducing advantage," says Pinna "They want to change this to a percentage of an income as it was in the past. The government also wants to eliminate or reduce the 11% capital gains tax on pension fund returns."
But most important are suggestions that the government wants to make TFR payments into pensions compulsory, but give people the possibility to reverse the decision. For Pinna, this would create problems for the management of the assets because a pension fund could not take a long-term position in the management of its assets. He has an alternative proposal: "I would suggest that they allow a pension fund to pay 100% of the TFR contributions as a lump sum on a member's retirement just to get them to participate in the pension funds. Then when they arrive at retirement they will realise it would be better not take the lump sum but rather to take an annuity."
But if the central government is reluctant to take further initiatives, other authorities can take the lead, says Michael Atzwanger, managing director at Bolzano-based PensPlan.
"What is missing in Italy is more action from local entities to promote second pillar pensions among the population. PensPlan is a project supported by the regional government of Trentino/South Tyrol that acts as an information provider at no cost to pension funds and as administration service provider, reducing costs. Consequently, 60% of the region's population is a member of a pension fund compared with 28% nationwide. We also assisted the social partners in setting up a local pension fund because sometimes people are keener to join them - in Italy we don't like sending money to Rome - so Laborfonds was created in 1998. It is now the fourth-largest pension fund in Italy and it has the lowest administration costs because the region is supporting it."
The regional authority backs a local open pension fund for the self employed, PensPlan Plurifond, which was established in 1999 by Trento-based insurance company Itas Vita and is Italy's largest open pension fund offered by an insurer.
"In movie terms PensPlan, which is a shareholding company owned by the region, is the producer and Laborfonds and Plurifond are the actors," says Atzwanger.
It is an alternative model that has spread beyond the Trentino/South Tyrol region. "Aosta has introduced a similar system and recently Veneto passed legislation to provide similar incentives," says Atzwanger. "Aosta and Trentino/South Tyrol are small but Veneto is an important region. There have also been discussions in Lombardy."