Sections

Getting to grips with severance pay

In Italy there is a legally required severance pay called Trattamento di Fine Rapporto (TFR.).
Such leaving-service indemnity is payable in any case of termination (dismissal, voluntary resignation, disability, death, etc).
Currently TFR is calculated as a career-average lump sum (the annual accrual corresponds to about 7% of annual pay) revalued annually on the basis of 75% of the cost of living inflation (C.OL) plus 1.5% fixed rate.
So far TFR has been accrued as an unfunded liability in the company’s book reserve. The amount accrued is equal to the one that would be payable if all the employees left the company at the balance sheet date.
Usually there are no specific assets to guarantee the payment of the TFR. However, INPS, the National Social Security Institute, guarantees the payment to the employees in case of the company’s bankruptcy.
The Italian law establishes that at the end of the year the annual cost of the TFR is calculated as follows:
o the total gross cash compensation of the employees is divided by 13.5 (which corresponds to about 7.41% of the payroll);
o the 7.41% is divided in two components:
1. 0.5% is paid to INPS (to guarantee the payment of severance pay in case of company’s bankruptcy);
2. 6.91% is accrued in company books;
o further more the amount accrued in the company book reserve at the beginning of the year is revalued on the basis of 75% of COL plus 1.5%;
o the annual cost corresponds to the sum of 7.41% of payroll plus the revaluation of accrued book reserve.
The same law establishes that the liability at the end of the year is made up by:
o the liability at the beginning of the year
minus
o the TFR paid during the year
plus
o the year annual accrual (7.41% of payroll)
plus
o the revaluation of the liability at the beginning of the year (after the deduction of the TFR paid during the year).

Furthermore it should be noticed that:
o a certain percentage of the annual accrual would have to be paid to the company/contractual defined contribution pension fund (if any);
o starting from 2001, revaluation of accruals is subject to a fixed tax equal to 11% of the revaluation of the year.
Since 2005 all the companies listed in an European Stock Market should apply the International Accounting Standards (IAS).
More specifically the Principle IAS 19 (concerning employees benefits) requires an actuarial valuation of the TFR (instead of the methodology currently used in Italy).
In fact the International Financial Reporting Interpretations Committee (IFRIC) has stated that “the IFRIC, considered the possibility of issuing guidance on whether vested benefits payable when an employee left service could be recognised at an undiscounted amount (ie the amount that would be payable if all employees left the entity at the balance sheet date). The IFRIC agreed that it would not issue an interpretation on this matter because the answer is clear under IAS 19: the measurement of the liability for the vested benefits must reflect the expected date of employees leaving service and be discounted to a present value”.
On the basis of this interpretation it is clear that the TFR should be subject to an actuarial valuation. The first valuation would have to be performed by Italian companies as of December 31, 2003 (in order, as requested by the IAS, to prepare the balance sheet for the year 2004 to compare to the first one made for the year 2005).
Claudio Pinna is actuary and partner at Adelaide Consultancy, based in Milan and Rome

Have your say

You must sign in to make a comment

IPE QUEST

Your first step in manager selection...

IPE Quest is a manager search facility that connects institutional investors and asset managers.

  • QN-2474

    Asset class: All/Large Cap Equities.
    Asset region: Global Developed Markets.
    Size: $150m.
    Closing date: 2018-09-25.

Begin Your Search Here