Italy's public pensions: Unfinished business?
Italy’s new government plans changes to first-pillar pensions that could have a significant impact on the country’s economy
Public pensions were one of the focal points of political debate ahead of Italy’s general election in March. The two anti-establishment parties that formed a government partnership, the Five Star Movement and the League, have pledged to ‘erase’ the Fornero reform of 2011. The law raised the retirement age, which is revised upwards every two years, and will reach 67 years in 2019. It also partly extended notional defined contribution (NDC) to older workers who were originally to entitled defined benefit (DB) pensions, a measure that resulted in lower-than-expected benefits.
The sweeping changes were implemented by the technocratic Monti government in 2011, when Italy was on the verge of default. Labour minister Elsa Fornero, a well-known academic, was asked to reform public pension provision in to minimise the impact of pension expenditure on Italy’s government budget. The reform was complex and was approved in a somewhat hasty fashion. But at the time the measures were forecast to save the budget more than €80bn over 10 years.
While savings have been lower than anticipated, the reform has stabilised long-term pension expenditure, which is currently about 16% of GDP. This is the highest ratio in Europe, excluding Greece. Fornero, however, says that thanks to her reform, the projections for pension expenditure are positive. Italy is among the few countries in the EU that looks set to see a reduction in spending over the long term. Some contend, however, that these projections assume rather optimistic rates of employment, productivity and growth.
An open wound
The Fornero reform has left a lasting impression on Italy’s society. Many Italians feel they were unjustly asked to sacrifice years of work to safeguard the interests of euro-zone banks that held Italian sovereign debt. Fornero has been subjected to fierce criticism and constant verbal attacks ever since the reform was unveiled.
Today, the government wants to row back on her reform, granting a lower statutory retirement age and simplifying the requirements in terms of age and years of contributions. One of the most powerful messages during the toxic electoral campaign was that workers, particularly women, should be allowed to retire earlier than 67. In fact, the average retirement age is 62, much lower than the European average. This is a result of the various options workers have to retire early, most of which were reintroduced after the Fornero reform.
However, the government has committed to implement a counter-reform, and it is unlikely to back-pedal. According to a poll by Ipsos published last month in Corriere della Sera, a national broadsheet, nearly a third of Italians say changing the pension system should be one of two priorities for the new government.
Pension reform is, in fact, part of the ‘Contract for a Government of Change’, an agreement between the two parties detailing the policy of the new government. In its earlier version, leaked during the negotiations to form the government, the contract specified that the Fornero law would be scrapped entirely, going back to the previous system. In the version that was eventually signed by the parties, the contract talks of ‘overcoming’ the Fornero law.
However, some key details about the plan had been released beforehand. The plan has been branded ‘Quota 100’, referring to the concept that benefits will be paid when the sum of a worker’s age plus years of contributions totals 100. As an example, workers with 40 years of contributions could retire at 60.
As the initial details of the counter-reform were unveiled, estimates of its costs were quick to appear. First came Istituto Nazionale di Previdenza Sociale (INPS), the country’s social security agency, which is the organisation responsible for calculating and paying pensions. INPS estimated that scrapping the Fornero reform would cost the country about €20bn per year until 2030. The figure roughly matches the savings that had been locked in by the Fornero reform.
Last month, the author of the reform design, Alberto Brambilla, who is a well-known senior civil servant, released the full details of the proposed framework. In his proposal, workers would be able to retire at 64 years of age, with 36 years of contributions, or having contributed 41 years. Another key measure in his reform programme is to scrap the link between demographic variables and age and contribution requirements. Furthermore, benefit rises will be granted in line with inflation. The plan seems much less drastic from a fiscal perspective than originally thought. Brambilla estimates the net cost of his proposal to be €5bn per year.
Brambilla, who today leads Itinerari Previdenziali, a pensions and welfare think tank, was a senior civil servant in the Berlusconi government between 2001 and 2005. He previously worked on the design of the 1995 pension reform of the Dini government, which laid the groundwork for the eventual switch to NDC in the public pension system.
Lack of flexibility
The key point, for Brambilla, is that the Fornero reform left the country with a system that lacked flexibility, and therefore left large gaps when implemented. On the eve of the reform, many workers had already organised their retirement, having a clear idea of when they would achieve the requirements to earn the public pension. Many had already left the workforce and were receiving unemployment benefits. When the reform was implemented, these workers were left with no work and no pension. In general, many found their plans for retirement were no longer viable.
In the years following the reform, succeeding governments had to fix this problem. First, they had to find room within the budget to safeguard about 130,000 workers who had been left out. They also had to take into account special categories of workers whose activities take a heavy toll on health and well-being. As a result, some workers just had their pensions paid as they would in the pre-Fornero world.
Furthermore, several key measures have been introduced to restore some flexibility. The Anticipo Pensionistico (APE) Volontario, a loan guaranteed by the future pension, allows workers to retire early. Anticipo Pensionistico (APE) Sociale allows early retirement under certain conditions, but at no cost, to workers in certain categories. This is a temporary measure and 45,000 workers will benefit from it. The RITA (Rendita Integrativa Temporanea Anticipata) allows workers to draw a pension from their second-pillar savings, but this means reducing their future pension pot.
These flexibility-focused measures have already reduced the savings created by the Fornero reform by about €12bn, notes Brambilla. By scrapping some of them, Brambilla says his reform can guarantee a lower cost than calculated by others. In particular, he foresees harmonisation of treatment across different categories of workers. Early retirement will be allowed to all those who meet the age and contribution requirements, rather than only for workers in jobs considered to be particularly burdensome. “There is no absolute scientific proof that certain jobs should be treated differently,” he says.
In line with previous reforms, Brambilla’s system foresees an NDC formula for contributions made from 1996. Workers who began their careers after that date will get fully DC pension. From 2019, no worker will earn a fully DB pension. “This way, we are rewarding work,” says Brambilla.
He argues: “The Fornero reform hasn’t fully worked, as shown by the many improvements that had to be made. The law was written in a way that basically banned retirement for a number of years after implementation. Those that had already reached the requirements when the law was signed off saw their right to retire infringed.
“We must introduce standardised, understandable concepts to give people flexibility, making sure they understand that the less they work, the lower their pension will be,” Brambilla adds.
Of course, there is chance that his reform will create similar, although more muted, effects to what the Fornero reform did. To address this, he foresees the use of ‘solidarity’ or ‘redundancy’ funds. These are essentially pools of money set aside by corporates to allow early retirement for workers, following agreements between trade unions and employer associations. This is an established medium that was also used as part of older reforms overseen by Brambilla. “The cost for the taxpayer is zero”, he points out.
Why spend more?
Critics of Brambilla’s policy design argue that raising pension expenditure is not advisable at this point. Rating agencies have already put Italy’s sovereign rating on review, partly due to the proposed reform. This is because the reform would likely result in a higher debt-to-GDP ratio, and therefore a more negative outlook on debt.
Brambilla takes aim at the agencies, saying: “Where were they when the post-2011 governments raised debt by €250bn, at a time quantitative easing, growth in the labour market and of higher GDP growth? Let them look at what we want to do in detail first, instead of relying on forecasts from parties that have not done that.”
His point may be valid, but some credit should go to the arguments against reforming the system brought by many, including Elsa Fornero. She makes the point that spending should be allocated to budget items other than pensions. This is because pension expenditure is stable, and there are ways to let more vulnerable workers, including women, retire earlier. Higher spending on pensions today means lower capacity to spend tomorrow, since Italy’s first pillar is a pay-as-you-go (PAYG) system.
Fornero says: “These resources need to be found somewhere. Since we are talking about large portions of GDP, we cannot assume we will find them by reducing misspending. There are only two ways, other than selling public assets. Either we cut expenditure on other items, for instance education, or we raise debt. Raising debt is the classic recipe to achieve something in the short term, but it means future generations will pay. Our reform, despite its imperfections, reduced the burden on those who will come next.”
Support for reforms that aim to lower retirement age is misplaced, adds Fornero, because there is no evidence that older workers leaving the workforce are replaced by younger workers.
A more urgent task, she says, is improving financial education. She argues that Italian workers would have taken more kindly to her reform had they been properly educated on its necessity and its consequences. The former minister is currently engaged in an informal campaign to persuade various stakeholders to support financial education, as a fundamental tool for reform success.
A recent study she co-authored shows that the cost of major pension reforms, from a political perspective, is lower in countries where the level of financial literacy is higher. “Knowledge of basic economic and financial concepts has distinctive features that may help reduce the electoral cost of reforms having a relevant impact on the life-cycle of individuals,” says the paper.
History repeats itself
Italians should be familiar with the negative consequences of pension reform, argues Claudio Pinna, head of retirement consulting at Aon in Italy. He points to several examples of expansionary reforms implemented in the past two decades, which were followed by harshly restrictive reforms a few years later.
Pinna says: “Reforms that raise pension spending have often resulted in cuts to benefits or the lowering of retirement age, usually a few years later. The Fornero reform itself was predated by another reform, in 2007, which had lowered the statutory retirement age. A country that already spends 16% of GDP on pensions should be extremely careful with raising spending further.”
It should also be noted, says Pinna, that the system is in deficit – to the tune of around €22bn, according to Itinerari Previdenziali. This means pensions are partly financed by taxes. The deficit is forecast to rise, even without the proposed reform. As a result, the burden on the tax system is bound to rise further. The outlook would deteriorate even further if pension expenditure were to be raised.
At the same time, the pressure on salaries in terms of mandatory contributions to the public pension system is already huge, notes Pinna. Contributions are about 30%, with workers contributing about 10%. “Raising contributions further would reduce Italian competitiveness further, until the situation becomes unsustainable”, he says.
Apart from changes in the demographic outlook and labour markets, the pension system was seen by many as too generous, at least until 2011. Until not long ago, it was customary for companies to negotiate retirement with relatively young workers (some as young as their 40s) in place of redundancies.
For Pinna the way out of this predicament is clear. “The chief solution is creating jobs and incentivising work, because pensions are paid primarily by workers. Among our objectives should be growing employment among women and people over 55. This is also to fulfil the promises we have made on the international stage,” he argues.
The government, in contrast, insists that allowing older workers to retire will contribute to jobs creation.