Persuading the silent majority
The slow development of Italian pension funds is mainly due to the lack of resources to finance them. Neither the companies nor the employees have ‘serious money’ to put into the funds.
Contributions made to the pension funds by companies and employees so far have been almost nominal (ie, a combined amount of 1-2% of gross pay) and employees have been very reluctant to join the fund (in order to save even the minimal amount at their charge). No doubt that the only ‘serious’ resource available to finance private pension funds is the TFR.
Currently, TFR contributions correspond to an annual rate of 7.4% of pay which is accrued in a company book reserve. Past years’ accruals are revaluated on the basis of 75% of cost of living inflation plus a fixed 1.5%.
Despite the fact that this guaranteed return is very modest, it has been perceived by employees as fairly competitive during the last few years considering that company book reserves do not carry any management fees. Furthermore, the TFR is paid in any case of employment termination, while private pension benefits are payable at retirement, with only 50% of the accrued amount given as a lump sum (the balance is paid as a life annuity).
For all these reasons, despite the fact that the TFR could be transferred into the pension funds on a tax effective basis since 1993, employees have been very reluctant to give up their statutory severance pay in order to finance their private pensions. The new legislation is unlikely to create more consensus on the transfer just because of the Silenzio-Assenso mechanism.
The significant level of information required by the law during the six-month period during which the employee should make their choice on the transfer, will make them well aware of the issue and therefore able to say ‘no’ if unconvinced. Consequently, a new tax incentive has been approved to promote the transfer. Benefits paid by the pension fund will be taxable on the basis of a 15% flat tax, which could be reduced by an additional 0.3% per year after 15 years of membership in the plan, with a minimum tax rate of 9% after 35 years of membership. Such rates are very competitive when compared with an average tax rate of 25-30% charged on TFR at the time of payment. A careful analysis of the tax impact of the two options (either leaving the TFR into company book reserves or transferring it into the pension fund) could be helpful in convincing employees.
Another factor to be considered is the freedom of choice recognised by the new legislation. In fact, until now an employee was not allowed to join any other pension fund than the one implemented at national level for that particular industry. And almost all the major industries have implemented their pension fund at a national level (Fonchim for the chemical/pharmaceutical industry, Fon.Te for commerce, Cometa for metalwork, and so on).
However, the rate of participation in these funds has been very low (around 11%), showing the strong reluctance of employees to join pension funds perceived as very far away from their real needs. The opportunity to ‘opt out’ from these national industry funds will certainly increase the rate of employee participation.
Furthermore an employee who wishes to change fund even without changing employer will be allowed to do so after two years of membership, while until now transfer to another fund was allowed only after three years of participation and five years since the fund implementation.
The Silenzio-Assenso means that, unless the employee refuses, their future TFR accruals will automatically be transferred to a pension fund. From a practical standpoint the following process will take place:
q At the end of 2007 employers should inform their employees of the choices concerning their future TFR accruals;
q On 1 January 2008, the six-month period during which employees should make their choice will begin;
q At the end of May 2008 employers should again contact those employees who have not yet made their choice, specifying that, unless they give different instructions during the following 30 days, future TFR accruals will be paid into a pension fund selected on the basis of the new law;
q Assuming that the employee does not react, immediately after the end of June 2008 the selected pension fund must inform the employee that they have been automatically enrolled and provide them with all the information concerning the investment of their TFR.
The identification of the pension fund that will be in receipt of the TFR accruals in the case of Silenzio-Assenso will be determined as follows:
q If the company has its own pension fund, the employee should join this fund;
q If the company does not have a fund, the employee will join the relevant national industry pension fund;
q If the industry does not have its own national industry pension fund, the employee will join a national supplementary pension fund set up by the National Social Security Institute (INPS) to collect the TFR of employees who have not made any choice, and have not been automatically enrolled in any other pension fund.
Contributions paid to the selected
pension fund as a consequence of Silenzio-Assenso must be invested in the most
conservative line, ie, able to guarantee a return comparable to the one established for the TFR. (Comparable means that the investment line should guarantee a given return, not just make the commitment of pursuing a very conservative investment policy.)
As of 31 December 2005, in Italy there were 602 pension funds with 2,211,835 participants, plus 818,000 members in individual insurance schemes. Assets of the ‘old’ pension funds (ie, implemented before 1993) at the end of 2005 were €30.5bn. Assets of ‘new’ funds (ie, implemented since 1993) were €10.5bn. Assets of individual insurance schemes were about €2.9bn. Overall, at the end of 2005, the members of pension funds were 3,029,835 with assets of €44bn.
The potential market linked to the transfer of the TFR is therefore very large, as there are about 12m employees in the private sector with an annual TFR accrual of about €13bn. Additionally, there are about 3.5m employees in the public sector and about 6m self-employed people.
Consequently, it is reasonable to expect that the Italian pension market could
rapidly reach €150-200bn of assets, a few years after the new law will enter in force (ie, around 2015). Obviously the main uncertainty lies on the effect of the Silenzio-Assenso.
Piero Marchetini is managing partner of Adelaide Consulting based in Rome