Italy: Lack of long-term vision threatens to stifle growth
In giving more freedom to employees to make pension choices, lawmakers are in danger of slowing down the growth of Italy’s second pillar
Regulation in summary
• A new asset allocation framework has been approved, allowing more freedom for pension funds as well as posing some difficult challenges.
• Capital gains taxes have been increased across investments, including pension funds.
• Workers can now request advances on their severance pay pot, subtracting funds from their pension pot.
• A law on portability of pension savings could affect pension outcomes, with workers choosing more costly and less prudent funds.
In the past 12 months, public and private pensions have been at the top of lawmakers’ agendas in Italy. However, because of pressure on the government to boost spending and increase tax revenue, the changes to pension rules might be counterproductive in the long term.
In November last year, a long-awaited revision of the framework for pension fund investment came into force. The Decreto Ministeriale (DM) 166 of 2014, which regulates pension funds’ asset allocation behaviour, allows much greater freedom compared with the previous version, and moves from a quantitative to a qualitative regulatory regime. In other words, pension funds will be allowed to invest in asset classes and under arrangements that were previously forbidden, as long as they can prove they have internal monitoring capacity.
While several important quantitative constraints remain in force, second-pillar pension funds will be able to invest in emerging markets, which were previously banned from portfolios. However, derivatives and leverage are still forbidden, which could affect funds’ fixed-income strategies.
The next step in asset allocation regulation is a new framework for casse di previdenza, the privatised first-pillar funds for white-collar workers. The rules will be similar to those adopted for second-pillar pension funds, which will restrict casse di previdenza’s current permissive framework.
The Renzi government has also introduced a new tax regime for pensions, which commentators say has the potential to discourage prospective savers in second-pillar funds. As part of the 2015 budget law the tax rate on pension fund returns was increased from 11.5% to 20%, and the measure applies retroactively to 2014 returns as well. The tax rate on investment returns earned on non-pension-fund investments was also increased from 20% to 26%, but this higher rate also applies to returns earned by members of casse di previdenza.
Returns from government bonds are the only exception in the tax rate hikes. They are still taxed at the original rate of 12.5%, which has major implications for pension fund portfolio allocation decisions. However, calculations show that, despite the tax rate increases, second-pillar funds remain the best arrangement compared with the alternatives.
The government offered an €80m tax rebate for pension fund investors that invest in the Italian real economy. Casse di previdenza and pension funds will be able to claim back 6% and 9% respectively on taxes on returns, but the investment opportunities are relatively scarce.
The Renzi government also approved a measure that is intended to encourage spending, but could potentially slow down the growth of second-pillar funds. From April this year, workers can cash in on their severance pay pot, the trattamento di fine rapporto (TFR). The TFR is deducted from employees’ gross salaries and either paid into second-pillar pension funds or kept on companies’ books until workers retire. This means the TFR constitutes the main engine for growth of private pension savings.
The measure drew much criticism, based on the argument that the temptation to cash in on the TFR would be too strong, and that most workers would stop contributing to their pension pots. So far, preliminary figures on the number of requests for TFR advances have proven those critics wrong so far; workers are keeping their TFR where it is. But it is too early to draw conclusions on the impact of the measure, as the cash-in window is open for two years. Commentators agree that it adds complexity to the pension system, potentially driving prospective savers away.
Among the more controversial measures affecting pensions is one that concerns competition between pension funds. In an effort to increase competition in the economy, the government has introduced a bill to parliament, referred to as DDL Concorrenza. The current draft of the bill allows workers to transfer their savings freely between pension providers, carrying their employer’s contribution with them. At the moment, employers are not required to contribute if workers transfer their savings.
The key issue at stake, critics say, is that for-profit pension providers such as banks and insurance companies will have an unfair advantage as they can afford large and well-established distribution networks. In other words, workers might be lured towards pension products that are not as cheap or as well governed as labour contract-based pension funds (fondi negoziali).
The pension regulator, COVIP, has expressed its doubts about the measure, presenting evidence that bank and insurer-sponsored individual pension plans (Piani Individuali Pensionistici, or PIPs) have grown far more rapidly than industry-wide pension funds in recent years. Furthermore, PIPs, by all accounts, charge members significantly more than labour contract-based pension funds.
All these measures, approved or planned, show that the government is focused on delivering objectives that clash with the long-term development of a complementary pension system. This is alarming, since the first pillar is coming under increasing pressure.
Earlier this year, the Italian constitutional court rejected one of the measures included in the major Fornero reform of 2011, which introduced notional defined contribution and replaced the generous defined-benefit pay-as-you-go system. The court ruled against the broad freeze on pension indexation that was included in the reform as a temporary measure. The immediate outcome of that ruling is that the government will have to unlock funding to cover those indexations, placing further strain on future public pensions.