Italy has staked the future of its fledgling second pillar pension system on defined contribution (DC) schemes. The legal framework for the system was set up as part of the pension reforms of two former prime ministers Giuliano Amato in 1993 and Lamberto Dini in 1995. However, it has been up and running for barely four years.
The new DC plans take two forms – closed and open funds. The closed funds, the ‘fondi negoziali e contrattuali’, are run by associations on behalf of unions and employers and cover groups of workers across specific industries. The open funds, ‘fondi aperti’, are run by banks and insurers and offered to anyone who is not covered by a closed scheme.
Membership of either scheme is voluntary, and coverage is still relatively low – some 7% of the workforce. At the end of June the total number of members of both types of plan stood at 1.36m, made up of 1,050,000 members of closed funds and 312,000 members of open funds.
Contributions from employers and employees range between 1% and 1.5%. However, this is supplemented by the TFR, Italy’s system of severance pay, representing 7.4% of gross salary split between employer and employee. TFR is now seen as the solution to the problem of the new funds – their lack of assets. These amount to only E2.5bn. TFR is estimated to be worth around E5bn of new money a year.
Increasing the wealth of the complementary plans is important if they are to be able to offer anything other than basic retirement pensions. Giampaolo Crenca, a consulting actuary and head of Crenca Consulting & Associates in Rome, says: “It’s very difficult to find new negoziali funds that offer death insurance, disability insurance or long-term care insurance. This is not because the insurers are not interested but because of the financing. There is not much money to finance the basic supplementary pension so it is very difficult to find money to finance anything else.”
The government has gone some way towards boosting pension fund assets by directing at least part of the TFR towards them. Modifications to the Amato/Dini reforms in 2000 meant that people who choose to join one of the new closed pension schemes must pay 100% of their TFR contribution directly into the pension fund if they started work after April 1993. Those who started work before April 1993 need only contribute a percentage, arrived at by their contractual agreement. This averages between 30% and 40% of TFR.
There are disadvantages to DC pension fund members from this arrangement, in particular, the availability of TFR-backed loans. People can borrow against their TFR contributions for house purchase or medical treatment. However, if they pay their TFR into a closed DC pension fund, they cannot use the contributions to raise a loan for eight years. One compensation for this is that they can borrow 100% of the TFR contributions at the end of this period, rather than a lower percentage in the former system.
There is a proposal before parliament to compel everyone to direct 100% of their TFR contributions into DC schemes. This has provoked considerable opposition – from employers that will lose a source of cheap finance, and from employees who will lose a useful source of savings. “For many young people TFR is their first substantial saving,” Crenca points out. “So many people say, okay, if that’s so then put it into the second- pillar system. It sounds simple but it isn’t.”
One complication is the TFR guarantee. The TFR is guaranteed to return 75% of inflation plus 1.5%. “In today’s conditions that is a good guarantee,” says Crenca. “If you put this money into a pension fund you lose this guarantee. The TFR guarantee has nothing to do with the markets, whereas the return in pension funds are based on shares whose values can go up or down.”
However, the most serious objection is that it adds an element of compulsion to what is a voluntary contributory pension system. Marcello Messori, president of Mefop, the organisation which promotes the new complementary DC schemes, says that the move would have the effect of making membership of these schemes compulsory . “When you freely choose to participate in the second pillar you must put the whole amount of TFR in. By making 100% transfer of TFR to second-pillar schemes compulsory, the government is making the entry into the second-pillar compulsory.
The challenge will be to harmonise the two systems, he suggests. “It’s quite difficult to harmonise a defined contribution scheme with a compulsory scheme like TFR, because in a DC scheme all the financial risk is on the participant and not on the sponsor So to oblige someone to take a financial risk seems illogical.”
In its evidence to parliament on the proposal, Mefop has suggested a solution – silent consent or the ‘negative option’. “If workers decide not to enter the pension system they would have to positively state that did not want to put their TFR into the pension system. If they said nothing, the TFR would be paid in,” Messori explains. “This would mean a lower rate of increase of wealth than if compulsion was used but it would nevertheless provide a good incentive to develop the market for pension funds.”
Mefop has modelled the effect of the negative option on the predicted assets of the closed DC pension funds in 2005, and found that it would broadly double these assets. If the system is left unchanged, pension fund assets are expected to increase fourfold to around E10bn. If the transfer of TFR to the pension funds is made compulsory, assets are predicted to rise twelvefold to E30bn. The negative option would produce a figure mid-way of E20bn.
Messori believes that this would be acceptable to all parties. “We do have a problem in that the amount of pensions wealth is very, very low, so it is a good idea to use TFR to increase the wealth. But it does not have to be so drastic as compulsion. Silent consent is a good solution.”
Whether the government decides to take this route will affect not just the future of TFR but the future health and wealth of the new occupational DC plans.