Despite the reduction in benefits provided by the compulsory state pensions system, the Italian pension fund industry is still struggling to take off. However, the forthcoming implementation of recent pension reform elements is expected to boost the second-pillar market in the medium term.
Impact of pension reforms
At the start of the 1990s the Italian pensions system suffered from three serious anomalies:
- A major financial imbalance. To cover the projected pension benefits under the rules then in force it would have been necessary to either progressively increase contribution rates to more than 50% or suffer from ever increasing public sector funding deficits.
- Inconsistency in the rules defining the benefits payable under the different systems in existence. These tended to favor professional categories, high earners (particularly those with high final salaries), and early joiners (thanks to the early retirement option).
- Significant incentives for early retirement and disincentives for those wishing to contribute beyond normal retirement age, in terms of the additional pension benefits offered.
A historic turning point in Italian social security policy came in autumn 1992, with the first pension reform (the so-called Amato reform). Indeed, the reform was followed by the 1995 Dini reform and by a further revision by the Prodi government in 1997. The reform enacted during the 1990s constitutes a radical departure from the past, and a brave attempt to correct the prior regime, which was overly generous.
When the reform process is fully phased in, the link between pension benefits and final earnings under the earnings-based method will be substituted by a more appropriate reference to earnings (Amato) and contributions (Dini) throughout the working life.
However, the shift from the current defined benefit scheme to the new notional defined contribution scheme was intended to be gradual, in an attempt to protect not only pensioners but also middle-aged and even younger workers. In particular, this meant excluding from the reform all workers having contributed at least 18 years in 1995. Younger workers are covered by a “pro rata,” or mixed, system: the years before 1995 generate an earnings-based pension, while the years after 1995 generate a contribution-based one. As a result of the long transition period, the new regime will be fully operative only after 2030 as far as the flow of new pensions is concerned, and only after 2050 for the entire regime.
Development of private provision
Complementary pension plans were introduced in order to help cut the cost of the compulsory state pensions system. The reduction in benefits under the compulsory system was intended to be offset by the introduction of private pensions operating on a funded (as opposed to pay-as-you-go) basis. In this way the overall pension would be the same, but it would be delivered by different types of pension, thereby reducing the risk of further imbalances in the compulsory system.
The pension reforms of the 1990s introduced a new legal framework for complementary pension provision. The current legislation defines three distinct types of additional pension provision:
- Closed (negotiated) funds established for particular categories of workers (such as employees, the self-employed, professionals, and groups of co-operatives) through collective agreements. Only workers belonging to the appropriate category are eligible to join such funds.
- Open funds established and managed by financial intermediaries such as insurance, stock broking, and asset management companies. These funds are open in the sense that any individual (including those not in employment, such as dependants) may join them.
- Individual pension plans via life insurance policies (PIPs), which are specifically designed for retirement savings and are subject to similar rules to open pension funds regarding the payment of benefits and the conditions for transfer and surrender. These rules allow PIP products to benefit from the same tax incentives that apply to open pension funds.
Participation in a pension fund is always voluntary for employees, and benefits are calculated, with a few exceptions, on a defined contribution basis. At the end of 2004, membership reached 12% of the working population and the overall pension provision industry was worth €41 billion (about US$50 billion), representing 3% of GPD and slightly more than 1% of household assets.
Development has been hindered by a number of factors such as the relatively generous state pensions system, the modest fiscal incentives and, last but not least, the fact that the 1993 complementary pension law became operational only a few years ago, in 1998.
New opportunities arising from recent reforms
To further accelerate the development of the supplementary pension system and to increase the participation of younger workers, the Italian government recently presented new rules for pension-savings investments.
One of the measures of the current draft law on pensions reform (which is now to be examined by parliament and the social partners) involves the Trattamento di Fine Rapporto or TFR, a deferred compensation fund retained in the employer’s books. The sum, equivalent to 6.91% of the gross salary each year, earns a guaranteed annual return of 75% of the rate of inflation plus 1.5%. The annual value of the TFR is around €14 billion; the government has targeted this as means to boost Italy’s second pillar pension system with a system of silenzio assenso, or silent consent, whereby if an employee does not make a request to the contrary, his TFR will be paid automatically into a pension fund.
According to the pension regulator Covip, the annual volume of TFR invested in pension products could range between €8 billion and €10 billion, although several analysts estimate that the sum could be closer to €13 billion.
Italian insurance players such as Generali, Unipol, Mediolanum, Cattolica, and Arca are expected in the medium term to take full advantage of TFR redirection, given their presence and penetration in the Italian pension market. Specific actions have been planned in order to attract a significant share of the new business, such as tailoring new pension products to meet the needs of small and medium companies (65% of TFR funds are reserved for companies with less than 20 employees).
Another important measure designed to stimulate the development of pension products was the removal of barriers, which prevented free participation and movement of workers between contractual funds, open funds, and individual pension plans. Therefore, the range of products available to workers and their right to select them has been broadened. The accruing TFR and the contribution made by the employer, if applicable, may be channeled to the pension arrangement freely chosen by the worker if the worker transfers voluntarily from one type of pension to another.
Unrestricted participation and movement of workers represents an essential means of safeguarding savings and a strong incentive for asset managers to maximise the value of the resources entrusted to them. With this kind of movement becoming the norm, workers will overcome their reluctance to channel their TFR into pension products.
In addition to recent pension reform developments, new investment laws are also expected to open the market to foreign investment managers and custodians. Italy has been a relatively closed shop for securities services providers and a strong universal banking model has enabled the local banks to dominate provision of both custody and asset management. The old pension funds, which were formed before the 1992 reforms, use foreign banks while the new pension funds, which are subject to more regulations and are required to have a depositary bank, tend to always pick an Italian bank. However, Italy is implementing the UCITS III directive of the European Commission. In February 2003, the Italian Parliament approved a law establishing the procedural steps needed to implement UCITS III. The new investment law will provide a better framework for international asset managers and depositary banks to do business in Italy. Opportunities will open up for foreign institutions as UCITS III is adopted and as newer pension funds become more experienced in selecting asset managers.