Sour prospects for la dolce vita

Italy's pensions systems have resisted recession better than most, but this luck may not hold, says Peter Davy

Italy is unaccustomed to having its pensions systems envied. It spends 14 per cent of GDP on them, the most in the EU15; it has the lowest birth rate; the worst dependency ratio; and public debt already at 109 per cent of GDP. By 2050, the statistics agency Eurostat predicts there will be fewer than two workers for every person over 65. As it is, 19 per cent of Italians aged 60 to 64 still work, against 33 per cent in Germany and Spain, 45 per cent in the UK and 60 per cent
in Sweden. The Bank of Italy, meanwhile, expects the economy to shrink 2 per cent this year.

It marked something of a turn-around, then, to see some good news for the country in IFSL's (International Financial Services London) report, Pension Markets 2009. This found that Italy actually topped a league: for pension fund returns during the first 10 months
of 2008.

Admittedly, in common with other OECD members, Italian funds lost money, but at 6 per cent the fall was smaller than elsewhere; on average, pension funds across the OECD were down 19 per cent. Even taking into account further drops in November and December (and the country's pension regulator, Covip, reckons funds lost 8.4 per cent over the duration of 2008) pension funds in Italy weathered the storm better than practically anywhere else.

As Luigi Ballanti, general director at the Italian society for the development of the pension fund market, Mefop, puts it: "They were affected by the economic situation, but not in a big way. Compared to elsewhere in Europe, it wasn't bad."

Problems remain
Every silver lining has a cloud, though. In some ways Italy's escape only serves to emphasise how far it still has to go, and the recession could end up hurting Italians' retirement prospects more than most.

Take those average figures, for instance. The reason Italy's funds were hit less hard is down to the fund allocation of the typical pension portfolio. This is, as the head of Southern Europe at Barclays Global Investors Oreste Gallo puts it, "ultra cautious". Equities make up less than 10 per cent of total pension assets, and most funds aren't even allowed to invest in more adventurous alternatives or illiquid assets.

That wasn’t such bad news last year, when the Italian benchmark stock index, the S&P/MIB, fell 50 per cent and hedge funds proved more correlated to the markets than most predicted. In the long term, however, workers, particularly younger ones, will need to rely on a greater range of assets if their pensions are to prove adequate in retirement.

"The problem is that the low exposure to equities is mainly due to a real aversion to risk. Behind that is the fact that the rationale for investing in equities in the long-term is simply not appreciated by people," explains Antonio Barbieri, head of institutional business at asset manager Arca Sgr.
There are signs that the government appreciates the problems, though. Last year, the Treasury Ministry decree 703/1996 outlined proposals to widen the investments available to pensions, allowing them to take short positions and invest in hedge funds, for instance. However, with turmoil in the financial markets and calls from the government's own Economy Minister Giulio Tremonti for a ban on hedge funds, such proposals appear to have been quietly dropped.

"I don't think it's going to happen," says Gallo. "'Hedge funds' is a phrase no one wants to hear anymore." Public attitudes to risk, meanwhile, are likely to have hardened; indeed one of Covip's responses to the crisis was to temporarily suspend the rules on the amount of cash pension funds could hold; previously they were limited to 20 per cent.

The bigger risk, though, is that the downturn will put Italians off private pensions altogether. Italy's pensions market is tiny – with assets equivalent to 2.3% of GDP last year – but in 2007 the Prodi government introduced reforms to try and bolster it. These centred on the TFR (Trattamento di Fine Rapporto), a fund into which 7.41 per cent of workers' gross pay is saved for each year of employment. Traditionally these funds were kept on the employer's books and paid when the worker changed jobs, quit, retired or was made redundant. The reform was designed to encourage workers to transfer this money instead into pension funds.

How successful this was is debateable. Tito Boeri, director of the labour market and social policy reform group Fondazione Rodolfo Debenedetti, believes it largely failed. "Very few workers transferred," he says. Despite a policy of "silent consent", so that the TFR money was automatically put into a fund if the worker failed to object, just 1.2 million opted to give up the TFR; about a quarter of those eligible.

Even that was an increase in new members of pension schemes of 64 per cent on the previous year, and the changes have seen an extra €3.2 billion flow into pensions.

"I never shared the prevailing pessimism," says Bruno Mangiatordi, commissioner at Covip. "Given that you were asking workers to give up their severance pay, the campaign was quite successful." Among larger enterprises, he adds, membership levels now compare to the US and UK. The economic difficulties, however, do undoubtedly make it difficult to build on these foundations. Already in 2008, membership growth was back down to 7.2 per cent, in line with the long-term average, and there is a danger this could slide further.

The problem is that those who opted not to put their money in pensions will be seen as vindicated. The S&P/MIB index has fallen 53 per cent since the TFR reform, and last year was the first time since 2003 that the TFR's guaranteed return (75 per cent of inflation plus 1.5 per cent) outperformed private plans. In effect, those that went into pensions have lost out.

"There is now a perception that keeping the TFR money out of pensions was very wise," explains Elsa Fornero, a professor of economics at the University of Turin, director of the CeRP (Centre for Research on Pensions and Welfare Policies) and a pensions reform advocate. "I have people coming up to me and saying, 'You were the one who wanted pension funds' – as if I should be ashamed of it."

And it's not just a problem for academics like Fornero. As Claudio Pinna, managing direct of Hewitt in Italy, explains, the market slump left many employers with red faces.

"It's put a lot of companies in a difficult position. They supported the transfer of pension funds and unfortunately the employees have ended up with lower returns than they would have got sticking with the TFR," he says.

Making the case
Persuading employees that there are still benefits in private sector pensions is a key question then, but one with no easy answer.

Part of it may be to look at the finality of the decisions. Massimo Borghello, principal at Towers Perrin, argues that many employees shied away from making the move into pensions, as once they opt to put the TFR in a fund there's no going back. Admittedly, the rules do allow workers to draw 75 per cent of their pension fund to buy a house or for medical bills, and 50 per cent for other reasons, but there are hoops to jump through and there was considerable nervousness about giving up the TFR safety net. After all, Italy provides little in the way of unemployment benefit. "Irreversibility is certainly something that could be looked at," he argues.

Carl de Montigny, retirement leader for Mercer in Italy, agrees: "That's probably what it will take to persuade people – the flexibility to go back on their decision."

Pension fund providers and asset managers can also play a part: Mangiatordi at Covip hopes the private sector will use this time to create the likes of life-cycle schemes to give those without much financial awareness access to appropriate funds. It has also asked fund providers to provide members with periodic estimates of their position and expected investment returns to bolster understanding of how much they need to put away.

Mangiatordi admits this isn't enough. "We know all the measures we can envisage are inadequate," he says. "What would be needed is a massive campaign of financial education." Without that, the public will continue to think the generous state pension provision enjoyed by previous generations will continue, when even now entitlements are set to start reducing next year.

That education would probably need to come from the government. Such a campaign would be hard to avoid if the recession were to force the government to look at further pension reform, as some have suggested. European Central Bank executive board member Lorenzo Bini Smaghi recently claimed this was Italy's only option, and the IMF also said the country should look again at raising the retirement age, as the move could free resources to provide better protection for workers facing unemployment.

The government may decide this latter argument would play well right now. However, it is just as likely that after so many reforms and so many other issues on its plate, it will put the problem off for another day.

"It's not that the government is unaware there's a huge issue here," says Fornero. "It's just not an emergency right now. They tend to work from day to day, and that's just not the best way when you're dealing with pensions. You need a long term perspective."

WRITTEN BY PETER DAVY,
A FREELANCE JOURNALIST