The Italian job

Francesca Fabrizi discovers that the Italians have a big job on their hands if they want to secure retirement provision going forward

Italy doesn’t like to do things simply – and being Italian I am allowed to say that – and pension reform is a prime example. Even Claudio Pinna, who was recently appointed to head up Hewitt Associates in Italy, marvels at the extent of pension reform he has experienced in his years in the profession: “I can’t even remember how many reforms there have been since I first got involved in the area of employee benefits and retirement provision in Italy and the last two years have been no exception.”

But there is no getting away from it – with one of the lowest average retirement ages in Europe, one of the lowest birth rates, and a virtually non existant private pension system, Italy has a big job on its hands. Like many of its European counterparts, the country is also facing the common problem of increased longevity (which, adds Pinna, “is good for us, but not for the system”) so what is the government actually doing about it?

Maurizio Valsecchi, managing principal at Towers Perrin Italy, explains: “The first major objective of current pension reform is to reduce the state expenditure on pensions. The Italian state system is currently one of the most generous in Europe and this means that the average retirement age has to increase and the current replacement rate decrease gradually in the long-term.”

But while the government agrees that early retirement ages need to increase considerably to bring it in line with the rest of Europe, the unions are fighting it with full force. After months of deliberation, explains Stefano Busatto, principal at Mercer Italy, it was finally agreed in July that the early retirement age would rise in accordance with the following schedule:

Date Age + years of contribution
01/01/2008: 58 + 35
01/07/2009: 59+36 or 60 + 35 (95)
01/01/2010:  59+36 or 60 + 35 (95)
01/01/2011: 60 + 36 or 61 + 35 (96)
01/01/2012: 60 + 36 or 61 + 35 (96)
01/01/2013: 61+ 36 or 62 +35 (97)

But while the reforms may be a step in the right direction they don’t, says Pinna, go far enough: “In my opinion these changes don’t take into consideration the main financial indicators. We have, comparing our situation with the some of the other European countries, one of the highest life expectancies and one of the highest dependency ratios. This is terrible in a system funded based on a pay-as-you-go-basis.”

The TFR
The second method of reform relates to a change in the Trattamento Fine Rapporto (TFR) – workers’ severance indemnity payments – a reform of which was approved in December 2006 and came into force on 1 January 2007.
With the aim of boosting private pension provision in Italy, this reform offers employees working at companies with more than 50 staff the option to re-direct their “indemnity payments” (which is a lump sum paid to them by law on termination of their employment contracts, be that at or before retirement) to a private pension fund and receive it as an annuity at retirement, or keep it within the company.

This change, says Carl de Montigny, retirement leader at Mercer Italy, was necessary in order to counterbalance the worsening of the replacement ratios for younger employees in the new State DC system (those who began to work from 1996 onwards).

Montigny adds: “Within six months from 1 January 2007 (for employees already hired at 31/12/2006 – or within six months from the date of hire for those hired in 2007), employees were asked to direct their annual future TFR into private pension schemes — open or closed funds, or personal insurance policies. The mechanism is based on voluntary decisions, with the transfer to pension funds being the default option (future TFR contributions go into pension funds unless the employee explicitly disagrees). Employees may also decide to retain the TFR in company books.”

The potential impact of the reform is undoubtedly significant – annual flows of TFR add up to €18 billion – however available data from the regulator of pension funds (COVIP) on active subscription rates (22.6 per cent of the working population) suggests that results are still disappointing relative to initial expectations, even if most of the subscriptions due to “silent assent” are missing.

Valsecchi says: “Exact figures are not available and there is some missing data but all in all the results seem to show that, even when taking an optimistic viewpoint, it is unlikely the percentage of employees with a private pension plan is more than 30 per cent – that effectively means that at least two workers out of three still have no private pension provision. While 30 per cent is better than nothing, it is still not really something we can define as a final solution for the problem of pension provision shortfall in the future.”

So why has there been such a resistance from the workers to re-direct their TFR in this way? Pinna says one reason is that a significant change in mindset is required: “The indemnity payment has never in the past been considered as post retirement income, but more of a lump sum for workers to spend as they wished.

“Workers would normally receive benefits from the social security which would be line with what they needed after retirement to continue to have the same standard of living that they enjoyed during their period of service; and then they would also receive this indemnity payment which they would use to perhaps buy a new car. So this reform is forcing a complete change in the mindset of the employees which takes time.”

The fact that it is an irreversible decision may also be a factor – although there are several special cases (such as medical reasons) whereby workers can opt to receive part of their accrued money as a lump sum before retirement, but this is only in special situations and only after a minimum number of years of accrual.

Another point to consider is that unemployment benefits in Italy are scarce, and therefore employees may prefer to keep the TFR in the company as precautionary savings in the event of job loss.

“In addition, the TFR helps overcome liquidity constraints because advances can be asked of employers”, adds Montigny.

But while take-up may be disappointing, the overall impact going forward could be significant, both for employers and employees. Montigny explains: “The main impact for employers is the TFR moving from being book reserved
to being largely externally funded through DC schemes from 1 July 2007. Therefore there is a quite high cash flow impact for the future as well as a change in the TFR accounting under the international accounting standard.”

And as far as the employees are concerned, they will soon be responsible for making financial decisions that will affect their retirement futures – decisions which, warns Montigny, are very difficult for them to make since in Italy there is a lack of knowledge of the supplementary pension system and of financial matters. 

On a more positive note, says Ottavia Sebastiani from bfinance, the recent changes have meant that mentalities in Italy are having to change for the better.

“I think it has become very clear to the average Italian worker that the state will not provide what is has provided in the past, and it is just a question of time before this message filters through to everyone – but the sooner there is this shift in mindset, and the sooner people start to make opportunistic investment choices, the better.”

The other impact, says Sebastiani, is that it has led to greater liberalisation and therefore more competitiveness in the Italian market: “The new law is likely to pave the way for major changes in the Italian pensions market, from being dominated by a small niche of selected players to being a more open market with greater freedom of choices. The new law will increase competitiveness among “Closed funds” and “Open funds”. Employees will be able to choose the most attractive fund for them and transfer the money accumulated.”

The third point she raises is that pension reform is likely to boost the gradually increasing interest in new asset classes: “There is still a very conservative asset management approach in Italy – at the moment fixed income accounts for more than two thirds of the average pension fund portfolio while other countries have equities accounting for two thirds of the portfolio.”

But, she continues, some funds have already started to hire specialist asset managers for single asset classes and this will most probably be the way for the future; “so although the existing regulatory framework still makes it difficult for funds to be overly adventurous, on the whole there is increasing interest from pension funds to get into funds of hedge funds, property funds, commodities, portable alpha, currency and so on.”

All in all, she concludes, it is a market that is opening up – it is a market where there is a lot of competition happening and it is a market that is very much interested in new asset classes – “so while it is not a market that is as developed as the Netherlands, UK or Nordic markets, slowly it is getting there”.

Written by Francesca Fabrizi