Italy: Why is the second pillar not taking off?
Written by Gabriella Franco
Over three years after Italy’s reform of the second pillar, why has such limited progress been made, and what are the obstacles that need to be overcome? Gabriella Franco finds out
Benefits from Italy’s second pillar remain mostly inade-quate for two reasons: the take-up rate is low, especially among young employees, and the level of contributions is low. But why is this, and what actions are required to improve the status quo?
In Italy, the main provider of retirement benefits is INPS (the Italian social security system). These benefits will decrease over time as a result of the reforms that have taken place, so legislative changes have been put in place to further develop a second pillar of retirement income.
However, this second pillar is unlikely to compensate for the redu-ction in social security benefits. This is mainly due to a combination of low take-up rates and low contrib-utions to supplementary pension plans which are likely to result in inadequate benefits at retirement, especially for young employees.
The social security system in Italy has undergone a number of reforms, most recently in 1996 when the system changed from defined benefit to quasi-defined contribution. A ceiling on pensio-nable earnings (currently at around E92,000) has also been introduced. The new system is less generous than previous regimes, especially for high earners, and will mostly affect young employees.
Meanwhile, the cost of social security has continued to increase and is currently about 15% of GDP. It is estimated to remain stable until 2022 and will increase rapidly in the following five years, then decrease. In the decades that follow, it should continue to decrease and stabilise at about 13.4% by 2060.
This decrease over the long-term is mainly related to the reduction
in benefits brought about by the 1996 reform, although other fac-
tors such as demographics also influence this trend.
- Legislative changes
New legislation came into force in 2007, redirecting the annual accruals of the mandatory termi-nation indemnity (TFR) (approx. 7.0% pa of gross salary) into supplementary pension plans unless the employee opts out.
Additional contributions are payable by the employer, provided the employee also contributes. There are three sources of contributions: TFR accruals, employee and employer contributions.
- Take-up rate
Enrolment in supplementary pen-sion plans in Italy is voluntary. Employees have a six-month window; if they have not opted out of the supplementary pension plan by the end of this period, they will be enrolled through the redirection of TFR.
After the initial growth of supplementary pension plans following the introduction of the 2007 reform, take-up rates have diminished. The total number of employees adhering to supplem-entary pension plans at the end of 2009 was about 5 million, 22% of the overall working population.
In 2009 there were 320,000 new joiners. The number of new joiners in 2009 was significantly lower than in 2008 (430,000). Young employees (under 35) have a lower take-up rate, whilst employees aged 35 to 54 have the highest. (The percentage of employees with supplementary pension plans who only redirect TFR has increased from 12% in 2008 to 16% in 2009. This is likely due to the impact of the global recession.)
So why is the take-up rate so low? The intent of the 2007 reform was to encourage employees to exchange their TFR – which provides a lump sum payable upon retirement or beforehand if the employee leaves the company – for pension benefits. But this may not be very attractive to employees who change jobs frequently. This may also explain why the take-up rate for young employees is lower, since they are less likely to stay with the same employer throughout their career.
- Contributions and education
One of the main advantages of joining a pension plan is the entitlement to employer contrib-utions which it provides – although this is subject to the employee also making contributions.
In the private sector, the level of employee and employer contri-butions is quite low. According to Mercer survey research, employer contributions for non-executives are about 1% and employee contrib-utions 1% to 2%. For executives, employee and employer contribu-tions amount to 4% each.
These issues highlight the need for action in order to improve the take-up rate and encourage employees to contribute. Education is critical to help employees make informed decisions. Indeed, the development of an effective information network has been under discussion for a while among the key stakeholders in Italy.
Tighter regulations must also be introduced. Employers do not have a vested interest in encouraging employees to join the supple-mentary pension plan, as that may result in higher labour costs if the employee contributes.
- Comparison with the UK
In the UK, the second pillar pension provision is shifting from voluntary to quasi-compulsory and a tighter regulatory regime is being introd-uced. The UK has a long history of second pillar pension provision, and tight regulations are critical to ensure success.
Although employee education is important, the UK example demon-strates that this may not be enough if the second pillar’s ultimate obje-ctive is to provide adequate benefits at retirement. The first step must be to introduce tighter regulations aimed at improving the take-up rate and encouraging both employees and employers to contribute.
Written by Gabriella Franco, a Principal in Mercer's International Consulting business