Setting the stage for pension reform
Written by Peter Davy
February 2013
Following reforms to Italy’s first pillar, now is the time for a greater focus on implementing more sophisticated investment solutions in the second pillar and increasing participation, finds Peter Davy
Few would dispute that much is at stake in February’s Italian election. Still deep in reces-sion, with youth unemployment at 37 per cent, and public debt second only to Greece, the country faces daunting challenges. And the candidates proposing to tackle them are certainly diverse: EU technocrat Mario Monti, media magnate Silvio Berlusconi (currently up on sex and corruption charges in Italian courts), and – the front runner – former communist Pier Luigi Bersani.
Whatever problems the winner faces, however, they can have a reasonable hope that pensions will not be one of them. There should be no repeat this year of Labour minister Elsa Fornero’s famous tears in 2011 as she defended the government’s reforms that year.
In large part that’s down to the reforms to the first pillar she introduced. These extended the defined contribution regime, raised the retirement age, linked it to longevity, linked future benefits with gross national product, and clamped down on early retirement rights (the so-called ‘seniority pensions’), among other changes. Fornero herself said the government had “taken the hatchet” to the system.
Actually, it’s possible to argue how much should be attributed to Monti’s government. In effect, it simply followed the course mapped out by earlier reforms, particularly those of 1995, which introduced the defined contribution regime. That was the key reform, according to Milan-based Adelaide Consulting managing partner Piero Marchettini.
“The latest reforms were the last of several adjustments, but the basic change was made at that time,” he says.
Few dispute the result, however. In October, the IMF’s director of fiscal affairs rated Italy as best prepared among developed nations to face the challenges posed by rising pension and healthcare costs. Others put the system’s sustain-ability second only to Sweden’s.
“Lots of people assume Italy is a semi-disaster, but the reforms started a long time ago and are now taking the pensions system to a position where it is almost self-sustaining – assuming the economy doesn’t collapse in the next 10 to 15 years,” says Franklin Templeton Investments senior director of Southern Europe & Benelux Sergio Albarelli.
Occupational changes
Attention therefore shifts to the second pillar. Indeed, with the majority of workers facing a significantly smaller pension in retirement, it’s natural to look at the alternatives. Mefop (the Association for the Development of Pension Funds) is cautiously optimistic that social security reforms could have a wider impact.
“Hopefully the severe reforms of the first pillar will boost the private sector pensions market,” says Antonello Motroni at Mefop.
How this will happen, however, is unclear.
Second pillar reform was what was missing from the Monti government’s reforms. Indeed, it’s what’s been missing from every government, complains the president of Fochim, the industry-wide complementary scheme for the chemical and pharmaceutical industries, Fabio Ortolani.
“As 20 years have now gone by since supplementary pensions were introduced, it is time for a revision to help boost adhesion,” he says. “In recent years, no government, including the current one, has wanted to do anything about this situation.”
Whether that will change with the new government is uncertain.
Certainly, there are changes coming to the second pillar. Perhaps most importantly, the pensions regulator Covip introduced new regulations last year requiring schemes to organise themselves with internal financial expertise to oversee investment policies and to deliver a statement of investment principles (Documento sulla Politica di Investimento), which was due by the end of 2012 for larger funds with more than 1,000 members. The statement will identify fund objectives, principles for implementation, rules and responsibilities within the process, and a system of monitoring and evaluation of results. Smaller funds must implement the statement by the end of this year.
It could have a significant impact on how pensions and their investments are run in Italy, says Italy’s RBC Investor Services managing director Mauro Dognini.
“In the Anglo-Saxon world it might be quite normal, but in Italy’s pensions industry, which is quite young, it is a bit of a revolution.”
RBC’s survey published in December found 83 per cent of funds said the changes would require a partial restructure, with 17 per cent needing significant overhaul.
That is a “great opportunity” for pension funds, according to Towers Watson investment leader in Italy Alessandra Pasquoni.
“They have a chance to review their investment policies and clearly set out their objectives,” she says. That means defining targets in terms of risk and return and linking those to liabilities: in effect reviewing their whole approach. It also, she adds, should bolster the role of consultants in asset liability management and the risk management space.
Added to this, a reform of Law 703 – which limits the types and amounts of assets pension funds can hold – is still expected; a draft law stalled as a result of the elections, but should be picked up by the new government.
That should replace the current quantitative limits on investments with a more qualitative approach to ensure investments are aligned with the scheme’s strategy – effectively giving them greater freedom.
Again, it’s not an insignificant change, particularly in a country where nearly 80 per cent in the industry-wide schemes was still invested in bonds in September 2012, according to Covip – and where bonds account for 90 per cent or more in the portfolios of some (although the open schemes’ managed by financial institutions have a much bigger allocation to equities – see boxout).
“The big problem with investment in the second pillar is that most of their investment has been in long-term Italian Treasury bonds,” remarks Marchettini. It’s particularly troubling, he adds, now that the first pillar is now linked to GNP.
“Pensioners are already taking a risk linked to long-term performance of the country in the first pillar. They’re adding risk to risk.”
Whether the reform of Law 703 alone will change this is questionable.
At FTSE Group, managing director of Southern Europe Luca Filippa agrees that Italian pension funds tend to be very conservative. However, he notes that how much this changes in the coming year will depend largely on the economy.
“The macroeconomic outlook is likely to dominate asset allocation decisions,” he says. For now, he expects asset allocations in 2013 to be more aggressive as international equity markets recover from the lows of the crisis.
“In any case,” he adds, “with pen-sion funds it’s always a slow process.”
Added to that, many of the pension funds are member-directed, offering a number of different lines. Pensplan Plurifonds, a regional pension fund with about €300 million in assets is typical, offering an equity investments line, a balanced line and a bonds line, as well as ethical investment options. More than half of the members opt for the bonds line, according to Michel Thomas of Pensplan Invest, which manages it.
Nevertheless, it is probably just a question of time before there is greater range in Italian funds’ investments. Andrea Canavesio at Mangusta Risk consultancy in Rome says that increased maturity, if nothing else, means that many are now looking at more sophisticated investment strategies.
“These pensions have now been established for 15 years and they feel much readier to start investing in something which is a bit more complicated,” he explains. Mangusta, for example, recently helped Cometa, Italy’s largest private pension scheme, introduce real estate and private equity into its portfolio for the first time.
Hearts and minds
More seriously, however, the real challenge facing the second pillar is participation. As of last September, membership of occupational schemes was just 3.5 million, with another 2.2 million in personal pensions: about a quarter of the workforce. And there are a number of reasons to doubt that will change, at least in the short term.
One, says Albarelli, is the failure of successive governments to adequately communicate the changes happening in the first pillar – in part because of a reluctance to highlight the low pensions many face.
“The reforms have never been explained properly to Italians. All the debate has been ideological,” he argues. “There’s never been real attention drawn to how the reform has been built and the benefits going forward.”
Canavesio agrees: “Look at the numbers who actually do have a second pillar pension and it is obvious that Italians have no idea about the changes that have been happening.”
Another reason for pessimism is the performance of the average pension fund. Many have recovered lost ground in the last year, with an average return of 8 per cent. However, the last decade has frequently seen returns fail to rise above the TFR, the severance pay fund accrued from salary contributions and guaranteed to rise at a rate equal to 75 per cent of inflation plus 1.5 per cent.
“Greater participation will take place only when the performance of the pension funds improves,” says Marchettini.
The reforms around investment might help here. However, other problems may be more intractable.
The first is the lack of money. Figures for the end of 2011 already showed 20 per cent of workers had stopped contributing to their occupational scheme, and an increase in those calling on TFR funds – both reflecting the economic strains on the population. Moreover, workers already contribute 33 per cent of gross income in social security contributions – much higher than in Germany or France – and that’s before the 7 per cent contribution to the TFR.
“We effectively have a contribution rate of about 40 per cent,” points out Aon Hewitt Italy head of consulting Claudio Pinna. That leaves little left to put into private sector pensions.
The one thing that might persuade people to do so is perhaps greater financial incentives to save. That, however, also seems unlikely to change. Last November, Fornero ruled out greater incentives in the short term, citing the cost. She did, however, note that the pension reforms provide for a future study on lowering payroll taxes in order to divert contributions to the second pillar.
This, says Pinna, is perhaps the best prospect of a longer-term boost to occupational pensions in the country. However, given the Italian first pillar is pay as you go, with current contributions funding pensions in payment, any changes will have to be introduced slowly.
As he puts it: “It’s not going to happen tomorrow.”
In any case, for whoever wins the election, it will just be another item in a fairly heavy in-tray.
Written by Peter Davy, a freelance journalist
Q&A with Cometa general director, Maurizio Agazzi
What impact have the pension reforms to date had on Cometa members? Do you expect any further reform? What has been the impact on awareness among Cometa members of pension issues and their benefits as a result of the discussions that have taken place over the course of the reforms?
Italians have not yet acquired an adequate pension culture. After the present legislation was introduced, which was in force since 1996, a famous communication campaign about where to allocate severance indemnity, company or pension funds was introduced, but since then the government made no more investments in this sector. It was left to the industry to inform its members. However, supplementary pensions still have a long way to go in Italy, as awareness regarding first pillar provision is low, especially with what will happen in the future when the effects of the new contributive system are felt in full. So the first pillar reforms have not had much of an effect on supplementary pension choices made by the Italians.
Does the outcome of the current elections hold any significance as far as the second pillar is concerned? If so, what?
Logically, recent government reforms designed for the first pillar accelerating towards the contributive system should have led to a reform of the second pension pillar. However, this has not yet happened. We are still far from any concrete reform proposal. Our faith lies in the next government.
Specifically, what has been the change in the asset allocation since the crisis began?
First of all, we must not forget that the Cometa mission is to pay supplementary pensions to its members when they retire. That is why investment plans are long term, with no speculative choices made. Our asset management is based on this. It must comply with this vision and be suitably diversified. It must also identify benchmarks and control parameters. These decisions have been the foundations of recent agreements stipulated. Within these, managers can make tactical choices, with full investment autonomy. These considerations are what a close partnership with managers must be based on, to choose the strategies best suited to achieving pension objectives and to make any adjustments to strategies adopted.
How significant is the reform of Law 703 for you, and do the changes go far enough in giving pension schemes the flexibility they need?
On the whole, I agree with the philosophy of the regulation, which confirms the governance structure of pension funds whilst stimulating a further qualification in both precise responsibility and competence terms. The document being analysed appears to be based on greater investment freedom and closely linked to greater pension fund accountability, coherent with directive no. 2003/41/EC.
This is set up through a process which defines objectives and asset management policies and creates control structures that can trigger off effective feedback mechanisms. However, I do feel it is important for laws to preserve that distinction between investments for pension purposes innate in the second pillar system, and merely speculative investment. For that purpose, the legislator must make a further effort to specify concepts such as effective management and take on the responsibility to establish certain investment limits. This is to guarantee that the management of pensions stays focused on what is trying to be achieved by having a pension, which should never be left to market operators.
To what extent have the reforms introduced last year by COVIP required pension schemes to reorganise and restructure their schemes? What changes have been made at Cometa, if any?
I do feel that, though faced with a time lag with the new Law 703, and with some areas for improvement, especially in aspects of the resolution on financial risks and relationship between the various parties, that Covip did a good job with its circular on 30th October, stressing the importance of financial investment, its control and competences needed.
The work done by funds on preparing the investment policy document has enabled analysis of resources available, control of any shortcomings and the start of a growth process, which I hope will not be frustrated by generalised use of external consultancy. I feel that it is fundamental and the circular confirms the Law 703 provision that finances be internalised by pension funds.
For this, Cometa has confirmed a choice made some 10 years ago now. At present, Cometa fund assets exceed €7 billion, split mainly into two areas, income with almost €4 billion and Monetary with over €2 billion.
