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International Seminar on Pensions 14 June 2001, Jerusalem, Israel Daniele Franco ITALY: THE ROLE OF FUNDING.

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Presentation on theme: "International Seminar on Pensions 14 June 2001, Jerusalem, Israel Daniele Franco ITALY: THE ROLE OF FUNDING."— Presentation transcript:

1 International Seminar on Pensions 14 June 2001, Jerusalem, Israel Daniele Franco ITALY: THE ROLE OF FUNDING

2 ITALY’S CRITICAL POSITION PENSION REFORM: MAJOR POLICY ISSUE A)High Pension spending: 16.0% of GDP in 1999 High incidence of pensions on total social spending (70%) B)Low fertility rate:1.2 children per woman of childbearing age POP65  /pop15-64: 1990 21% 201030% 203048% C)High public debt (110% of GDP)  LARGE GENERATIONAL IMBALANCE  NEED FOR LARGER REFORMS

3 A LONG REFORM PROCESS  to ensure fiscal consolidation and long-term sustainability  to increase low participation rates  to support non-elderly groups PENSION REFORM NECESSARY: REFORM PROCESS FROM 1992: long, incremental, unfinished ROLE OF FUNDING: LIMITED, BUT GROWING

4  1898 VOLUNTARY  1919 COMPULSORY (OLD AGE AND DISABILITY)  1942 SURVIVORS BENEFITS MAIN SCHEME - PRIVATE SECTOR EMPLOYEES: DEVELOPMENTS UP TO 1950s CRISIS OF FUNDED SCHEMES SHIFT TO PAY-AS-YOU-GO GUARANTEED MINIMUM PENSION EARLY HISTORY: PUBLIC, FUNDED, INDUSTRY-BASED SCHEMES; PAYROLL TAXES AFTER WW2:

5 EXTENSION OF PENSION COVERAGE: FARMERS (1957) ARTISANS (1959) OTHER SELF ‑ EMPLOYED (1966) WORK ‑ DISABLED CITIZENS (1966) LOW INCOME ELDERLY (1969) 1965: SENIORITY PENSIONS (35 YEARS CONTRIBUTIONS) FOR PRIVATE SECTOR WORKERS 1969: PRIVATE SECTOR EMPLOYEES FROM CONTRIBUTION-BASED FORMULA TO EARNINGS-RELATED 1969: FORMAL BENEFIT INDEXATION LATE 1950s TO 1960s: EXTENSION OF COVERAGE

6 A)NEW BENEFITS (POOR ELDERLY AND DISABLED) ALSO, TO SUPPORT FARMERS AND POOR REGIONS: B) EXTENSIVE USE OF DISABILITY PENSIONS (SUBSTITUTE FOR UNEMPLOYMENT BENEFITS; POLITICAL PATRONAGE) C) EASY ACCESS TO MINIMUM PENSIONS ALSO, BREAKDOWN IN CONTRIBUTION-BENEFITS LINK: D)MINIMUM & MAXIMUM PENSIONS, SCHEMES WITH DIFFERENT RULES, DIFFERENT INDEXATION RULES 1960s TO MID 1970s: EXPANSION OF WELFARE FUNCTIONS

7 1980s: RATIONALISATION AND FURTHER EXTENSION FIRST STEPS TOWARDS REFORM 1983MEANS TESTING FOR MINIMUM AND DISABILITY PENSIONS 1984ELIGIBILITY REQUIREMENTS FOR DISABILITY TIGHTENED 1984UNIFORM INDEXATION SYSTEM BUT: A)NO LARGE SCALE REFORM B)GRADUAL INCREASE IN BENEFITS FOR SELF EMPLOYED C)FREQUENT CHANGES IN RULES  DISPARITIES DEPENDING ON YEAR OF RETIREMENT

8 THE SITUATION IN THE EARLY 1990s RISING EXPENDITURE (CHART 1): 5.0 % OF GDP1960 7.41970 10.21980 14.91992 1960-95ELIGIBILITY RATIO = + 60% DEPENDENCY RATIO = + 60% TRANSFER RATIO = +15% PENSION EXP./GDP EXPECTED TO INCREASE FURTHER: CLOSE TO 25% BY 2030 (  DEPENDENCY & TRANSFER RATIOS) TREASURY (1994): “EQUILIBRIUM CONTRIBUTION RATE” FOR PRIVATE SECTOR EMPLOYEES 44 %1995 502010 602025.

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10 A)LOW RETIREMENT AGE (60/55 FOR PRIVATE SECTOR MALE/FEMALE EMPLOYEES) B)HIGH ACCRUAL RATE (2% OF EARNINGS FOR YEAR OF CONTRIB.) C)RELEVANT EARNINGS: LAST 5 YEARS IN PRIVATE SECTOR, FINAL SALARY IN PUBLIC SECTOR 40 YEAR CONTRIBUTION  ABOUT 75% OF FINAL WAGE D)ELIGIBILITY TO OLD-AGE PENSION: 15 YEARS OF CONTRIBUTION E)INDEXATION TO EARNINGS OF EMPLOYED WORKERS F)USE OF PENSIONS TO SUPPORT SOME SECTORS AND REGIONS REASONS FOR HIGH EXPENDITURE

11 REFORM URGENT ALSO FOR: A)LABOUR MARKET REASONS DIFFERENT RULES   JOB MOBILITY INCENTIVE TO RETIRE EARLY B)EQUITY REASONS MESSY DISTRIBUTIVE EFFECTS (UNEVEN RATES OF RETURN) LIMITED RESOURCES FOR OTHER SOCIAL POLICIES SHARP IMPROVEMENT IN CONDITIONS OF ELDERLY: POVERTY RATE = GENERAL POPULATION RATE THE NEED FOR REFORM

12 EXCHANGE RATE CRISIS AND NEED TO CURB DEFICIT: PENSION SYSTEM EXTENSIVELY REFORMED A)  RETIREMENT AGE. PRIVATE SECTOR EMPLOYEES: WOMEN FROM 55  60; MEN 60  65 B)“PENSIONABLE” EARNINGS: LAST 5  LAST 10 YEARS; YOUNG WORKERS: WHOLE WORKING LIFE C)ENTITLEMENT TO OLD-AGE PENSION: FROM 15 TO 20 YEARS OF CONTRIBUTIONS D)INDEXATION: FROM WAGE TO PRICE DYNAMICS E)SENIORITY PENSION FOR PUBLIC SECTOR EMPLOYEES: FROM 20/25 TO 35 YEARS OF CONTRIBUTIONS THE 1992 REFORM - 1

13 EFFECTS OF REFORM (+ TEMPORARY FREEZE ON INDEXATION): A)25/30% OF PENSION LIABILITIES CANCELLED:  EXPECTED EXPEND. B)GRADUAL HARMONISATION OF PENSION RULES C)STRONGER CONTRIBUTION- BENEFITS LINK BUT: A)SENIORITY PENSIONS REDUCE EFFECTS OF INCREASE IN RETIREMENT AGE B)PENSION EXP./GDP STILL EXPECTED TO INCREASE THE 1992 REFORM - 2

14 NEW MAJOR REFORM IN 1995 OBJECTIVES: A)REMOVE SENIORITY PENSIONS AND IMPROVE EXPENDITURE CONTROL B)REDUCE DISTORTIONS IN LABOUR MARKET (BY LINKING PENSIONS TO INDIVIDUAL CONTRIBUTIONS) C)IMPROVE HORIZONTAL EQUITY (HARMONISE RULES; REMOVE ADVANTAGES FOR WORKERS WITH DYNAMIC CAREERS)  FROM DEFINED BENEFITS TO DEFINED CONTRIBUTION  VIRTUAL FUNDING THE 1995 REFORM - 1

15 THE 1995 REFORM - 2 NEW RULES: A)OLD-AGE PENSION RELATED TO LIFE-TIME CONTRIBUTIONS (CAPITALISED AT GDP GROWTH RATE) AND TO RETIREMENT AGE (LIFE EXPECTANCY) CONTRIBUTIONS * AGE-RELATED COEFFICIENT  ANNUITY B)FLEXIBLE RETIREMENT AGE: FROM 57 TO 65 WITH ACTUARIAL DISCOUNT (PROVIDED PENSION  1.2 “MINIMUM PENSION”) C)SENIORITY PENSIONS GRADUALLY ABOLISHED D)SAME RULES FOR ALL WORKERS

16 PENSION EXPENDIT.  16% GDP IN 1999 TREASURY PROJECT.:+ 1.4% BY 2015 + 1.6% BY 2025 THEN DECLINE INPS 1998-2025: EQUILIBR. CONTR. RATE PRIV. SECT. EMPLOYEES:45%  48.5 SELF-EMPLOYED:19.4%  33.9 16.7%  30.0 FURTHER INCREASES IN CONTRIBUTION RATES OR GENERAL TAXATION (47% GDP)  NOT FEASIBLE INTERNAL MARKET, GLOBALISATION   FACTORS MOBILITY  TAX DEGRADATION - COMPETITION TREND TOWARDS LOWER TAX RATES CRITICAL ASPECTS: EXPENDITURE IN THE TRANSITION

17 CONTRIBUTION-BENEFITS LINK FOR INDIVIDUALS, BUT SYSTEM VULNERABLE TO DEMOGRAPHIC & ECON. SHOCKS  BIRTH RATE: NO EFFECTS ON PENSIONS  LIFE EXPECTANCY: DELAYED EFFECTS ONLY ON NEW PENSIONS (VIA COEFFICIENTS)  GDP GROWTH: DELAYED EFFECTSONLY ON NEW PENSIONS (VIA NEW CONTRIBUTIONS)  EARNINGS/GDP: DELAYED EFFECTS ONLY ON NEW PENSIONS (VIA COEFFICIENTS) CRITICAL ASPECTS: SYSTEM VULNERABILITY

18 REFORMS RELIES PRIMARILY ON REDUCING TRANSFER RATIO AVERAGE PENSION/PER CAPITA GDP: 15.5% 1998-2015  10.1% IN 2050 LIMITED REDUCTIONS IN NUMBER OF PENSIONS PENSIONS/EMPLOYMENT: 92% IN 1998  130% IN 2050 A)LOW RETIREMENT AGE (57-65): COEFFICIENTS? LABOUR DEMAND? B)(PARTIAL) PRICE INDEXATION: SUSTAINABLE OVER LONG RETIREMENT PERIODS? CRITICAL ASPECTS: COMPOSITION OF CUTS

19 ACTUARIAL CONTRIBUTION-BENEFITS LINK:  INCENTIVE TO WORK/DELAY RETIREMENT BUT:LINK SHOULD BE TRANSPARENT AND PERCEIVED AS STABLE ACTUALLY:LONG TRANSITIONEXPECT FURTHER CHANGES (VULNERABILITY)LACK OF TRANSPARENCY (NO FORMULA)EFFECTIVE CONTRIBUTION RATES  IMPUTED RATES CRITICAL ASPECTS: EXPECTED MICRO EFFECTS

20 A) FASTER TRANSITION TO NEW RULES (DON’T APPLY TO WORKERS WITH  18 YEARS OF CONTRIB. IN 1995; WORKERS WITH  18 YEARS: APPLY ONLY TO NEW CONTRIB.) B)FASTER REMOVAL OF SENIORITY PENSIONS NO EFFECTS ON STRUCTURE OF SYSTEM, BUT POLITICALLY SENSITIVE (OLDER WORKERS) IMPORTANT TO FINANCE TRANSITION TO FUNDING POLICY OPTIONS: ACCELERATE TRANSITION

21 A) SHIFT IN RETIREMENT BRACKET (eg: FROM 57-65 TO 62-70) B)STEEPER CONVERSION COEFFICIENTS C)MORE FREQUENT REVISIONS OF COEFFICIENTS (NOW: 10 YEARS) D) ADDITIONAL FACTORS CONSIDERD IN REVISIONS OF COEFFICIENTS E)  COEFFICIENTS + ADJUSTMENT TO REAL GDP & DEMOGRAPHIC- ECONOMIC CHANGES A & B:  RETIREMENT AGE C, D & E: FASTER ADJUSTMENT TO SHOCKS POLICY OPTIONS: CHANGE 1995 PENSION REGIME

22 TOTAL CONTRIB. RATES TO PAYG AND FUNDED PILLARS:  40% ASSUMING LONG CAREERS (25-65) & 3% REAL NET RETURN ON FUNDS: PENSION / FINAL WAGE  100%  MARGINS TO  REPLACEMENT RATE  10% CONTR. RATE  REPL. RATE  75% OBSTACLES: A)SLOW DEVELOPMENT OF FUNDS B)BUDGETARY PROBLEMS C)NEED TO ENSURE  RETIREMENT AGE POLICY OPTIONS:  FUNDING AND  PAYG CONTRIBUTION RATES

23 ACTUAL AVERAGE RETIREMENT AGE IN 1995: MALES60 YEARS FEMALES57 YEARS (1997: 36% OF EXPENDIT. TO  65 YEARS) A)SUPPLY SIDE CHANGE IN RETIREMENT BRACKET  INCENTIVES TO RETIRE LATER  FLEXIBILITY (PART-TIME) B)DEMAND SIDE: LABOUR MARKET CHANGE IN LABOUR COST TRAINING NEED TO INCREASE RETIREMENT AGE

24 LIMITED ROLE OF FUNDING IN ITALY:  COLLAPSE OF FUNDS AFTER WW2  LACK OF TAX AND LEGAL FRAMEWORK UP TO 1993  EXTENSIVE DEVELOPMENT OF PAYG  SEVERANCE-PAY FUNDS  LITTLE DEMAND AND LITTLE RESOURCES FOR SUPPLEMENTARY PENSIONS 1990s: CONSENSUS TO DEVELOP FUNDS SUPPLEMENTARY FUNDS

25 7.4 % OF MONTHLY EARNINGS TO SEVERANCE-PAY FUNDS (of which 0.5 % to insurance fund) RETURN: 1.5 % + 0.75 * INFLATION RATE BENEFITS PAID OUT WHEN LEAVING EMPLOYER EMPLOYERS: CHEAP SOURCE OF FINANCE WORKERS: SOURCE OF LIQUIDITY IN UNEMPLOYMENT SPELLS CONTRIBUTIONS (PRIVATE SECTOR)  1 % OF GDP FUNDS  10 % OF GDP SEVERANCE-PAY FUNDS

26 STRATEGY TO DEVELOP SECOND PILLAR: SEVERANCE-PAY + ADDITIONAL CONTRIBUTIONS  SUPPLEMENTARY FUNDS GRADUAL PROCESS: MEMBERSHIP COMPULSORY ONLY FOR NEW ENTRANTS TWO TYPES OF FUNDS: (i) CONTRACTUAL (CLOSED) (ii) OPEN DEFINED CONTRIBUTIONS TAXATION: E - T - T NEW LEGISLATION

27 FUNDS SET UP BY AGREEMENTS BETWEEN EMPLOYERS & EMPLOYEES AT COMPANY OR INDUSTRY LEVEL SELF-EMPLOYED ASSOCIATIONS CAN START FUNDS FUNDS INDEPENDENT FROM COMPANIES EXTERNAL MANAGEMENT OF ASSETS (BANKS / INSURANCE COMPANIES / OTHER FINANCIAL INSTITUTIONS) CONTRACTUAL FUNDS

28 FUNDS SET UP BY BANKS, INSURANCE COMPANIES, OTHER FINANCIAL INSTITUTIONS FUNDS INDEPENDENT FROM PARENT COMPANIES INDIVIDUAL OR COLLECTIVE MEMBERSHIP CAN MANAGE ASSETS DIRECTLY OR VIA FINANCIAL INSTITUTIONS OPEN FUNDS

29 SUPERVISION FUNDS TO BE AUTHORISED BY COVIP (PENSION SUPERVISORY BOARD) SUPERVISION BY COVIP + BANK OF ITALY AND INSURANCE COMPANIES SUPERVISORY BOARD COVIP EVALUATE IMPLEMENTATION OF TRANSPARENCY CRITERIA COVIP COLLECT AND PUBLISH DATA

30 AT LEAST 50% OF CAPITAL AT RETIREMENT TO BE CONVERTED INTO ANNUITY ANNUITIES TO BE PAID BY (i) LIFE-INSURANCE COMPANIES OR (ii) PENSION FUND (BUT NEED RE- INSURANCE CONTRACT FOR DEMOGRAPHIC RISK) CHARACTERISTICS OF ANNUITIES TO BE DETERMINED BY PENSION FUNDS BENEFITS

31 1) PORTFOLIO DIVERSIFICATION 2) MINIMISE TRANSACTION AND MANAGEMENT COSTS 3) MAXIMISE NET RETURNS CANNOT HAVE: (i)  15% OF ASSETS IN SINGLE ISSUER (ii)  20% OF ASSETS IN COMPANIES RELATED TO MEMBERS (30% FOR INDUSTRY FUNDS) (iii)  10% OF SHARES ON THE MARKET OR CONTROL ISSUER (iv)  20% OF ASSETS IN CASH FUND MANAGEMENT CRITERIA

32 CONTRIBUTIONS contributions deductible up to 12% of annual salary or 5,000 Euro (but severance-pay contributions at least 50% of total contributions) RETURNS reduced tax rate on returns (11% instead of 12,5%) BENEFITS no taxation on benefits attributable to returns from capital; benefits attributable to capital component are subject to separate taxation (rate depends on years of work) TAX RULES

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34 (1) LONG PROCEDURES TO START FUNDS (2) SEVERANCE-PAY: EMPLOYERS LOSE CHEAP FUNDING EMPLOYEES LOSE LIQUIDITY (3) MODEST TAX INCENTIVES (4) LIMITED FREEDOM OF CHOICE FOR EMPLOYEES (TRADE-UNION INFLUENCE) (5) YOUNG WORKERS PROBABLY UNDERESTIMATE ISSUE; OLDER HAVE SIZEABLE PENSIONS PROBLEMATIC ASPECTS - 1

35 (6) UNEMPLOYED WORKERS CANNOT CONTINUE CONTRIBUTING (7) INCREASING MOBILITY (8) LACK OF INSURANCE FOR MANY SELF-EMPLOYED WORKERS, PART-TIMERS, ECC. (9) SUPERVISION: OVERLAPPING AUTHORITIES? PROBLEMATIC ASPECTS - 2

36 INSTITUTIONAL INVESTORS’ PORTFOLIOS (1998 data unless otherwise indicated)

37 INSTITUTIONAL INVESTORS : net fund-raising and assets under management (billions of lire and, in brackets, percentage of GDP)

38 Pension funds in Italy: summary data (billions of Italian lire)

39 PENSION FUNDS: ASSETS (billions of lire; in brackets millions of euros)

40 Old Pension Funds: Summary Data

41 Old Pension Funds: types of funds (year 2000)

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43 Contractual pension funds: members and potential members (end of year 2000)

44 Contractual Pension Schemes: Average Contribution Rates

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46 Open Pension Funds: Assets (31-12-2000 - percentage points)

47 Age Distribution: Contractual Pension Funds vs Social Insurance Scheme of Private Sector Employees

48 Open Pension Funds Structure of the Market (31-12-2000)

49 Age Distribution of Members: Open Pension Funds vs Social Insurance Schemes of Self-Employed Workers

50 Open Pension Funds: Asset Composition and Age Distribution of Members

51 Contractual and Open Funds: rates of return (percentage points)

52 A)USE OF SEVERANCE-PAY CONTRIBUTIONS CORRECT, BUT PROCESS SLOWER THAN EXPECTED B) DEVELOPMENT OF FUNDING SLOW WHEN (i) PAYG CONTRIBUTIONS AND BENEFITS VERY LARGE AND (ii) PUBLIC FINANCE TIGHT C) CLOSE LINK WITH PAYG REFORM: DEVELOPMENT OF SUPPLEMENTARY PENSIONS NECESSARY TO REFORM PAYG, BUTPAYG REFORMS NECESSARY TO ALLOW ROOM FOR CONTRIBUTIONS AND TAX INCENTIVES CONCLUSIONS - 1

53 D) IS IT OPTIMAL TO COMBINE PAYG DEFINED CONTRIBUTION PENSIONS WITH FUNDED DEFINED CONTRIBUTION PENSIONS? E) POSITIVE MEMBERSHIP TREND F) MAIN OPEN ISSUES: (i) PUBLIC SECTOR FUNDS; (ii) FREEDOM OF CHOICE OF FUNDS; (iii) SUPERVISION; (iv) LENGTHY PROCEDURES G) CAN EXPECT IMPORTANT CHANGES IN CORPORATE GOVERNANCE CONCLUSIONS - 2

54 A)LATE REFORM  PAINFUL AND LESS GRADUAL (EG  5 YEARS RETIR. AGE OVER 8 YEARS) B) LENGHTY REFORM PROCESS:  UNCERTAINTY AND  PEOPLE RETIRING EARLY (  EXPENDITURE) C) DIFFERENT SCHEMES & RULES  REFORMS HARDER D) SPECIAL INTEREST GROUPS: MIXED EXPERIENCE *PUBLIC SECTOR WORKERS ACCEPTED BIG CUTS; *RETIREMENT AGE INCREASED FAST; *SENIORITY PENSIONS RETAINED WHICH LESSONS FROM ITALY?

55  INERTIAL EFFECTS OF DECISIONS TAKEN IN 1950s AND 1960s  SEGMENTATION OF SYSTEM: SEGMENTED POLICY-MAKING LOW DEPENDENCY SCHEMES  HIGH RETURNS; HIGH DEPENDENCY SCHEMES  SUBSIDISED BY GOVERNMENT  LACK OF ESTIMATES OF LONG-TERM EFFECTS WHY PENSION EXPENDITURE IS SO LARGE IN ITALY? ITALY:PENSION-BIASED SOCIAL PROTECTION SYSTEM OLD-AGE+SURVIVORS / TOTAL EXPEND.: 63% IN ITALY; 42% IN EU

56 NEED FOR REFORM RECOGNISED IN LATE1970S, NO ACTION UP TO 1992 WHY WAS THE REFORM DELAYED UP TO 1992?  SHORT-TERM VIEW OF BUDGETARY DEVELOPMENTS  NO AGREEMENT ON EXPENDITURE TRENDS  NO AGREEMENT ON CHANGES: FUNDING, GENERAL REVENUE FINANCING  SEGMENTATION OF SYSTEM: UNEVEN BURDENS  SIZE OF PENSION WEALTH & NUMBER OF PENSIONERS

57 ITALY: PROJECTIONS FROM PUBLIC INSTITUTIONS ONLY IN LATE 80S INITIALLY, OPTIMISTIC PROJECTIONS RELIABILITY IMPROVED IN 1990S THE ROLE OF FORECASTS  FREQUENT CHANGES; REVISIONS USUALLY UPWARD  PROJECTIONS INFLUENCED REFORMS - PERHAPS POLITICAL DECISIONS TO ACCELERATE- POSTPONE REFORMS INFLUENCED FORECASTS POLICY IMPLICATIONS:  NEED REGULAR REVISIONS  NEED ANALYSIS OF CHANGES  AN INDEPENDENT AUTHORITY?

58 IMPORTANT CHANGES : HAS POLICY-MAKING CHANGED AFTER 1992? (1)  FROM EXPENDITURE EXPANSION TO EXPENDITURE REDUCTION  MAIN ACTORS IN POLICY: TREASURY AND PRIME MINISTER  BEFORE 1992: ADVANTAGEOUS RULES FOR PUBLIC SECTOR EMPLOYEES AND SELF-EMPLOYED AFTER 1992: LOWER BURDEN FOR PRIVATE SECTOR EMPLOYEES  PRESSURE GROUPS: FROM EMPLOYMENT TO GENERATIONAL DIVISIONS

59 HAS POLICY-MAKING CHANGED AFTER 1992? (2) BUT :  REFORMS STILL INTRODUCED WITHOUT PRELIMINARY WORK  NO GOVERNMENT DOCUMENTS ABOUT NEED FOR REFORM, OBJECTIVES, ETC.  INCREMENTAL APPROACH: UNCERTAINTY ABOUT FURTHER CHANGES IN PAYG SYSTEM + SLOW DEVELOPMENT OF FUNDING  UNEVEN BURDEN: PROTECT VOCAL GROUPS E.G. LOWER BURDEN ON WORKERS WITH LONG RECORDS

60 EMPLOYMENT RATES


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