Designing and supervising DC pension plans: The Italian experience in managing choice and competition

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Designing and supervising DC pension
plansThe Italian experience in managing choice
and competition  Ambrogio RinaldiCentral
director, COVIPChair of the Working Party on
Private Pensions, OECDrinaldi_at_covip.it  2
MENA Workshop on Private Pension Regulation and
SupervisionAmman, Jordan, 1-2 March 2011 
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• Outline
•  
• Background information on the Italian pension
  system
• current structure of the reformed 1st pillar
• development of private pensions
• Main features of private pensions in Italy
• Interaction of different kinds of funds
• Choice to be made between funds and between
  investment options
• Regulatory and supervisory arrangements to
  promote orderly competition and facilitate choice

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• The Italian pension system
• the 1st pillar
• Coverage
• General for all employed workers and most
  self-employed, managed by public agencies as PAYG
• A few funded schemes for professional categories
  (lawyers, doctors, etc.), with special rules and
  managed by the same categories with a certain
  autonomy
• Retirement age
• currently 65Y men, 60Y women
• or 40 years of contributions regardless of age
• or level 96 (summing-up age and years of
  contributions)
• from 2015 will be indexed to improvements in
  life expectancy
• gender difference declared unlawful by ECJ, but
  only for public sector employees
• Contributions
• 32.7 for employed workers
• 20 for the self-employed
• Benefits
• Earnings-related for older workers, NDC for the
  younger, mixed for the middle age
• Means-tested minimum old-age non-contributory
  benefits around 400-450/month

 
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• The Italian pension system
• Major reforms of 1st pillar
• In 1992-1995 two rounds of reform introduced
  substantial changes, aimed at controlling growth
  of public expenditure for pensions
• Changes where first parametric (1992)
• Indexation to prices (partial over a threshold)
  and not any more to salaries
• More stringent age requirements
• Calculation based on earnings over a longer time
  span
• then structural (1995) introduction of NDC,
  with a long transition period
• 100 NDC for younger workers (newly employed
  since 1995)
• 100 earnings related for older workers (in 1995
  already contributing for 18 years)
• pro rata for intermediate cohorts
• In 2004 and thereafter, several additional
  parametric changes reinforced the control over
  public expenditure
• In 2010 retirement age has been indexed to future
  increases in life expectancy (to be applied
  from 2015)

 
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• Development of private pensions
•  Before the reforms of 1st pillar, public
  pensions were generous private, supplementary
  pension funds were limited to high salary workers
  (managers of large companies, financial sector
  employees) around 700.000 members, or 3 of the
  workforce.
•  Reforms of 19921995 had as a major element the
  creation of a system of private pensions directed
  to all workers, in order to compensate the
  (future) reduction in benefits from the 1st
  pillar
• Comprehensive legislation and secondary rules
  were introduced between 1993 and 1997
• COVIP, the specialized pension regulator/superviso
  r, was instituted in 1996
• The first new pension fund was created in 1997,
  and at the end of year 2000, there were already
  about 140 new pension funds in place
• Substantial fiscal incentives were introduced
  (although the system remains ETT, but with a very
  small third T )

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• Development of private pensions
• (follows)
•  With memberhip fully voluntary, coverage rate
  was slow to rise at end-2004, still around 3
  million workers, or 13 of the workforce
• The automatic enrolment of private-sector
  employed workers of all ages (more than 12m) was
  implemented in the first half of 2007 (with the
  possibility to opt out), and was introduced
  permanently for newly-employed workers
• Auto-enrolment based on the payment in a pension
  fund of the TFR (a sort of severance pay, worth
  about 7 of salary)
• Results have not been satisfactory (also the
  financial market crisis has not helped )
• At end-2010
• 5.3 million workers, or about 23 of the
  workforce
• 82 billion in assets, or about 7 of GDP

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• Private pensions main features
• Different kinds of plans interact, targeting
  different sections of the market, with overlaps
  that allow competition to work
• Contractual Pension Funds (CPFs)
• usually industry-wide, governed jointly by
  employers and trade unions, as non-profit
  entities
• Open Pension Funds (OPFs)
• set-up by AM companies, insurance companies, and
  banks, for commercial purposes
• target personal plans, but may also run company
  plans (including those opting out from CPFs) and
  implement auto-enrolment
• Insurance-based Personal Plans (PIPs)
• may anyway receive the TFR and employers
  contributions. Only the auto-enrolment is not
  allowed. They are split in new and old
• Pre-existing Pension Funds
• play a marginal role, as they cannot extend their
  membership area

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• Private pensions main features
• (follows)
• A pure DC system, with a role for guarantees
• employers commit to pay contributions, but do not
  bear any financial risk
• employees choose between different investment
  options
• Options offered by each fund are usually 3 to 5,
  including one that has a minimum rate of return.
  Some target date of life-cycle mechanisms are
  also offered
• The guaranteed option has to be the default line
  for auto-enrolment
• Contributions
• The TFR (7 of salary) is the main source for the
  employed workers
• Additional contributions are set by labour
  agreements, typically around 1-1.5 form the
  employer, with a minimum matching contribution by
  the employee
• Benefits
• 50 annuitization mandatory at retirement, except
  when the accumulated balance is below a certain
  threshold
• Several possibilities for early withdrawals

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Membership before and after the TFR reform by
kinds of plans
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The competition in the pension funds market in
Italy
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A general problem How much choice for
individuals?

• Choice of what?
• Whether to enrol (Voluntary, mandatory,
  auto-enrol matic w. opting out)
• type of provider
• investment option
•   ?too many options for individuals may be
  bad
•  Related issues
• Default options
• Information to members, advice
• Financial literacy development of pension
  planning skills in the public at large
• ?Extreme models
• Paternalistic Dutch model all decisions taken
  by employers/trade unions
• Liberistic DC systems based only on personal
  schemes

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Choice and competition in the Italian system

• Italian system is an interesting hybrid
  competition is favoured by a high degree of
  transparency and comparability between the plans,
  and is set to work through a carefully designed
  system of collective and individual choices
• by collective agreement at company level,
  workers may opt-out as a group from the
  industry-wide CPF and enter an OPF (collective
  choice)
• individual workers may also opt-out from the
  occupational PF (either a CPF or a OPF) and
  choose their favourite OPF, or also an
  insurance-like personal plan (PIP) but in this
  case they do not have the right to employers
  contribution
• as a result, the Italian pension market is made
  contestable, as a whole and in its segments

 

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Contractual pension funds membership rate and
firm size

• Two equilibria
• a good one (cafeteria effect, peer behaviour)
• a bad one (little and distorted information)

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Cost competition in the market for occupational
plans5 years time horizon
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Cost competition in the market for personal
plans5 and 35 years time horizon
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• Main arrangements to promote competition
• and favour choice
•  Highly standardized information to members, in
  order to favour comparison across eligible plans
• Comprehensive information document at enrolment,
  in long and short form
• Synthetic cost indicator to be disclosed, based
  on a standardized methodology
• Constraints imposed to cost structure, and
  attention put on avoiding hidden costs
• Pension projections to be delivered to members,
  based on assumptions standardized across funds,
  with expected returns set as a function of asset
  allocation
• Comparative tables of costs and returns made
  available on the Supervisor website