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Designing and supervising DC pension plans:The Italianexperience in managing choice and competition Ambrogio RinaldiCentral director, COVIPChair of the Working Party on Private Pensions, OECDrinaldi@covip.it2° MENA Workshop on Private Pension Regulation and SupervisionAmman, Jordan, 1-2 March 2011
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
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
The Italian pension system • Major reforms of 1st pillar • In 1992-1995 tworoundsofreformintroducedsubstantialchanges, aimed at controllinggrowthof public expenditureforpensions • Changeswhere first parametric (1992)… • Indexation to prices (partial over a threshold) and notany more tosalaries • More stringent age requirements • Calculation based on earnings over a longer time span • …thenstructural (1995): introductionof NDC, with a long transitionperiod • 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)
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, or3% of the workforce. • Reforms of 1992–1995 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/supervisor, 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” )
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
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
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
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
Choice and competition in the Italian system • Italian system isaninterestinghybrid: 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 alsoan 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
Contractual pension funds: membership rate and firm size • Two equilibria : • a good one (“cafeteria effect”, peer behaviour) • a bad one (little and distorted information)
Cost competition in the market for occupational plans5 years time horizon
Cost competition in the market for personal plans5 and 35 years time horizon
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
