SPAIN – An election fraught with uncertainty2019/04/23
Italy: what lessons should be learned from the new pension (counter-)reform?
A radical but incomplete reform
Since the early 1990s, Italy’s pension system has undergone a series of radical and seemingly bold reforms. Prior to these reforms, Italy had a compulsory basic public pay-as you-go annuity pension system. This system operated on the principle that two people with the same final salary would receive the same pension, irrespective of their contribution history. Annuity and contribution rates were set arbitrarily, without regard for the sustainability of the defined benefit system. The low statutory minimum retirement age and the option to retire early without losing out on pension benefits made for a generous system but one that ultimately became unbalanced. The way in which the system was regulated called for higher contribution rates and growing transfers from the state. The almost confiscatory level of contribution rates and pension expenditure, which was set to rise from 15.2% of GDP in 1992 to 23.3% in 2040, alongside a worrying ageing population trend, called into question the long-term financing of the system and highlighted the need for an overhaul.
The fiscal consolidation to which Italy committed in order to be able to join the single currency, as well as pressure from both markets and European partners to cut public spending, gave the country an opportunity to get to grips with the problem at the same time as forcing it to shorten the time taken to debate the reform. This resulted in a hastily constructed solution that favoured the medium-term political goal over considerations of sustainability and equity. This context nevertheless allowed apolitical technocratic governments (Amato in 1992 and Dini in 1995) to implement reforms that various majority governments had previously failed to push through. Trade union support was gained through “consultation”, leading to less radical reforms and protecting the acquired rights of pensioners and older workers.
The seemingly radical 1995 “Dini” reform turned the design of the pay-as-you-go annuity system upside down, transforming it into a public virtual funded system by creating an individual account for each contributor into which a fixed portion of his or her salary was paid. The virtual capital was revalued and converted into an annuity by applying a coefficient that increased with age and decreased with life expectancy. The choice of retirement age was no longer determined by an explicit collective standard, but became flexible. The reform introduced two key elements: an initial 23% drop in the replacement rate for a typical contributor retiring at 60 and drawing his or her pension for 40 years; and a 6% discount/premium per year of early/late retirement, which helped minimise the drop in the replacement rate, thus encouraging contributors to keep working longer. The average replacement rate fell from 88% for contributors to the old system to 64% for those covered by the new system.
The compromise between trade unions and employers’ organisations resulted in a long transitional phase during which the new points-based system only applied to workers who had begun to contribute in 1996 or later; workers who had been contributing for at least 18 years in 1995 were still covered by the old annuity system, while other contributors were covered by a mixed system. Under this arrangement, 40% of employees were exempt from the new pension calculation rules. The first pensions under the new system will begin to be paid out in the 2030s; not until the 2060s will all pensions be paid out under the new system.
Transition : the key question
The extended transition between the two systems meant the “intergenerational pact” was not wholly undermined, since the acquired rights of pensioners and older workers were protected. The bulk of the adjustment cost, which is inversely proportional to age, is borne by the younger generations who, in theory, could use private insurance schemes. However, new contributors receive lower pensions than those they are funding for current pensioners, while their ability to build up additional insurance is limited by continuing high contribution rates. This partially reformed system is a source of inequity: the long transitional period means different replacement rates exist for the same contribution rate. Moreover, the continuation of the “seniority pension” (which allows for early retirement on full pension) ensures a continuing disconnect between contributions paid and benefits received. The life expectancy figures used to convert virtual capital into annuities were only reviewed every ten years. As such, the ability to regulate the system was limited by these obsolete estimates.
Imbalances thus continue to build up in the annuity system, and are set to worsen until 2030. This will place an additional burden on new contributors. The legislature will have to take action to “recalibrate” the parameters. This will lead to a further decline in replacement rates. However, the extent of this decline is not, at this stage, easy for contributors to calculate. As such, new contributors will have great difficulty protecting themselves against potential falls in their replacement rate.
Renegotiating the 1995 compromise
In spite of persistent imbalances, subsequent governments took only marginal action on pensions. Not until the dawn of the current decade was the question of completing the reform raised, under pressure of the urgent requirement to stabilise public finances following the financial crisis. Adjustments to pensions every two years in line with increasing life expectancy became automatic under the Monti government in 2011. The transition to the defined contribution system was quickened by extending it to all employees (including those who started work before 1995) in proportion to the amount of contributions already paid. The statutory retirement age was raised, and contributions length of by workers covered by the old system and wishing to take early retirement on a full pension was increased.
Pensions counter-reform, particularly in relation to the adjustments made in 2010-2011 (notably under the Fornero reform), has now become the hobbyhorse of both parties in the new government.
The aim is to freeze the upward trajectory of the statutory minimum retirement age. Matching retirement age with the life expectancy trend would mean raising the pensionable age by three to four years over the next two decades. Abandoning this adjustment would cost €140 billion between now and 2035.
The government-backed “Quota 100” proposal (with 100 being the sum of the number of years’ contributions and retirement age, subject to a minimum of 38 years’ contributions and a minimum retirement age of 42) is groundless and foreign to the contribution-based approach founded on the free choice of retirement age within a range common to all workers. Furthermore, the government is proposing a “citizenship pension” of €780 a month – a version of the “citizenship income” for the older section of the population. Through these proposals, the government has opted to divert scarce financial resources to a segment of the population that is relatively unaffected by poverty and that already benefits from universal anti-poverty measures (minimum pension).
These measures do not equate to an overall reform of the system; rather, they are an attempt to maximise the electorate’s short-term interests while forgetting the fundamental decision made 23 years ago to adopt a contribution-based approach. The aim is to defend privileges acquired under the old system; the arguments of sustainability and equity are missing.
So, if there is one lesson to be learned from the reform of Italy’s pension system, it is this: while the excessively long transition to the reformed system admittedly ensured that the reform would be acceptable to trade unions and employers’ organisations at the time, it delayed its financial effects and created the illusion that structural action to ensure the system was sustainable was no longer necessary. In the meantime, politicians seeking political gains were ensnared by the reform’s pitfalls, forgetting the fundamental choices on which it was based and aggravating imbalances in the system, which will make adjustments more expensive for future generations.
Paola Monperrus-Veroni - email@example.com