Master Thesis
The development of the Italian
complementary pension system:
behavioral patterns of Italian investors
Alessandro Pala
University of Groningen
Faculty of Economics and Business
MSc Business Administration, Specialization Finance
August 2011
Abstract
In this thesis, I examine the development of complementary pension plans in Italy. Despite the recent reforms introduced by the Italian Government, the development of the complementary pension system is still partially unsatisfactory even if improvements have been registered in the last years. Moreover, I analyze different behavioral issues that affect the cognitive process of investors bringing them to act in a manner that is not consistent with Modern Portfolio Theory. Through a survey, I find strong correlation between the effective behavior of the Italian investors and several behavioral biases.
Keywords: behavioral finance, pension funds, complementary pension, Italy, financial planner
Table of Content
List of Tables ... 3
Table of Figures... 4
1. Introduction ... 5
2. Background Literature Review ... 9
3. The Italian pension system ... 17
3.1 History... 17
3.2 Eligibility requirements ... 20
3.3 TFR ... 22
3.4 Complementary pension ... 22
3.5 Closed pension Funds ... 23
3.6 Open pension funds... 23
3.7 Individual pension plan ... 24
3.8 Preexistent pension fund ... 24
3.9 Fund investment contribution ... 24
3.10 Anticipations ... 26
3.11 COVIP... 30
4. Data and descriptive statistics... 31
4.1 How are pension funds performing? ... 31
List of Tables
Table 1: Anticipations ... 26
Table 2 : Redemption ... 27
Table 3 : performance example ... 29
Table 4 : contribution list ... 30
Table 5: Subscribers of complementary pension plans... 32
Table 6: complementary pension forms. Subscribers according to the job position. ... 34
Table 7: Adherence rate ... 34
Table 8 : Resources and contributions ... 35
Table 9 : Characteristics of complementary pension system ... 36
Table 10: Outcomes of the behavioral bias present in the survey ... 60
Table 11: percentages of the answers ... 77
Table of Figures
Figure 1 : Replacement rates trend for an average income ... 6
Figure 2: Demographic rate and welfare ... 7
Figure 3 : Pension Funds in the OECD countries. Ratio between Assets managed and the GDP... 38
Figure 4 : Pension fund asset allocation for selected investment categories in selected OECD countries ... 39
Figure 5 : Results Question A ... 43
Figure 6 : Results Question B ... 44
Figure 7 : Results Question C ... 45
Figure 8 : Results Question D ... 46
Figure 9 : Results Question E ... 47
Figure 10: Results Question F ... 47
Figure 11: Results Question G ... 48
Figure 12 : Results Question H ... 49
Figure 13 : Results Question I ... 50
Figure 14 : Results Question L ... 51
Figure 15: Results Question M ... 52
Figure 16 : Results Question N ... 52
Figure 17 : Results Question O ... 53
Figure 18 : Results Question Q ... 54
Figure 19 : Results Question R ... 55
Figure 20 : Results Question S... 56
Figure 21 : Results Question T ... 57
Figure 22 : Results Question U ... 58
Figure 23 : Exponential versus Hyperbolic Discounters : Growth of $1 Over Time ... 70
Figure 24 : Decision Framing: The impact of automatic enrollment on New Hire Plan Participation Rates ... 70
Figure 25: Prospect Theory Value Function ... 71
1. Introduction
The public Italian pension system is almost entirely structured according to the distribution criteria. This means that contributions, which are deposited into pension institutions, are used to pay out the pensions of those who are retired; no reserves are required to face the payment of the future pensions.
INPS (Social Security Institute for the private sector) is indeed the main institution which administers around 80% of the contributors of the public pension system. It is followed by INPDAP (Social Security Institute for the public sector) which administers around 15%.
The increase of the life expectancy of the Italian population and the slowdown of the economic growth posed a serious issue regarding the sustainability of the “classic” pension system. In order to face this problem, relevant changes have been made in the system during the last decades with the aim to cut the pension expenses.
Figure 1 : Replacement rates trend for an average income
M Dip = Male dependent worker F Dip = Female dependent worker M Aut = Male self employed F Aut = Female self employed
Figure 2: Demographic rate and welfare
Male Female
Figure 2 shows the age range (on the y-axis) and the number of persons that are part of that range (on x-axis).
Despite the deep reforms and benefits introduced in the last years, the development and the adherence to the complementary pension system have been described as “unsatisfactory” (so far only 5 million people joined a complementary pension plan out of 60 million). The main Italian Institutions which are involved in the Italian welfare system development constantly pose several questions regarding the problems which affect the development and the adherence to the complementary pension system. Among the several theories, one of those is that the decisions of Italian investors are affected by cognitive, social and emotional factors. A field of finance that proposes psychology-based theories to explain market anomalies is behavioral finance. It assumes that the information structure and the characteristics of market participants systematically influence individuals' investment decisions as well as market outcomes.
regarding their own retirement under mental or emotional constraints. The thesis initially reviews past literature regarding modifications and reforms connected with the Italian complementary pension system
In the following step, I investigate the typical behavioral aspects shown by workers who have to make saving and investment decisions for the retirement period (Mitchell and Utkus, 2006). This process usually begins with the accumulation phase in the early stage of working life and ends with the decumulation phase which is typical of the period close to the retirement.
In the third chapter, the Italian pension system is studied broadly, showing the history of the Italian Welfare System and the development of the severance pay (TFR). In particular, it is analyzed COVIP (Vigilance Commission on Pension Funds) annual report about the complementary pension system in Italy.
In the next section, the performance of Italian pension funds is analyzed as well as the international situation of the complementary pension system compared to the Italian one.
The underlying idea of this thesis is that people‟s decisions are subject to “bounded rationality” (Kahneman, 2003). People try to maximize their self-interest, but their decisions are generally made with imperfect outcomes. Therefore, when it comes to retirement savings decisions, people face cognitive constraints that bring them to opt for decisions that deviate from the rational investment decision making underlined in Modern Portfolio Theory.
mainly related to some behavioral bias shown by their clients. Moreover I try to investigate some critical points of the recent reforms of Italian welfare system (i.e. fiscal benefits) and understand whether according to the Financial Planners those are favoring the joining to the complementary pension system.
2. Background Literature Review
In a related paper, Brugiavini and Peracchi (2003) try to understand the role of financial incentives in the choice of retirement savings, focusing on the timing of the retirement decisions. Recently, Cozzolino et al. (2006) in an empirical study show that only 21% of Italian householders interviewed by the Bank of Italy in 2004 considered the public pension system adequate, although among these individuals only 23% regarded as useful the adhesion to a pension fund. The authors base their conclusions on the important reform of 2005; this reform regulates the complementary pension system, labeling it in various categories, states that the contribution-based system is on voluntary basis and gives the possibility to all the private and public employees to join a complementary pension plan. It is also possible for the employee to decide where to allocate his own severance pay (either to leave inside the workplace or to allocate it to a pension fund).
The authors also show that the share of individuals willing to maintain future severance pay in the firm increased from 40% to 53% between 2004 and 2005. According to the authors the reason of such growth has been caused by the irreversibility of the choice of switching to the complementary pension system. Again, 56% of interviewed considered the fiscal benefits provided by the reform as insufficient.
Cesari et al. (2007) state that the economic benefits provided the reform to join to the complementary pension system are relevant for both fiscal rebates and for the presence of the employer contribution which is considered as a “windfall gain” for the employee. Bardazzi and Pazienza (2005) run simulations aiming at estimating the cost of the reform for Italian firms concluding that such a cost would add up to 5% of total wages after ten years and that, both taking into account the interest rate structure of loans and the size of the severance pay stock currently held by the firms, such a cost is inversely related with the firms‟ size.
Finally, Corsini et al. (2010) try to investigate through a model, workers‟ choice problem of switching between different pension schemes. In their model, each worker, when deciding whether to permanently adhere to the complementary pension system, not only has to trade off the direct economic advantages and disadvantages (consisting in higher but riskier returns), but also has to take into account the effects of this individual decision on the financial health of the firm in which he/she is employed. According to the authors, workers‟ incentives to switch to a pension fund depend positively on the expected returns of the pension fund, on the size of the firms and negatively to risk aversion. Moreover, they argue that the lack of efficacy of the reform may be due to the peculiarity of the Italian production system, populated by a large number of small and medium enterprises which have a fragile financial structure and by the institutional characteristics of the Italian labor market and the workers‟ preferences, opportunities and information sets.
According to Simon (1955), in the real world, peoples‟ decisions are subject to “bounded rationality”. This means that people try to maximize their self-interest but often they are not able to do so because certain types of decisions and problems may be too complex. Moreover, Thaler et al.(2000) add that individuals have the right intentions or beliefs but they lack the willpower to carry out the appropriate changes in behavior (“bounded self-control”) and that many people try to maximize their own welfare and yet they prove far more cooperative than economic theory predicts they are (“bounded self-interest”). In their paper, Mitchell and Utkus (2006) base their research on how markets work and how consumers make decisions when some people work under mental or emotional constraints and complications. In their paper they analyze key aspects of behavioral research applying it in order to find better ways to design and manage retirement systems. The most relevant aspect of their paper is their aim to understand how employers and retirees might deviate from the rational economic agent that underlies economic theory as well as retirement plan design.
According to the neoclassical economic theory, investors are thought to compare the benefits gained from consuming their income today with the benefits of deferring part of the income into the future. Modigliani and Brumberg (1954) developed the so called life-cycle theory model, where workers tend to be net dissavers during their younger years, while middle-aged workers are net savers and they enter in the so called “accumulation phase”, where they accumulate assets for the retired life. According to the life cycle theory, people will develop assets for retirement that will be sufficient to protect them from unexpected declines in their standard of living in old age. Basically it means that saving generally rises with income and age and it is positively correlated with education and total wealth; young investors tend to have higher debts then assets, while middle aged investor tend to save and accumulate financial assets. Finally, retired people tend to consume the financial assets accumulated during the working life.
suggests that individuals are not that good at retirement savings problem and few people are able to make an efficient plan for retirement. Previous surveys find that fewer than 40 percent of US workers have calculated how much they will need to retire on, 30 percent have not saved anything for retirement and only 20 percent feel very confident about having enough money to live comfortably in retirement (EBRI 2003). This behavior seems consistent with the illustration of Simon‟s “bounded rationality”: being rational at retirement savings requires accurate estimates of uncertain future processes including lifetime earnings, asset returns, tax rates etc. In order to solve this problem the human brain needs to solve many problems related to the long time value of money, which is subject to uncertainties. Therefore, it is not surprising that workers face difficulties with retirement saving: workers struggle in view of the problem‟s complexity and “do not get the saving problem right”, which is opposite to the assumption of rationality which is stated by the classical life-cycle model.
According to Thaler and Shefrin (1981), the lack of retirement preparation might be also due to the fact that people try to save for retirement, but they are limited in their capacity or desire to execute intentions. Regarding pension saving, it seems that if from one side people understand the benefits of retirement saving, they have difficulties implementing their intentions. They often have problems taking actions and, when they do, their behaviors are often ineffective.
consume too much today and not save for the retirement due to self-control problem. In Choi‟ survey (Choi et al 2001a), 68 percent of participants from a single firm of 10.000 employees stated that retirement savings rate was too low, reporting that they should be saving 14 percent of average earnings, whereas actually they were saving just 6 percent. In Clark et al (2004), retirement plan participants reported that they knew they were saving less than they should confirming the fact that the main problem is to overcome hyperbolic discounting.
The fact that people tend to stick with the default option is caused by inertia. Madrian and Shea (2001) also show that the benefit of higher plan participation rates appeared to be offset by a deep level of inertia. They found out that once enrolled, participants made few active changes to the contribution rates or investment selected for them by their employer; actually most of the participants remained at the default saving set by the employer. Choi et al (2001) argue that participants tend to follow the so called “path of least resistance” in decision making, which means making the easiest decision (which is not always the best). Sethi-Iyengar et al (2006) also show that workers often face the so called “choice overload”, where participants become overwhelmed with the complexity of the decision and pension plan participation is reduced as consequence.
Another issue is related to how individuals build their portfolios. According to the modern portfolio theory (MPT), rational investors aim to obtain efficient combinations of securities that optimize risk and return in order to get a portfolio on the efficient frontier which offers the highest return for a given level of risk. According to MPT, investors are supposed to choose from a variety of portfolios from the efficient frontier based on their expected utility, where individuals are supposed to be risk-averse which means that they demand higher compensation for riskier investments. As mentioned by Markowitz (1952) one of the key aspects of MPT is that in an efficient capital market, investors are not compensated for assuming the risks of investing in an individual security but only for the aggregate market risk they endure. This basically means the investors will try to completely eliminate the so called “stock specific risk” maximizing portfolio diversification. This principle has been at the foundation of the growth of low-cost index strategies as an investment management style in both DB and DC retirement plans.
million participants had 60 percent or more in company stock, which might indicate a related diversification puzzle
Benartzi and Thaler (2001) show that the way investors diversify their portfolios is influenced by the menu design and how choices are presented. They conducted an experiment where participants were asked to select an investment mix for their retirement plans given two fund offerings. Some participants were presented with a stock fund and a bond fund, some with a stock and a balanced fund and a third group with a bond fund and a balanced fund. In all three cases, a common strategy was to choose a 50/50 mix of the two funds offered, although many participants did select different weightings. Actually, different underlying asset allocation ensued, given the different choices offered. Interestingly for people given the choice of a stock fund and a bond fund, the average allocation to equities was 54 percent. Instead those offered two equity-oriented portfolios, a balanced fund and an equity fund, the average allocation to equities was 73 percent. For those offered a balanced and a bond fund, the average allocation to equities was only 35 percent. This experiment shows that menu design might have a more powerful influence on participant decision-making than the underlying risk and return characteristics of the investments being offered. The investment menu is a frame that investors cannot see clearly in order to get properly the underlying risk and return characteristics.
Still Tversky and Kahnemann (1979) try to give an explanation on how pension plan participants make decisions under uncertainty about their pension investments, given that they are not rational mean-variance investors. They propose the so called “prospect theory” that models individuals as if they make decisions to maximize a S-shaped value function (see Figure 25). This function is peculiar because individuals consider how a decision influences incremental gains and losses rather than total wealth. Second, individuals treat gains and losses quite differently, with losses felt much more than gains.
performances which is cheaply available. Moreover, investor tend to be affected also by the “representativeness heuristic”; it means that people tend to see patterns in small series of numbers and when taking decisions, people tend to apply some patterns on the information they face.
A clear example of those two heuristics is the one based on mutual funds investment. People tend to identify a fund manager with few years of good performance and concluded that the manager has outstanding skill (representativeness) rather than view it as a random process and tend to strongly rely on past performance (availability) despite they know that it is not a guarantee of future results.
I decide to use a survey in order to answer the main questions of my thesis. In fact, they can be divided into three questions:
“Why the Italian complementary pension system is still underdeveloped?”
“Are there behavioral motivations connected to Italian individuals that are affecting the lack of adherence to a complementary pension system?”
“Which modifications could the Italian System follow in order to improve the adherence to the complementary pension system?”
3. The Italian pension system
3.1 History
In this chapter, I would like to give a brief chronology of the main reforms introduced in Italy regarding Italian welfare system; moreover I put on evidence the main important steps that brought the development of the complementary pension system 1
1898: the “State welfare Fund” is created for private employees.
1919: the invalidity, unemployment and old-age insurances are made compulsory for all private employees. The contributions are invested in government bonds and after retirement, the earnings of those contributions go to the employees.
1924: unemployment benefit is introduced
1933: the State welfare Fund is replaced by INPS (Istituto Nazionale Previdenza Sociale) and family paycheck is introduced in order to develop a demographic rate
1965: “welfare pension” and “old age pension” are introduced. Thanks to the welfare pension, a minimum wage is guaranteed to the workers, while the old age pension is guaranteed after 35 years of contributions
1982: The age indemnity benefit is replaced by the introduction of Trattamento di Fine Rapporto or TFR (severance pay).
1992: The structure of the Italian pension system is deeply reformed since 1992. Among the principal changes that are introduced in order to develop financial sustainability in the long run there are:
– Elimination of pension indexation to real wages
– Introduction of the contribution-based method, which significantly reduces the size of early retirement pensions, especially for the self-employed
– Tightening of the minimum eligibility requirements for both old age and early pensions (Aprile, 2008).
As a result of the 1995 pension reform, the Italian pension system is moving step by step from an earnings-related system to a contribution-based one, which is fully applied to all labor market new comers after the 31st of December 1995. The main feature of the new system regards the way it is computed, which is now based on a defined contribution formula unlike the previous system which was based on a defined benefit formula.
The reference wage is an average of the last wages, indexed to prices up to the year before that of retirement. The number of wages involved in the calculation varies depending on the scheme and the years to which contributions refer (Aprile, 2008).
Contribution-based regime. Under the contribution-based regime, the amount of pension is calculated as a product of two factors: the total lifelong contributions, capitalized with the nominal GDP growth rate (five-year geometric average) and the transformation coefficient, which is mainly based on mortality rates schemes. As a consequence, pension amount is proportional to the contribution rate and inversely related to retirement age - the lower the age, the lower the pension and vice versa.
The transformation coefficients are available for the year-range between 57 and 65. As reported by Aprile (2008), for retirement ages falling below (i.e. disability pensions) or above the range, the lowest and the highest transformation coefficients are applied respectively. Either way, employees may not retire before 65 unless they have reached the eligibility requirements stated in current legislation and an amount of pension not less than 1.2 times the old age allowance (OECD, 2010). Until 2010, the transformation coefficients to be applied are those introduced by law 335/95, which range from 4.72%, at the age of 57, to 6.14%, at the age of 65. In 2010 the new coefficients, revised on the basis of the procedure described by law 335/95, will be applied, which range from 4.42% to 5.62 percent. According to current legislation, it is envisaged that transformation coefficients will be revised every three years on the basis of a procedure falling entirely under the administrative sphere of competence
Transitional phase. The new regime will be totally effective around 2035. Meanwhile, there will be a transitional phase which only affects workers already employed at the end of 1995. In particular, two different calculation methods will be used, depending on the years of contribution matured at the end of 1995:
– workers with less than 18 years of contribution will be subject to the so-called pro-rata, mixed regime, according to which the pension is obtained as a sum of two components: the first, related to contributions accrued up 1995, is calculated according to the earnings-related method88; the second is calculated according to the contribution-based one (Aprile, 2008).
The law n.252 of 2005 is a key point for the development of complementary pension system in Italy. This law regulates the complementary pension system, classifying the various complementary pension plans into closed, open and individual plans. It also states that the contribution-based system is on voluntary basis. All the private and public employees can join a complementary pension plan.
As reported by COVIP (2009), since 2006, further changes to pension legislation have been adopted with the aim of supporting the reform process. The major changes arose from the implementation of the 23rd July Agreement on welfare between government and social partners, which showed:
i) An increase of low amount pensions;
ii) The slowdown of the process of elevating minimum requirements for early pensions, without altering the phased-in targets previously foreseen and
iii) The adoption of the updated transformation coefficients and the reinforcement of the procedure for subsequent revisions (Aprile, 2008).
More recently, law 133/2008 has strengthened the possibility of accumulating pension and labor income (COVIP 2009)2.
3.2 Eligibility requirements
Old age pensions. Under the earnings-related and mixed regimes, the age requirement to be entitled to an old age pension is 65 for men and 60 for women, together with a minimum contribution period of 20 years. Under the contribution-based regime all
pensions are referred to as „old age‟ ones. However, the same requirements must be fulfilled as those required for early pensions under the earnings-related and mixed regimes in order to retire before 65 for men and 60 for women. Between 60 and 65, women may retire with 5 years of contributions, as long as the prerequisite of an amount of pension of at least 1.2 times the old age allowance is fulfilled. Above 65 the latter prerequisite is no longer required.
Early retirement pensions. From 2008, for all regimes (earnings-related, mixed and contribution-based), the possibility of receiving a pension at an age lower than 65 for men and 60 for women is allowed to all workers with at least:
– 40 years of contributions, regardless of age
– 35 years of contributions together with an increasing age requirement.
The latter is 58 (59 for the self-employed) from 1st January 2008 to 30th June 2009, 60 (61 for the self-employed) from 1st July 2009 to the end of 2010. Subsequently, the age requirement rises by one year in 2011 and 2013, thus reaching 62 and 63 for the employed and the self-employed, respectively. In addition, starting from July 2009, workers are allowed to access early retirement at an age lower by 1 year than the age requirements mentioned above, provided that they possess at least 36 years of contributions instead of 35.
Further postponement of pension payments is foreseen, (after meeting the requirements) by the so-called „exit windows‟. Such postponement is developed for all regimes and, starting from 2008, will average about 9 months for employees and 15 months for the self-employed For the period 2008-2015, women under earnings-related and mixed regimes who have satisfied the requirements laid down by law 243/2004 are allowed to retire before 60 as long as they choose the less favorable pension treatment provided by the contribution-based system. For specific categories of workers involved in particularly hard and stressful jobs the possibility to retire with a minimum age requirement lower than the normal one is also envisaged, albeit within very stringent limits (Aprile 2008)3
3
3.3 TFR
One of the most relevant news of the Reform regards the so called “Trattamento di Fine Rapporto” (TFR) which can be used as a source of financing of complementary pension plans.
TFR is the amount that is given by the employer to the employee at end of the working period. TFR is computed adding every working year an amount equal to 6.91% of the total retribution. The amounts deposited are revaluated by a fixed rate of 1.5% and by the 75% of the growth of the prices‟ index furnished by ISTAT. During the liquidation period, TFR is taxed with the application of the average IRPEF rate of the worker during the year when it is received.
From the 1st January 2007 every dependent worker, with the exception of some specific branches of public administrations workers can choose to deposit his/her own future TFR either to the complementary pension systems or to his own employer. For the workers hired before the 31st December 2006, the decision deadline expired on the 30 June 2007, while for the workers hired after 31st December 2006 the deadline is in six months from the hiring date. The worker who has already deposited totally the TFR in a pension fund before the 1st January 2007 does not have to make any choice. Those workers hired after the 31st December 2006 who did not make any choice regarding the destination of the TFR for a previous working activity, have to make a choice about the destination of TFR using the “TFR2 form”. If The TFR2 form is not given to the employer within six months from the hiring date, an automatic adherence to pension funds applies through the mechanism of silent consent (tacito conferimento TFR) 4
3.4 Complementary pension
Complementary pensions have been created in order to provide an alternative pension which adds up to the obligatory one. They can be divided into four main
categories: open pension funds, closed-contractual pension funds, individual pension plans (PIP), and pre-existing pension funds (before 1992).
Another ranking can be made distinguishing between group and individual forms. The former generally refers to a group of workers who belongs to the same field of work, while the latter implies that the joining is made only personally.
3.5 Closed pension Funds
Closed-contractual pension funds are part of group forms; those funds thus are born from collective deals, which refer to specific workers of a specific fields/sector (for example metal workers) or even to a pre specified region. The activity of this kind of fund basically consists of gathering of the contributions and of the setting the investment plan of the resources which are committed to external institutions specialized in financial management.
The closed pension fund is a juridical entity totally autonomous; the manager of the fund is generally the general director itself.
The assembly is formed by representatives of the subscribers while the administration and control authorities are formed both by representatives of workers and employers. Instead, the management of financial resources is run by specialized entities like banks, insurance companies, management societies etc. while pensions are paid out by insurance companies.
3.6 Open pension funds
The interest of the joiners is safeguarded by an organism of surveillance, whose role is to verify that the administration and the manager of the fund are following the best interests of the joiners of the fund.
The responsible of the open fund performs his own activity independently from the society which created the open fund and cooperates with the organism of surveillance in the way that the management of the fund fits the best interests of the joiners.
3.7 Individual pension plan
Individual pension plan (PIP) is realized through signing of life insurances with welfare targets. Financial resources gathered through those kinds of contracts are part of a separated and autonomous asset. Like in the open funds, there is a person in charge which mansion is to verify that the management of the fund is run according to the best interest of the subscriber.
3.8 Preexistent pension fund
Preexistent pension funds are those which were created before 1992 and have distinctive features compared to new kinds of funds. One of this is the possibility to manage directly resources without the need for specialized intermediaries. Joining this kind of fund occurs on group base.
3.9 Fund investment contribution
of those contributions. It is possible to participate in the complementary pensions in different ways:
- future severance pay (Trattamento di fine rapporto or TFR); - contributions in charge of the employee;
- contributions in charge of the employer.
Since 1st January 2007, it is possible to join complementary pensions even through the sole deposit of the future severance pay. This joining does not imply the obligation to deposit other contributions, neither from the side of the employer nor from one of the employee. Either way it is possible for the worker to deposit further contributions freely. In the groups oriented pension funds, it is possible to predetermine the minimum contribution to the funds of the employers and the employee.
As already mentioned, the contributions managed by specialized managers are part of a separated and autonomous asset, the target of which is purely of welfare purposes. A specific discipline determines rigorous criteria of risk allocation and risk management. The organ whose mission is to control the efficiency of this discipline is called COVIP. In some pension plans, the investment policy of resources is unique for all the participants so that they receive equal benefits of financial management.
In other plans, investment is divided into different lines which differ according the typology and the risk. In this case the participant is free to choose the line of investment which suits more to his/her taste. A well-reasoned investment plan needs to consider social and economic conditions as well as the age, age of retirement, and the risk aversion. The expected return of the investment is thus highly correlated to the risk level that the employer is willing to take: therefore higher risk means higher expected return while lower risk means lower expected return. A younger employee for example, is more likely to be less risk averse than an employee that is close to the retirement.
guarantees to the worker the repayment of the principal with a higher chance to realize returns which are equal or superior to those of the severance pay.
3.10 Anticipations
In some particular cases, regulation allows the worker to get an anticipation from his own investment pension plan. The amount that is possible to receive before the retirement day is computed on the accrued position, which is formed by the deposits and returns realized until that moment. From the 1st January 2007, the subscriber can obtain the anticipation for the following reasons:
- Medical expenses due to critical conditions of the subscriber or his direct family. This amount can be obtained at any time and until 75% of the accrued position. - The purchase of the first house for the subscribers or his/her sons. The amount that can be required is 75% of the accrued position and this can be done only after 8 years of participation to the fund.
- Any further needs of the subscriber after 8 years and with a limitation of the 30% of the accrued position
Table 1: Anticipations
Typology Period Amount
Medical expenses Always Until 75%
Buy and maintenance of the first house After 8 years Until 75%
Any further needs After 8 years Until 30%
From the 1st January 2007 the subscriber that loses the requirements to participate for the complementary pension fund is also able to redeem of the accrued position or as an alternative to maintain the accrued position in the fund, even without any further contribution. The redemption can be partial or total and can be asked according to this scheme:
- 50% of the accrued position in case the unemployment as a consequence of the termination of the working activity is in the range between 12 and 48 months - 100% of the accrued position in case the period of unemployment is above 48 months or in case of permanent invalidity that reduces the working skill to less than one third.
In case of the death of the subscriber before the retirement, the entire accrued position is redeemed by his/her heirs at law or in their absence, by beneficiaries named by the subscriber. In the absence of beneficiaries, the position is absorbed by the fund or used for humanitarian purposes (in case of an individual position).
Table 2 : Redemption
Typology Amount
Permanent invalidity which does not allow any working activity 100%
Termination of working activity with following unemployment period above
48 months 100%
Death of the subscriber before the maturity of the right to the pension
contribution 100%
Loss of participation requirement (the least favorable taxation regime) 100% Termination of working activity with following unemployment period > 12
and < 48 months 50%
Mobility procedures 50%
Life annuity
Life annuity represents the typical payoff of complementary welfare plan. According to the law, 50% of the amount accrued has to be paid out as a life annuity In case the subscriber decides to opt for a 100% of life annuity; it is allowed to obtain a yield which consists of a predetermined amount of annuities.
The worker has also the right to request 50% of the accrued yield as a capital. It is possible anyway to obtain 100% of the accrued yield as a capital if the 70% of the final amount accrued converted as a life annuity is below to the half of the welfare paycheck provided by INPS (381.72 Euros monthly).
Fiscal regime
The fiscal regime of complementary welfare plans is organized according to the so-called E-T-T system (exemption-taxation-taxation). This means that each of the three phases of the pension plan, which are accumulation investment and yield, follows a different fiscal regime. According to this scheme, contributions are tax exempted (with a fixed limitation), while during the accumulation of the returns and the yield, the fiscal regime applies.
Contributions
Since 2007 new regulations have been implemented in order to favor the participation in the complementary pension plans. It means that for those who decide to join a complementary pension plan it is possible to obtain fiscal benefits.
It is possible thus to deduct the contributions entirely from the “Irpef total income” with a cap of 5.164,57 Euros per year. This basically means a saving in terms of less taxes paid which is equal to the higher fiscal rate applied to the total income of the worker.
can benefit of the tax deductibility. TFR is anyway tax exempted when is put in the complementary pension plan.
Performances
Pension‟s performances given out in the form of capital or life annuity are part of taxable income only for the part that has not been taxed during the accumulation phase. The taxable part of pension‟s performances is taxed at the source as an Income Tax at 15% rate which decreases of 0.30% per year of participation above the 15th. The maximum reduction is anyway of 6% points, therefore after 35 years of participation the tax rate is 9%.
Table 3 : performance example
Years of participation Tax rate Paid taxes per 1000 Euros
1 15% 150 … 15 15% 150 16 14,7% 147 17 14,4% 144 … 35 9% 90 36 9% 90
The anticipations obtained to face medical expenses and the sums received as redemption in case of unemployment which last for at least 12 months, permanent invalidity or death face a withholding tax of 15% with a decrease of 0.30% per year of participation above the fifteenth. Even in this case, the lower tax rate reachable is 9%. Anticipations received for other reasons (purchase of the first house for example) as well as other redemption not listed above face a fixed tax rate of 23%.
Table 4 : contribution list
Contribution typology Tax Income
Life annuity contribution; capital contribution; anticipations for medical expenses; redemption according to the law “Redemptions because of early death”;
15% in the first 15 years and -0,3% for any following year, until 9% is reached.
Anticipations for purchase or maintenance of the first house; untypical redemptions.
23%
Returns
Returns which are produced by the financial management of the pension plans face a fixed tax rate of 11%. Even in this case, the tax rate is lower if compared to those applied to returns of other financial investments.
3.11 COVIP
COVIP (Commissione Vigilanza sui Fondi Pensione) vigilates the complementary pension forms. It is itself controlled by Minister of Labor and Social Security.
4. Data and descriptive statistics
The empirical analysis is comprised of two parts. In the first part, I analyze the performance of the pension funds in Italy using mainly a quantitative method, especially through the evaluation of statistics provided yearly by the Italian Vigilance Authorities (COVIP). In this part I try to provide evidence on the difference between pension funds and which kind of funds, Italian investors are participating in. I also show the differences between Italian welfare system and the one of other developed countries being part of OECD.
In the second part I apply both quantitative and qualitative methods trying to investigate investors‟ behavior and the reasons that govern such behaviors. In particular, I create a survey in order to test multiple behavioral issues affecting investors‟ decisions, which seem to drive them away from the efficient economic theories.
4.1 How are pension funds performing?
The adherence
Table 5: Subscribers of complementary pension plans (data of end 2009)
Funds
Subscribers(1) New subscribers during the year(2) Number var % 2009/2008 Number % on the joiners of 2008 Group pension Funds 39 2,040,150 -0.2 66,000 3.2 Open pension funds 76 820,385 3.1 40,000 5.0 Preexistent Pension funds 391 673,039 -0.6 29,000 4.3 PIP “new”(3) 75 893,547 27.3 195,000 27.8 Total 581 4,463,581 5.3 321,000 7.6 PIP “old”(4) 654,376 - - Total general 5,055,284 4.2 321,000 6.6
(1) Joiners that did not deposit during the year are included. Retired person are excluded (2) Incomplete data
(3) PIP s according to the law. 252/2005. (4) PIPs created before the reform of 2005.
COVIP also states that 120.000 subscribers ended their plans, mostly through the ransom of the position (92.000 subscribers) and capital account performances (26.000). Only 2000 subscribers got the payoff through the annuity payment. A relevant trend shows that 700.000 subscribers decided not to deposit anything during 2009 which corresponds to 15% of the total subscribers (old PIPs are not included). During the previous year, there were only 12% of subscribers who decided not to deposit. 40% of the subscribers which are not depositing are part of the open funds, while 30% in PIPs; only 18% is allocated in group-oriented funds and 12% in the pre-existent funds.
This behavior shows that people are reluctant to invest in pension plans, maybe due to the financial credit crisis that reduced the savings of investors or due to some specific behavioral biases of the investor. According to COVIP self-employed face the highest probability to skip some yearly deposits. This is due to the fact that self-employed do not receive TFR therefore they lose a big part of fixed amount to deposit in pension plans. 50% of self-employed subscribers did not deposit anything during the 2009 in the open funds while 37% did not deposit in the PIPs.
Table 6: complementary pension forms. Subscribers according to the job position. Dependent employees Autonomous employees Total Private sector Public sector
Group pension funds 1,902,199 134,296 3,655 2,040,150 Open pension funds 395,901 …. 424,484 820,385 Preexistent pension funds 644,182 4,222 24,635 673,039
New PIP 544,832 …. 348,715 893,547
Old PIP 201,918 …. 452,458 654,376
Total 3,692,223 138,518 1,224,543 5,055,284
(data of the end 2009)
Table 7: Adherence rate
(data of the end 2009)
Typology of investors Adherence to complementary pension forms
Occupation Adherence rate(%)
Private sector employees 3,692,000 13,716,000 26.9
Public sector employees 139,000 3,566,000 3.9
Autonomous 1,225,000 5,640,000 21.7
Total 5,056,000 22,922,000 22.1
Workforce 25,066,000
According to COVIP report, men are more likely to subscribe to a pension investment plan than women. Interestingly, individuals in Northern regions are more likely to invest in the complementary pension plans than those living in the South and the Centre, which is indeed consistent with the level of earnings and savings5. Northern regions count for around 60% of the subscribers with an average national rate of 53%; the central regions count 21% of subscribers while south ones only 19%.
COVIP also confirms that the concentration of the subscribers in the Northern regions is indeed high when it concerns the group-oriented funds and preexistent funds with a rate of 65% while it is lower in the case of open funds and PIPs with a rate of 55%. In the southern regions, the scenario is opposite; PIPs and open funds have rates of 24% and 21% respectively while group-oriented funds and preexistent funds reach only 16% and 15% respectively.
An interesting peculiarity registered in two regions in the North of Italy has to be mentioned. In Valle D‟Aosta and Trentino Alto Adige a particular kind of pension plan, the so-called “territorial pension plan”, has been introduced and thanks to that the rate of subscribers among the workers of the private sectors is the highest in the country (around 40%). On the other hand, Sardinia and Calabria register the lowest rate of subscribers.
COVIP also says that in the end of the 2009, the resources assigned to the pension funds‟ performance reached 73 billion Euros with an increase of 11.6 billion from 2008, which corresponds to a growth of 19%. Preexistent funds are those with the highest quota of 39 billion of euro while group-oriented funds reached the amount of 19 billion. Open funds remained close to 6 billion while new PIPs reached the level of 3.5 billion, which means it is still less than old PIPs (5.6 billion).
Table 8 : Resources and contributions
(data of end 2009; flow per contribution; amount expressed in million euro)
Resources for contributions Contributions
Amount var. % 2009/2008 Amounts of which: TFR Group pension funds 18,757 33.1 4,186 2,742 Open pension funds 6,269 34.4 1,152 469 Preexistent pension funds 38,943 8.5 3,798 1,631 New PIP 3,397 73.5 1,244 228 TOTAL 67,388 19.0 10,390 5,080 Old PIP 5,569 19.3 731 - TOTAL 72,957 19.0 11,121 5,080
5. International situation
5.1 Public pensions
pension systems. However, many countries introduced working pension schemes and private mandatory and voluntary schemes.
Regarding the typology of pension benefits paid out by public earnings-related schemes, most countries provide defined benefit pensions. However, recently a number of countries such as Sweden, Bulgaria, Estonia, Latvia, Lithuania, Hungary, Poland and Slovakia, have moved away part of their public pension into private funded plans.
5.2 Private pensions
In light of fiscal pressures arising from demographic trends, many countries have taken steps to encourage the creation of complementary pension schemes. As a result, the role of these plans has recently increased. Still, the role of privately managed pension schemes is currently rather limited, as the major part of pension income is provided by public pension systems. In general, net contributions to complementary pension funds are developing over time and there is still a long way for them from being mature funds.
Table 9 : Characteristics of complementary pension system
Mandatory Fiscal system
Performance incidence over GDP Active pension funds over GDP Active life insurances over GDP Belgium NO EET 2.2 4.8 33.2 Denmark NO ETT 0.7 21.5 54.5 Germany NO EET/TEE 0.5 3.3 36.6 Spain NO EET 1.1 2.1 25.0
France YES EET 0.6 - 65.9
Italy NO ETT 0.5 3.2 15.9
Holland YES EET 5.1 85.6 51.8
Austria NO EET - 2.6 24.0
Portugal NO EET 0.8 12.0 21.5
Finland NO EET - - 17.3
Sweden NO ETT 1.0 2.7 65.6
United Kingdom NO EET 5.5 83.7 102.0
Two different kinds of system can be underlined: the Anglo-Saxon system where public welfare plays a limited role unlike the private capitalization system which plays the main role. The “Mittel-Europe” system instead gives a relevant role to the public welfare with the private system playing a limited but still lately increasing role. Pension funds play an important role on financial markets of several countries where they represent the main class of institutional investors in terms of managed resources.
During 2009 pension funds benefited from the recovery of markets even if the trust of investors dropped after the credit crisis of the 2008 is not fully regained.
Figure 3 : Pension Funds in the OECD countries. Ratio between Assets managed and the GDP.
Source: OECD (2009)
From the graph below (figure 4), it can be seen that portfolio allocation of the U.S.A., U.K and the Netherlands is mainly based on equity which represent around 40 percent of the total asset. Those countries have in common a more developed history of the complementary pension system.
In other OECD countries, where the level of complementary pension system is not that high, we can notice that asset allocation is mainly based on debt with percentages that go from 30-40 percent in Switzerland, Portugal and Italy itself and 50-60% of Denmark, Finland, Norway, Poland and Spain. 6
6
Figure 4 : Pension fund asset allocation for selected investment categories in selected OECD countries
Source: OECD (2009)
In the United Kingdom, defined benefit funds performed very well with positive returns around 15 percent, while the level of funding increased at 100 percent (80 percent during the 2008).
According to COVIP, the returns of defined contribution funds were around 10 percent. Defined contribution funds offerings increased during all the 2009 thanks also to the reforms introduced by several OECD countries, which especially aim to introduce a compulsory adherence to a complementary pension plan for those employees who did not have any. In 2009 in the United States dependent employees above 22 years and with a certain income, which were not part of any complementary pension plan, have been automatically subscribed to a defined contribution fund.
Despite the fact that pension funds performed well during the 2009, in different countries an important political debate has been initiated in order to achieve higher level of fairness and adequacy to sustain pension funds in the long run. According to different control authorities, such as COVIP, the communication with the subscribers and potential subscribers need to be further developed; moreover the risk management tools need to be improved.
6. Survey Results
This paragraph is dedicated to the presentation of the survey. I decide to use a survey in order to answer the main questions of my thesis. Basically they can be labeled in three questions:
- “Why the Italian complementary pension system is still underdeveloped?”
- “Are there behavioral motivations connected to Italian individuals that are affecting the lack of adherence to a complementary pension system?”
- “Which modifications could the Italian System follow in order to improve the adherence to the complementary pension system?”
In order to test these questions, I ask for the support of several Certified Financial Planners. I decide to send my survey specifically to financial planners for various reasons:
First of all, I believe Certified Financial Planners have an above average knowledge of financial markets and financial assets allocation. Financial Planners are also on average well informed and updated regarding all the rules modifications concerning Social Welfare System. Moreover, it is compulsory for Certified Financial Planners that are operating with any pension funds, to be part of ISVAP (Institute for the Surveillance on Private Collective Security). In order to access ISVAP, it is necessary to attend a 60 hours course which is based on all different aspects regarding the Italian Pension System including Italian legislation, fiscal regimes, new regulations, performances of various pension funds etc., followed by an exam. Moreover it is compulsory for the Financial Planner to attend a 30 hours update course once per year.
money they manage and the performance of the assets managed. Moreover they get in contact with clients or potential clients daily, which means they face all the behavioral and emotional issues of individuals constantly and it is in their best interest to deeply understand and overcome such impediments in order to boost their own performance. Therefore, I strongly believe that this survey might be a small but significant representation of the reality of the attitudes of the Italian Investors and can shed some light on the unsatisfactory level of the complementary pension system, which might have been undervalued so far.
In total, I have sent out during the month of May and June 2011, 520 surveys and respondents were 114 financial planners for an overall response rate of 21.9%. Overall, the amounts of clients represented by those financial planners are 12510 with an average of approximately 110 clients per planner. The survey contains 23 questions (see appendix). The survey was meant to cover all the regions of Italy; therefore I have sent it out to Financial Planners who are operating in all the twenty Italian regions. Respondents anyway, are mainly located in the Northern regions.
I try to tackle different behavioral bias and general issues in order to get an in depth and multivariate analysis of all the different aspects that are concurring in the actual situation of the Italian welfare system.
A) According to the respondents, half of the people in Italy do not know, or partially know yet what “complementary pension” is. Thus, to the question “How many clients heard about complementary pension before you mention to him/her”, 53% of the planners answered that less than 50% of clients heard about it, with a 22% of respondents classifying their clients in the category of “below 25% heard about complementary pension”.
mass-channels like internet, TV and newspapers but also investors need to be informed more directly and privately by their own banks or insurance companies.
Figure 5 : Results Question A
B) The outcome of the next question is indeed more remarkable. Through the question “How many persons did already activate a complementary pension plan before becoming your client?” I want to check the propensity of Italian people to invest voluntarily in complementary pension plans. Around 90% of population answered that less than 25% of their clients invested in a complementary pension plans before actually becoming their clients, and of those 34% did not invest at all in that. I believe through this question I might get a general picture of the actual situation of the complementary pension system in Italy; it seems thus consistent with the real total adherence to the complementary pension system (which is around 10% of the total population living in Italy). The result, thus, seems to confirm empirical evidence which states that the adherence to the complementary pension system in Italy is still low.
Figure 6 : Results Question B
C) The next question is directly correlated with the previous one. Thus through the question “How many persons did activate a complementary pension plan after becoming your client and after you shown the benefits correlated to it?” I want to check different behavioral aspects that might affect Italian workers.
The most relevant result is that about 34% of planners answer that more than 50% of their clients invested in a complementary pension plan after having received a personal tutorial regarding the benefits, against the less than 1% of the question B. Overall around 82% of the population answered that between 25% and 75% of their clients decided to invest in a complementary pension plan (against the 10% circa of question B).
This result might indicate several behavioral biases.
First of all, Italian workers seem affected by the concept of bounded rationality. Their level of investment in complementary pension plans deeply increased after the financial planner helped them to solve some cognitive constraints that brought them to opt for decisions against the rational investment decision making.
Another relevant behavioral aspect is inertia. I believe that financial planners help investors to face their inertia in doing an active change about their retirement
savings. Italian investors might also be confused by the numerous amount of information regarding the choice of a pension plan and therefore be affected by the choice overload. Moreover investor might have run a poor diversification in their asset allocation, facing the problem of naïve diversification which can be at least partially solved by the professional assessment of the financial planner.
Finally the result might indicate that Financial Planners do a good job in helping to develop the complementary pension system through their professional skills given the improved rates from question B to question C. For example, if in the question B less than 1% of the population declared than more than 50% of their clients subscribed a complementary pension plan before being a client himself, in the question C the rate jumped to approximately 34% for the same category.
Figure 7 : Results Question C
Figure 8 : Results Question D
E) In question E it is asked how many persons became retired while they were clients already. Around 70% responded that less than 25% of their clients are actually retired and 25% circa that they are less than 50%. The percentages between question D and E are just slightly different, despite the recent changes (2007) that increased pension age, which shows that retirement age remained more or less similar in the last years and the impacts of recent changes are not yet significant.
Figure 9 : Results Question E
F) Many respondents answered that their clients complained about a downgrading of their life standard. In particular, around 38% of the population says that between 50 and 75 percent of their clients complained about their life standard. This might actually be strictly connected with the credit crisis of the 2008 which might have sharpened loss aversion behavior of the investors.
Figure 10: Results Question F
G) In question G, financial planners have to express their opinion about the behavior of their clients. On the question “How do you judge the behavior of your clients regarding the savings for complementary pension plan?” 84% of the population answered that their clients do not invest enough in the complementary pension plan and only 13% believe that a sufficient amount is invested in a complementary pension plan.
Hyperbolic discounting seems to explain this behavior: investors might indeed overvalue present gains and at the same time give a lower value to future ones, consuming too much today showing also a self-control problem.
I) Question I asks if the respondent agrees with a cognitive process of a client and it is strictly related to question H. The mental process is: “I prefer to use the money I have today because there is no certainty about tomorrow”. Even in this case self-control problem and hyperbolic discounting are checked. 72 percent of respondents definitely agree with the statement, while 26 percent agree partially. The results are in line with question H because from the outcome of this question, it seems that investors tend to use high discount rate for short term periods and lower discount rates in the long run. It might show that also highly informed people like financial planners might still be affected by the same behavioral bias.
1 2 3 4 5 6 0.00% 15.79% 81.58% 2.63% 0.00%0.00% 0.00% 20.00% 40.00% 60.00% 80.00% 100.00%
L) Question L asks which age‟s range is likely to be more affected by hyperbolic discounting and it seems that most of respondents ( 82 percent) agree that young people (below 35 years) applies the higher discount rates to the short term. Remarkably no one believes that pre-retired (55-64 years) people are likely to be more affected by this constraint.
This outcome seems consistent with empirical evidence. Young workers generally tend to have less savings and lower salaries than adults, moreover they face higher expenses like mortgages, and therefore they are less likely to think about retirement issues. 0.00% 26.32% 71.93% 1.75%0.00%0.00% 0.00% 10.00% 20.00% 30.00% 40.00% 50.00% 60.00% 70.00% 80.00% 1 2 3 4 5 6
M) In question M, I ask: “how many clients do you think know their replacement rate?” Interestingly, around 68 percent of the population believes that less than 25% of their clients know their real replacement rate, while 30 percent think that less than 50 percent know it. Bounded rationality seems to be the most relevant behavioral issue in this case; investors thus might actually be constrained by the long lifetime earnings and they might not get the problem right and not be fully aware of his/her real replacement rate. Inertia seems to be a relevant issue as well. Investor might be too lazy to actually get to know their real replacement rate and thus make their own conclusions regarding their real substitution rate, basing them on partial information or simply feelings which might actually also means a narrow framing attitude. Availability heuristic might also be relevant, considering that investors might still be relating their expectation to past replacement rates, which are poor indicator of the actual and future ones.
82.46% 17.54% 0.00% 0.00% 10.00% 20.00% 30.00% 40.00% 50.00% 60.00% 70.00% 80.00% 90.00% 1 2 3
Figure 15: Results Question M
N) Question N aims to check whether Italian investors are affected by inertia. At the question “do you think that investors know that they have to invest in a complementary pension plan, but often do not really wish to do so”, respondents strongly agree (88 percent circa) and around 9 percent fully agree. Therefore inertia seems to be strongly affecting decisions of Italian investors.
0.00% 3.51% 87.72% 8.77% 0.00% 20.00%40.00%60.00%80.00% 100.00 % 1 2 3 4 l 68.42% 29.82% 0.00% 0.00% 0.00% 1.75% 0% less than 25% 25-50% 50-75% above 75% 100%
O) “Do you think that fiscal benefits recently introduced are really helpful to develop complementary pension system in Italy?” is the question O. In this case, financial planners do not need to give a response based on the behavior of their clients but merely according to their own opinion. Half of the respondents are very satisfied with the actual fiscal benefits, while around 42 percent recognize that despite those measures are helpful, something else needs to be done.
P) In this question, financial planners are asked whether it is more convenient to move the severance pay to a pension fund or to leave it in the workplace instead. Around 86 percent of respondents believe that it is convenient to move the severance pay (TFR) to pension funds instead that letting it in the workplace. It seems that financial planners clearly opt for an active choice of your own TFR. This might be helpful for the development of the complementary pension system in Italy, because clients might be keen in following the professional suggestion of their own financial planner and in this way avoid some behavioral bias like inertia, poor diversification skills or bounded rationality. All those biases thus are found in the following question.
Q) Differently from the outcome of question P, 61 percent of the population states that less than 25% of their clients decided to move their own TFR to pension fund instead
0.88% 42.11% 50.00% 7.02% 0.00% 10.00% 20.00% 30.00% 40.00% 50.00% 60.00% 1 2 3 4
