The decision to favour contributors to Italy’s defined benefit pension plan during its transition to a defined contribution model favours early retirees and disadvantages younger people, according to an article in the Journal of Pension Economics and Finance.
In 1995, Italy’s public pension plan, which operates in a similar manner to the Canada Pension Plan, began a long transition from a DB model to a DC model. In switching over, certain groups received more favourable treatment, the article found. Workers with more seniority who retired earlier received the most benefit from this transition. Over the next quarter century, these distinctions were aggravated by changes in Italy’s worker demographics and a lack of real indexing of pensions.
“As time passed, however, the lack of real indexation of pension benefits, coupled with the increasing proportion of older pensioners, led to a polarization along the age axis, increasing the disparity between pension benefits of older and younger pensioners,” wrote author Carlo Mazzaferro, an assistant professor at the University of Bologna.
The article identified two mechanisms at work in the Italian pension system as the cause of this distributive trend. The more seniority that pension members accrue in their careers, the higher the payouts, while the lack of indexation penalizes pensioners who have been retired longer.
“The replacement rate has a positive correlation with seniority at retirement and with seniority pension benefits, while the correlation is negative with the retirement age and with the position in the distribution of pre-retirement earnings distribution.”
For workers who retired between 1996 and 2019, the Italian pension plan is generous. About 92.6 per cent of people who began receiving pensions in the period can expect to recoup more money than they paid in to the scheme, according to the article, while the net present value ratio of pensions for those who retired in 1995 was about 1.99. In 2019, it averaged at just 1.04, though for people who retired at 55 in 2019, it was at 1.69. For those who didn’t retire until age 67, the net present value ratio sat at just 87 per cent in 2019.
This downward trend appears likely to continue and may be exacerbated by the fact that the average Italian is working later in life, noted the article. In 1995, close to 40 per cent of pensioners were younger than 65 and the average pensioner was 68.4 years old. By 2019, just eight per cent of Italian pensioners were younger than 65 and their average age was older than 75.
“This means also that, from 1995 onwards, pension liabilities have increased,” stated the article. “This, in turn, given the poor growth prospect of the Italian economy, put an additional burden on future generations and increasing intergenerational disparities between current and future retirees.”
According to Mazzaferro’s calculations, the total cost of the favourable terms of the switchover will be equal to about five per cent of Italy’s annual gross domestic product. “By implementing a pension benefits recalculation process for individuals who retired under the main Italian pension scheme between 1996 and 2019, which brings the pension benefits closer to an actuarially fair value, we estimate that the decision to favour older workers in 1995 will cost 80 billion euros in implicit pension liabilities.”