ITALIAN PENSION SYSTEM:

PAY AS YOU GO AND

WISHFUL THINKING?
VITTORIO FILIPPINI
FILIPPO ALOISI DE LARDEREL
REPORT
2022
EXECUTIVE SUMMARY
This report aims at understanding the state of sustainability of the
current Italian pension system, stressing the need for rapid intervention.

We first give a brief overview of the structure of such system,

highlighting the main reforms of the past 20 years. While some reforms
have been attempted, they have never fully addressed Italy's structural
problems; the result is an inter generationally unfair and generous
pension system, with an extremely high pension burden.

We proceed with a demographic analysis, looking at both causes and

implications of demographic trends. Italy appears to be pioneering the
Second Demographic Transition, as continuous increases in life
expectancy and persistent sub-replacement fertility rates are inexorably
shaping Italy's age structure. These macro trends, combined with brain
drain and the lack of political will to accept legal migration influxes, are
shifting upwards the median age and the old age dependency ratio.

The interaction of demographic trends and the pension system's

functioning creates structural weaknesses, which we address with
tailored recommendations. In the short run the system's burden could
immediately be lowered by increasing retirement age and reducing
current pensions' replacement ratios; better integration migratory
policies would also help migrants obtain legal jobs. In the medium run,
policies to stop the current brain drain along with a partial fully-funded
pension system transition should be enacted. Lastly, incentives to
significantly increase the total fertility rate would ensure a long run
sustainability to Italy's pension system.

This report provides an overview of Italy's pension system, identifying

key weaknesses and proposing actions to address the rising demographic
and financial challenges.
 TABLE OF CONTENTS
Executive Summary:...................................................................................................................................

Evolution of the Italian pension system:..........................................................................................2

Demographic Analysis:............................................................................................................................3
Fertility..........................................................................................................................................3
Mortality.......................................................................................................................................4
Migration......................................................................................................................................4
Age structure..............................................................................................................................6

Deriving Issues:..........................................................................................................................................7

Policy Recommendations:......................................................................................................................8
Short run..................................................................................................................................8
Medium run.............................................................................................................................8
Long run...................................................................................................................................9

Conclusion:................................................................................................................................................10
Bibliography:............................................................................................................................................11

OECD 2
INTRODUCTION
Since the 1980s, Italy has been one of the leading countries in lowest-
low fertility rates among advanced economies. The demographic
challenge, combined with a very generous Pay-As-You-Go pension system,
poses a threat to the system's long run sustainability. This report
analyzes the phenomenon, looking at it's causes and suggesting policies
to tackle issues that are bound to arise in the medium-long run.

EVOLUTION OF THE ITALIAN PENSION

SYSTEM
The Italian pension scheme was a pay as you go system with defined
befits up to 1995. In 1995, the Dini reform lead the change from a
defined benefit, DB, to a defined contribution, DC, system.

The difference between the two schemes is substantial:

• the Italian DB system was linked to a percentage of the last salaries
received by a worker. This lead to a high replacement ratio (pension
installment/ salary income), given that the last wages, received at the
apex of a career, were usually the highest.
• the DC system, is linked to the amount of contributions paid by the
worker during the working life.

The transition from one calculation regime to the other took place
gradually. These changes lead to a significant decrease in the
replacement ratio.

In 2007, in an effort to raise the retirement age, the so-called "quotas"

were introduced to access the retirement pension.
Quotas were determined by the sum of the age and years worked.

Quota = age + years worked

In 2009 the quota to be reached was 95 (with at least 59 years of age), in

2011 it rose to 96, and in 2013 to 97.

In 2011, following the Greek sovereign debt crisis and fearing a default
on the sovereign Italian debt, the Fornero reform was introduced.
This reform marked the accelerated completion of the transition to an
NDC, Notional Defined Contributions, system started by the above-
mentioned Dini reform. It also further increased retirement age to 67
years.

In 2019, the “Quota 100” reform radically changed the system.

It reduced the minimum retirement age to just 62 years with 38 years of
minimum contribution.

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The outlined events led to an overburdened pension system.
Italy is currently spending 15.6% of its GDP on pensions,
consistently ranking amongst the highest spenders for the last 20
years. For comparison the OECD average is 7.7%¹ (OECD, 2017),
and the EU average is of 12.7%² (Eurostat, 2018).

POPULATION DYNAMICS
Fertility
Since the 1970s, Italy’s fertility has been among the lowest in Europe and
the world. Indeed, the Crude Birth Rate (CBR) dropped from 18 to 10
births per 1,000 people between 1964 and 1985, and the Total Fertility
Rate (TFR) (Graph 1) surpassed the critical 2.1 replacement rate threshold
in 1975.

The small recovery that took place before 2008 was not enough to offset
this trend, which worsened with the financial crisis and Covid-19. In fact,
Italian couples have been the most inclined to abandon fertility plans, as
opposed to fertility postponement in countries such as Germany and
France (Luppi et. al.). Even if an increase in TFR is expected over the
next century, projections expect Italy’s fertility to consistently remain
below replacement level.

Total Fertility rate

Source: Our World In Data, December 2017.

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Mortality
With the general decline of all-cause mortality over the last century and
a health system (SSN) virtually free for everyone, the Crude Death Rate
(CDR) has stabilized at around 10 deaths per 1,000 people since the
1960s (WorldBank). The only significant increase has been due to Covid-
19 related deaths. Thus, Italy is among the countries with the highest life
expectancy in the world (83 years), and this number is expected to
increase up to 92 years by 2100.

In 2007 the CDR surpassed CBR for the first time, and the gap has been
widening since (Istat) (Graph 2): this implies that the population relies on
net migration to grow.

Graph 2: Italy's birth rate, death rate, natural growth rate and population

Source graph: own elaboration. Unit of measure: millions for population, thousands for other rates, 2018.

Migration
Emigration
Emigration has risen in the last decade, especially in response to the
2008 financial crisis. Growing every year, the number of Italians leaving
the country went from less than 40,000 to 122,000 in 2019 (Istat). Over
than last decade, around 900,000 individuals left the country.

These individuals are mostly either students or workers, as 90% of them

are younger than 50. It is worth noticing that many of them can be
considered highly skilled, as 1 in 4 has a bachelor's or equivalent (Istat).

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UN DESA

Immigration
On the other hand, there were 5 million legal immigrants in 2020, which
marks a substantial increase from the 1.3 million in 2001 (Istat). Most of
them are from Romania, Albania, and Morocco and live in metropolitan
areas. They are not highly skilled, as only 1 in 10 has a bachelor's
degree.

As of 2018, undocumented migrants were estimated to be around 670,000

(Ispi). This number is expected to have increased by 140,000 units in the
following 2 years, mostly in response to the 2018 “Decreto Salvini” which
abolished the humanitarian protection layer, making it more difficult for
immigrants to gain legal status (Ispi).

Asylum seekers in Italy’s immigration centers diminished from 183,000 to

80,000 between 2017 and 2020 (Ispi): this trend should not be
interpreted as a sign of decrease in general migration, but increase in
undocumented migration.

The number of both legal and undocumented immigrants has

consistently surpassed that of emigrants, ensuring a net migration of
between 200,000 and 400,000 per year since 2012³. Overall,
immigration of mostly low-skilled migrants has offset the emigration of
young students and workers, preventing population decline (Graph 3).

Graph 3: population growth rate with and without migration

Source: Our World In Data, 2020.

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UN DESA

Age Structure
With the above-mentioned demographic trends in place, Italy’s age
structure will undergo many changes in the future decades, possibly
entering the “Second Demographic Transition” characterized by sustained
sub-replacement fertility and no stationary population (Lesthaeghe).

Italy’s population is expected to have already reached its peak, remaining

slightly above 60 million until 2050 and declining afterwards. With
stagnant population growth, the median age will rapidly reach values
around 50 by 2030 and remain stable until 2100 (WorldBank).

Italy’s population pyramids will move according to these trends, shifting

the most prominent age group from today’s 45-55 to 70-80 by 2050
(Figure 1).

Figure 1: Italy's population pyramids 2020 - 2050

Source: PopulationPyramid.net, 2019

Additionally, the old age dependency ratio, the ratio between the number
of people over 64 and those between 15 and 64, is currently one of the
highest in Europe at 35%, and is expected to reach 67% by 2075⁴ (OECD,
Pensions at Glance)

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UN DESA

DERIVING ISSUES
Some structural weaknesses will arise in the next decades in the Italian
pension system. As the pool of taxable workers shrinks for the
demographic reasons outlined earlier and that of retirees enlarges, the
overall burden of taxes necessary for the pension scheme will grow and
be distributed on an increasingly smaller number of taxpayers.

These factors are combined with the political difficulty to reform the
pension system, given that retirees represent 35% of the 46 million
Italians eligible to vote.
An example of the political influence of retirees is given by “Quota 100”.
This reform trashed the steps taken towards a more sustainable pension
system, at the expense of younger generations, by exploiting the relative
political weight of the elderly compared to their nephews.

Such a deadlock could easily feed into a vicious cycle, incentivizing

young Italians to leave the country and reinforcing the decrease of
workers on which the taxes’ burden is distributed.

Generation X (born between 1965-1980) will mark the end of the current
pension scheme. The Italian pension system, almost like a Ponzi Scheme,
needs a wide base of new funds or investors to maintain the illusion of
sustainability.
Looking at the 2050 population pyramid of Italy (Graphs 4 - 5), we can
see that when gen X, which is now supporting the current PAYG system,
will reach retirement age, it will still represent the most populated age
group.

Consequently, there will not be a large enough pool of taxpayers to

support gen X’s pensions.
The current system that has been sustainable up until now will no longer
be.

At that point, the elderly generation will find itself having contributed to
the system, but not having a corresponding guaranteed pension.
Alternatively, the administration will be forced to come up with the
funds, sinking the government budget, leading to a decrease in
government spending, increasing taxes, or raising additional debt.

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RECOMMENDATIONS
We believe that the following policies could be implemented to tackle
the previously mentioned issues:

Short run
Regarding retirement policies, we recommend:
Increasing retirement age, especially for non-physically demanding
jobs, accounting for the increase in life expectancy.
Reintegrating part of the recently retired workers into the labor
force.
Recalculating the amount of NDC pensions using a less generous
formula, leading to an overall reduction of the replacement ratio

Additionally, migration policies should aim at funding more and better

functioning immigration centers, fostering legal migration and
integration.

Medium run
In the medium run, further changes should be made concerning both the
pension system and migration flows.

Italy should switch from the current pay-as-you-go scheme to a mixed

PAYG and fully funded one. The goal would be to have a mandatory
“minimum pension” paid by the current PAYG scheme, and an opt-out
quota paid by the pension fund.

This change should be gradual and, in an effort to safeguard

intergenerational fairness, the transition costs should be mitigated.
To do so the World Bank⁵ recommends affecting:
the speed of the transition to fully funded. A longer transition period
allows the transition costs to be spread out on more generations,
reducing intergenerational unfairness.
the size of funded pensions relative to the pay-as-you-go scheme. A
lower portion of funded pensions makes it easier for workers to
simultaneously pay for the funded pension and the pay-as-you-go
scheme.
the reduction of the replacement ration under the existing system.
allowing the government to share in any extra returns earned by the
funded scheme.
In addition, limiting the fully funded program's coverage to younger
workers distributes the transition cost over a longer time span.

To improve the demographic outlook of the country, incentives for young

people to remain and work in Italy should also be implemented. These
could include tax deductions for firms hiring young workers.

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Long run
In the long run, tackling Italy’s fertility trends is of pivotal importance.
In developed countries, the timing of fertility is moving from an early
fertility to one of late fertility, concentrated between the ages of 25 and
35. The average age for an Italian mother is 33 (Ministero della Salute).
Family support policies need to evolve accordingly, targeting family-
work balance.

The main points to incentivize fertility could include:

Affordable childcare, with a focus on kindergarten and babysitting
vouchers.
Balanced maternity and paternity leaves, non-discriminatory for
women.
Broad and consistent fertility policies. As families expect fertility
policies to last throughout the child’s youth, they are more willing to
take the potential childbearing risk. The stability of policies is linked
to the popular support that policies receive.
The amount of per child benefits increases in the number of children
per family.

A virtuous example can be found in France, which has consistently had

one of the highest fertility rates in the EU. French fertility policies offer
diversified resources to families in the form of money, time, and services
needed to raise children.
Notably, in the past 20 years, France has been spending roughly 3% of
its GDP on family benefits, while Italy is only spending around 1.9%, one
of the lowest values in Europe and below the OECD average.

CONCLUSION
This report stresses the need for rapid intervention to address the fault
lines of the Italian pension system: immediate action is necessary to
guarantee its sustainability and intergenerational fairness.
A policy package containing a mix of short, medium and long term
policies could effectively ensure positive net migration rates of legal
migrants and invert the brain drain trend while partially shifting to a
fully funded pension scheme.

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BIBLIOGRAPHY AND SOURCES
1: OECD, https://data.oecd.org/socialexp/pension-spending.htm, 2017

2: Eurostat, https://ec.europa.eu/eurostat/statistics-
explained/index.php?title=Social_protection_statistics_-
_pension_expenditure_and_pension_beneficiaries, 2018

3: Net migration in Italy. https://www.economy.com/italy/net-

migration, 2017

4: OECD, https://read.oecd-ilibrary.org/social-issues-migration-
health/pensions-at-a-glance-2017/old-age-dependency-
ratio_pension_glance-2017-22-en#page1, 2017

5: The World Bank, “Paying for a shift from pay-as-you-go financing to

funded pensions”,
https://openknowledge.worldbank.org/bitstream/handle/10986/11242/
333900rev0PRPNoteTransition.pdf?sequence=1&isAllowed=y

6: Ministero della Salute,

https://www.salute.gov.it/portale/news/p3_2_11_1.jsplingua=italiano&
menu=notizie&p=dalministero&id=5518

7: Convip, "L’evoluzione del sistema pensionistico in Italia", convip.it,

2018,
https://www.covip.it/sites/default/files/evoluzionedelsistemapensionis
tico.pdf

8: Inps, "Relazione Annuale del Presidente dell'Inps e XX Rapporto

dell'Instituto" , July 2021,
https://servizi2.inps.it/servizi/ComunicatiStampa/DownloadCS.aspx?
ID_COMUNICATO=2899

9: Nicholas Barr and Peter Diamond, "Reforming Pensions in Chile",

2016, https://economics.mit.edu/files/12427