An impending crisis of Bulgarian PAYG pension system forced the government to develop a three-pillar pension system. Measures were taken in the following order:
q Establishment of supplementary third-pillar pension funds, initiated by the tax incentives provided in 1994;
q First-pillar reform aimed at: establishing a more direct link between the contributions paid and benefits awarded; improving the compliance rate and system administration; improving the formula for benefit calculation, and lowering early retirement;
q Establishment of supplementary second-pillar pension funds that accumulate part of the compulsory contributions redirected for private management.
The involvement of private sector institutions in retirement provision is being implemented under stringent government supervision. The State Insurance Supervision Agency (SISA) was established and began operations in 2000. SISA is an administrative structure under the council of ministers responsible for licensing and supervision of supplementary pension, health, and unemployment insurance companies. In July 2000 SISA initiated the long-expected licensing procedures. The first retirement provision licences were issued in October 2000.
Then, in compliance with the legal requirements, the licensed pension companies registered with the court their third-pillar pension funds. The next step for pension companies was to receive approval by SISA on court registration of occupational second-pillar funds. In February 2001, SISA issued the first approvals for court registration of universal second-pillar funds. Thus the Bulgarian private retirement provision market has been institutionalised.
The country’s pension reforms represent a tremendous shift of the responsibility for a decent retirement income from the government to individuals and their employers. Therefore the choice of a sound and reliable retirement provision provider is becoming extremely important.
Bulgaria’s first pillar of retirement provision is compulsory. It is a typical pay-as-you-go (PAYG) system, which has been frequently amended in the past couple of decades. It is administered by the National Social Security Institute (NSSI), an autonomous legal entity based in Sofia. The supervisory board is structured on a tripartite basis: representatives of nationally recognised employers’ and employees’ organisations and representatives of the government. NSSI reports to parliament.
The latest legislative development, the Compulsory Social Security Code, which came into force on 1 January 2000, is aimed at: establishing a more direct link between contributions paid over the whole working career and benefits awarded; abolition of the unsound privileges related to recognition of non-contributory periods of insurance, and sharing the contribution burden between employers and employees.
The retirement age for men and women is in the process of changing. It is now 61 years and six months for men and 56 years and six months for women. This will be increased by six months every year until it becomes 63 years for men and 60 for women. The new rules introduced a ‘retirement point’ system. Retirement points represent the sum of the insured years of employment and age at retirement. People acquire the right to retire upon fulfilment of the retirement age and point requirements.
First pension pillar contribution rates are 29% for those born before 1 January 1960 and 27% for those born after 31 December 1959. An employer pays 75% of the contribution, employees the rest. There will be a gradual transfer of the contribution burden from employers to employees until it is equally shared in 2007.
For people working under the first and second labour categories there is an additional contribution of 3% paid by and employer on top of the above rates.
Though an increase of first-pillar pensions have been reported by NSSI their amount is still insufficient to sustain a decent life after retirement. Thus second and third pillars of retirement provision are strongly expected to provide the necessary additional sources of retirement income.
The second pillar is an entirely new area that was given the necessary legal framework at the beginning of 2000. Participation is compulsory and it provides supplementary retirement benefits. Second-pillar pension funds are not employer-based but employee-related and operate as saving and investment vehicles. They offer fully funded defined contribution retirement schemes with individual capitalisation accounts. They are established and managed by special legal entities – private-sector pension companies – the ones which manage third-pillar pension funds as well. The minimum capital requirement for a pension company is BGL3m (e1.5m) allowing for establishment and management of second and/or third pillar pension funds. A second-pillar pension fund and a pension company are separate legal entities. A pension company may establish and manage only two second-pillar pension funds – one universal and one occupational. There is a personal choice of a second-pillar retirement provider. An individual pension fund member is to submit an individual application form to the pension company chosen and to enter a personal contract.
Two types of second-pillar retirement provision are legally regulated: universal (for working persons born after 31 December 1959), and occupational (for people working under the first and second labour categories). The universal second pillar is aimed at providing a supplementary pension for life whereas the occupational second pillar aims to provide a supplementary pension for a certain time period covering the early retirement of those working under these labour categories.
The universal second-pillar contribution is 2%. Occupational second-pillar contribution rates are 12% for those in the first labour category and 7% for those in the second labour category.
The universal second-pillar contribution is paid in the ratio of 75:25 employer:employee during 2002. There will be a gradual transfer of the contribution burden from employers to employees until it is equally shared between them in 2007. The contribution under the occupational second pillar is paid by an employer only. All contributions are credited to members’ individual accounts with second-pillar pension funds.
Contribution payment under the universal second pillar started on 1 January 2002. Contribution payment under the occupational second pillar started as from 1 January 2000. The NSSI is the national collector of both first- and second-pillar contributions. Once second-pillar contributions are collected, NSSI transfers them to the respective pension fund. The first occupational second-pillar contributions were transferred to the funds in May 2001.
Second-pillar retirement benefits are calculated on the basis of contributions paid and the respective investment income. Pension companies are obliged to allocate 100% of the investment income earned to pension fund members’ individual accounts with second-pillar pension funds. A pension company collects management fees for its activity.
The occupational second-pillar pension fund assets under management were BGL38.9m at 30 September 2001, which is 25.2% of all second- and third-pillar pension fund assets under management. The beginning of the universal second-pillar provision as from January this year is expected to further enlarge the second-pillar retirement provision market.
Bulgaria’s third pillar of retirement provision has been in existence for eight years. Participation is voluntary and it provides supplementary retirement benefits. Third-pillar pension funds are employee-related and operate as saving and investment vehicles. They offer fully funded DC retirement schemes with individual capitalisation accounts. They are established and managed by special legal entities – the private-sector pension companies that also manage second-pillar pension funds. The minimum capital requirement for a pension company is BGL3m allowing for establishment and management of second and/or third pillar pension funds. A third-pillar pension fund and a pension company are separate legal entities. A pension company may establish and manage only two third-pillar pension funds – one with money contributions and one with privatisation voucher contributions. The latter is rather a legal possibility than a business practice. There is a personal choice of a third-pillar retirement provider. An individual pension fund member concludes a contract with the pension company chosen. Everyone over the age of 18 can participate.
The monthly minimum third-pillar contribution amount is 10% of the country’s minimum salary. There is no maximum limit. Contributions are paid by employers and/or employees and self-employed. Contribution payment by employers does not make it obligatory for pension fund members to pay personal contributions. All third-pillar contributions are credited to pension fund members’ individual accounts with third-pillar pension funds.
Third-pillar retirement benefits are calculated on the basis of the individual account accumulation with a third-pillar pension fund, ie contributions paid and the respective investment income. Third-pillar of retirement provision allows for more freedom and flexibility in benefit payment than the second pillar. Pension fund members are free to chose between a supplementary pension, planned withdrawals and lump-sum payments at retirement.
Pension companies are obliged to allocate at least 90% of the investment income earned to pension fund members’ individual accounts.
Individual members of the third-pillar pension funds established and managed by the eight licensed pension companies totalled 449,946 at 30 September 2001, an increase of 18.78% compared to 31 December 2000.
Third-pillar pension fund assets under management are BGL115.4m at 30 September, which is 74.8% of all second- and third-pillar pension fund assets under management. An increase of 33.14% has been observed as compared to 31 December 2000.
Bulgaria, like most central and eastern European countries, has had the chance to take advantage of its private retirement provision disadvantages. It is obvious that its lack of experience in private retirement provision is a drawback in terms of not being able to draw readily from past experience. However, past experience is not always an ideal guide. Bulgarian legislators did not have to go through the process of reforming past experience – retirement schemes based on book reserves, employers’ defined benefit schemes, for example – simply because they did not exist. The second and third pillars of retirement provision were designed ‘from scratch’ as fully funded DC saving and investment vehicles, while preserving the first PAYG pillar. Moreover an export of pension reform from Bulgaria to other countries in the region is likely to be observed in the near future.
Of course, it is early to say this is the best model. What is certain is that the private pension industry is gaining experience extremely fast with the clear vision that the best is yet to come.
Nickolai Slavchev is chief retirement scheme analyst with the Allianz Bulgaria Pension Company in Sofia