One of the effects of Bulgaria’s accession to the European Union next year would be to relax significantly the investment restrictions on the country’s second and third pillar pension funds.
Bulgaria has already relaxed its investment restrictions on pension fund investment to conform with European pension legislation. This has removed the obligation to invest heavily in government securities and expanded the ability to invest in equities and other financial instruments.
The ability to diversify the portfolios will increase on the accession date, 1 January, when Bulgaria’s regulatory authority, the Financial Supervision Commission will be obliged to treat European financial instruments in the same way as Bulgarian instruments.
Both these developments will broaden the investment opportunities for Pension Assurance Company (PAC) Doverie, Bulgaria’s leading supplementary pension fund manager in terms of membership.
PAC Doverie, based in Sofia, was created in 1994 by TBI Holdings, a Dutch company, establishing a strategic presence in pension, insurance and asset management lines of business in Central and Eastern Europe.
By 1994 PAC Doverie launched Bulgaria’s first supplementary pension scheme, a voluntary pension fund. By 2000 it had gained 110,000 members and 620 contracts with employers.
Following the social security reforms of 1999-2000, PAC Doverie became one of the eight pension companies, licensed to provide and manage second pillar pension funds in Bulgaria. All pension funds are fully funded defined contribution (DC) plans, with individual member accounts. Defined benefit plans are not allowed under the current legislation.
The reforms established a three pillar structure of the pension system based on Poland’s ‘Security through Diversity’ World Bank model. The existing pay-as-you-go basic pension was retained as the first pillar, and the existing voluntary pension funds (VPF) as the third pillar.
For the second pillar, two new types of supplementary pension funds were created, in which membership is mandatory: a professional pension fund (PPF), with provisions for early retirement for workers in hazardous occupations; and a general pension fund (GPF) for all employees, including the self employed, born after 31 December 1959.
PAC Doverie administers and manages one of each type of the second and third pillar scheme pension funds: the Doverie Voluntary Pension Fund, a voluntary fund operating since 1994, the Doverie Professional Pension Fund, a professional fund established in 2000; and the Doverie General Pension Fund, a general fund established in early 2001.
In 2003, in the first merger of its kind between pension funds in Bulgaria, PAC Doverie merged its mandatory and voluntary funds with those of the Bulgarian Pensions Insurance Company, Bulgaria’s fourth largest licensed pension fund company. This added further 150,000 members, bringing PAC Doverie’s total membership to 1m and its market share to 42%.
The largest of Doverie’s current funds in terms of membership and assets is the general pension fund, with 914,495 members and 198m Bulgarian Lev (€101m) assets as of 31 March this year. This represents a market share of 40% in membership and 41% in assets. Altogether, PAC Doverie manages more than €200m in pension fund assets.
The assets are managed in-house supported by an investment consultancy of TBI Asset Management and controlled on a daily basis by a special team. Their task is to implement the investment policy, developed by the investment committee and approved by the management board.
The objective of the investment policy of the Doverie pension funds is to increase in real terms the supplementary pension savings of the fund members through achieving the highest rate of return possible for a given level of risk.
Even with a large fixed income allocation, the PAC Doverie funds’ investment performance has been strong. The distributed yield of the general pension fund was 8.68% in 2005 and 14.21% in 2004.
Much of this is a reflection of macro economic conditions. Bulgarian economy has been growing at an average rate of 5% to 5.50% annually in recent years. The level of unemployment went down from over 17% in 2001 to just over 10% at the end of 2005. Government debt as percentage of GDP went down from over 100% in 1996 to 24% in 2005. The inflation rate has been stable at an average rate of 4 to 5% a year since 2000. The stable macro economic environment led to significant growth in the value of different local financial instruments.
This growth has impressed outside observers like the credit rating agencies, who have taken a positive view on the development of the country. There were several credit rating increases which led to tightening of the spread of government debt over the benchmark issues. This in turn has had a positive impact on debt portfolios, which have risen in value, says the management team. Currently, Bulgaria’s credit rating is BBB and the yield of the 10-year government bond is 50-60 bps higher than the benchmark issue.”

The strong investment performance is also a reflection of PAC Doverie’s style of managing its pension fund portfolios. Broadly, PAC Doverie actively manages the assets it knows best – domestic assets – and passively manages those where its knowledge is less – foreign assets.
Currently, PAC Doverie gains exposure to foreign assets through exchange traded funds (ETFs) and structured products. It is substantially increasing the use of these products following the introduction of the new investment regulations, which bring Bulgaria into line with European directives, and give pension fund companies greater freedom to diversify within and between asset classes.
The main change introduced by the new regulations is the abolition of the requirement to invest in Bulgarian government bonds. Under the old regulations, the two types of mandatory second pillar pension funds – the professional pension fund and the general pension fund – had to invest a minimum of 50% of their portfolio in government debt. For the voluntary pension funds the minimum was 30%.
Under the new regulations, pension funds are free to choose the percentage allocation of government debt. As a result PAC Doverie is reducing its holdings in government debt and diversifying into other types of fixed income. Total exposure to fixed income is still high. Yet the current allocation of around 84% fixed income is not representative since the pension fund portfolios are in a transition period.
The new regulations raise the limit on equities as a percentage of the total portfolio from 10% to 20%. PAC Doverie’s current allocation is between 11% and 12%, and the intention is to increase this gradually rather than in one leap to reduce the impact on the market.
Current exposure to foreign equities through structured products is 5%, but PAC Doverie intends to increase this substantially over the next 18 months. By the end of 2007 about 50% of the allocation to equities will be invested in domestic shares and 50% in foreign shares. Most of the foreign shares will be European, but there will some exposure to global equities for diversification.
The new regulations also enable pension funds to increase their investment in real estate investment trusts (REITs), an asset class that is currently flourishing on the equity market. In the previous regulations REITs were included in the 10% limit of exposure to equities. The new regulations define REITs as a separate asset class.
The limits for direct real estate investments remain the same, at 5% for the mandatory pension funds and 10% for voluntary pension funds. Yet the effect of the disaggregating of asset classes is that mandatory pension funds can now increase their exposure to traded equities and REITs from 10% to 25% of the total portfolio.

The relaxation of investment restrictions provides new opportunities for PAC Doverie. Yet this is unlikely to translate into a demand for the services of external (both local and foreign) asset managers, at least in the near future. PAC Doverie does not use external asset managers for two reasons. First, because the law forbids it. Under the existing law, the pension fund companies are the only companies licensed to manage pension funds.
The second reason is size. With only €200m assets under management, PAC Doverie’s cake is currently too small to slice up as mandates for external management.
This situation can only change when the law itself changes. The situation could also change when PAC Doverie’s assets under management has grown large enough to divide up and assets are expected to grow exponentially over the next years.
Assets are bound to grow in the main mandatory fund, the general pension fund, since its membership is restricted to people born after 31 December 1959. Consequently, there will be no significant pay out of pensions for the next 20 years.
Meanwhile, contributions, which totalled €50m last year, are likely to rise in line with increases in the number of members, in members’ salaries and in contributions as a percentage of salary.
Current contributions are calculated as a percentage of salary with a minimum (floor) and maximum (cap). For 2006 the level of the floor depends on the economic activity of the company and the position of the employee. The cap is fixed at (€714) 1,400 Bulgarian lev.
The contribution rate for the general pension fund has gradually increased from 2% in 2002 when the fund was launched, to 4% this year, and is expected to increase to 5% in 2007.
The contribution is currently divided between employer and employee at a ratio of 65:35, but the eventual aim is a ratio of 50:50. Contributions to the professional pension fund are borne solely by the employer.
Employers can, in theory, set up pension funds for their employees through the third pillar. Any company can sign a contract to provide voluntary pensions to its employees. Initially, foreign companies based in Bulgaria chose this option. More recently, some Bulgarian companies have shown an interest. The last successful tender in 2006 was Bulgarian National Radio.
Yet the potential of this market has yet to be realised. Salaries are low, and a culture of savings is underdeveloped. Currently voluntary pension insurance is provided for only about 10% of the potential market, both companies and individuals.
Although membership of a mandatory supplementary pension fund is, by definition, compulsory, people are free to choose between the funds offered by the different pension companies, and pension fund companies put substantial resources into their efforts to attract new members. PAC Doverie has developed various sales channels, including direct sales, sales through the agents network and through brokers, and sales through the internet.
It is possible for a member of one pension fund to transfer to another. Since 2004, a regulation issued by the FSC allows people to switch out of the mandatory pension fund they initially chose by signing an application for transfer with another fund.
Earlier problems of fraud, and pressure from agents to persuade people to switch funds unnecessarily, led the authorities to tighten up the procedure on transfers. Since July last year, an amendment to the regulation says that every transfer application must be endorsed by certification by a notary.
Yet transfers between pension funds are relatively uncommon. Generally people stay where they are, and the new regulations are designed to ensure that only people who have a good reason to move will do so.
The rules that govern membership of the mandatory pension schemes provide an incentive for the eight licensed pension funds to keep fees low and yields high.
People who are eligible to join a mandatory fund are allowed a period of three months in which to choose a fund managed by one of the licensed pension companies.
At the end of this period, all those who have not made a choice are compulsorily enrolled in one of the pension funds. This was done by the National Social Security Institute (NSSI), which was the record-keeper of pension fund contracts. Now starting 1 January 2006 some of the functions of NSSI and Tax Administration are merged into National Revenue Agency (NRA)
The NRA identifies employees who have not made a choice by matching its database of people enrolled with the first pillar pay-as-you-go system against the contracts sent in by the pension fund companies. It then decides where these members will go on a lottery basis.
In the lottery system, the total number of members distributed to a fund depends on three equally weighted factors: the number of new members the fund has attracted over the last quarter; the level of fees levied; and the level of yield, calculated on a 24-month basis.
The effect of this is to give the greatest number of new members to the most successful funds. The system is an incentive to pension funds to encourage employees to make their choice. It is a stimulus for pension funds to lower their costs, and it is an incentive for them to achieve higher yields.”
PAC Doverie is optimistic that, with Bulgaria’s accession to the EU, it will be in a better position to achieve these yields.