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The quiet revolution

Privatisation of Bulgaria's pension system started in 1994, but so cautiously and unobtrusively that many Bulgarian social security experts, not to mention international observers, are still unaware of that fact.

Pension system privatisation can be thought as having two stages. The first is establishing a favourable legal and economic environment that allows for supplementary provision from private sector institutions.

This is exactly what happened in Bulgaria in 1994: the government provided income tax incentives on contributions paid by employees into private pension companies. Private pension companies are legal entities established in conformity with the Commercial Law. In 1995 employers were allowed to lower their taxable profit by the tax-qualified amount contributed for their employees to private pension companies. After amendments to the Income Tax Law, the Profit Tax Law and the adoption of a number of government decrees and regulations, private retirement provision has shown steady growth over the past four years.

Private pension companies operate on the basis of a fully funded defin-ed contribution (DC) model. Each fund member has an individual ac-count. All investment returns ac-crue to the individual account. When the individual reaches retirement age, becomes disabled or is entitled to survivors's benefits, the accumulated sum is available to him. It can be taken as a lump sum, planned withdrawal until the account is exhausted or converted into an annuity. The individual can decide to purchase an annuity from the private pension company or from any issuing institution. Private pension contributions are voluntary and made regardless of compulsory public ones.

The second stage in developing a private pensions system is transfer of rights and responsibilities from the government pension system to it.

Bulgarian labour is too expensive and ironically too poorly paid. High social security taxes -reaching 52% of gross salary - do not mean high levels of social security. High taxes are devastating the labour market and depriving the country of productive investment opportunities.

The main objective of this second stage is developing a strategy for a profound government pension re-form that will increase private sector involvement in retirement provision. Part of the obligatory social security contribution could be directed for management in private pension companies, leaving the government responsible for a basic amount of retirement income. Private pension companies ought to be preserved as fully funded DC plans.

Even though tax incentives are too timid if we take into account only the current tax-qualified private pension contribution amount, a potential market of 2.5m employees means we could expect contributions into private pension companies amounting to $500m a year.

The private pension industry, re-cently established and suffering from a lack of mass public awareness, has covered only about 10% of the potential market so far. This can be considered quite an achievement in four years, given Bulgaria's turbulent and uncertain economic climate. The amount of accumulated capital will increase enormously if a portion of social security tax is transformed into a private pension contribution. It goes without saying that freedom of investment of funds held by private pension institutions is crucial not only for the success of the pension industry itself but also for the effective allocation of capital and capital market development.

The start of a private pension system is often compared to an airplane taking off. Passengers are told to fasten their seat belts. But the belts must be adjustable. If the private pension industry is forced to abide by limits and restrictions, these should only be in terms of economic incentives and disincentives and suit each insured person's particular needs. They should not be against individual freedom and the market economy model.

Nickolai Slavchev is chief retirement analyst, Bulgaria Voluntary Pension Fund in Sophia

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