Bulgaria’s new pensions landscape: looking over the horizon

Bulgaria has had a colourful journey from communism to the EU. It has included the assassination of a former prime minister after he reputedly fell out with a rival faction in his socialist party, the former Soviet-era communists, over a division of the privatisation spoils. It also saw the formation of the eponymous Movement for Simeon II (NMS) by the former king, who was ousted and sent into exile when the communists took over after World War II, which won a subsequent election and propelled him to the premiership.

And the transition is not yet over. In June a European Commission report gave a damning assessment of Bulgaria's attempts to crack down on organised crime and corruption, noting that "contract killings continue to be of great concern and in particular the recent killings of local politicians. To date no prosecution and conviction have taken place." And in July a businessman and major contributor to the current president's election campaign was shot in front of his office.

It was against this background that Bulgaria carried out its pension reform. In fact, the first pension funds were formed in 1994, before legislation was passed to regularise the situation.

"A law for voluntary pension insurance was passed in 1999 and a mandatory social security code was issued in 2000," recalls Miroslav Marinov, chief financial officer at Doverie pensions insurance company. "Later the two laws were merged into the social security code that in its first part covers the first pillar PAYG system and in its second both mandatory and voluntary private pension funds. Under the law a pensions management company can manage one voluntary fund and two mandatory funds."

Bulgaria has two types of mandatory scheme, a professional fund for people working under difficult conditions like miners and pilots who therefore can retire earlier than the average, and a universal pension fund for everybody born after 31 December 1959 regardless of their job and gender.

"The professional fund pays out in the period between early retirement to the normal universal retirement age," says Stanislav Dimitrov, CEO at DSK Rodina. "Contributions are paid by the employer and amount to 10% of salary, 3% that stays in the national social security institute and 7% that goes to individual accounts. The 5% of a salary that is the contribution to the universal pension funds is levied from the employer and the employee on a ratio of 65% and 35% respectively."

The intention is that in the near future it will be 50:50. There was also talk of an agreement between the social partners to lift the contribution to 6% of salary but this proposal appears to have dropped off the radar.

"There is a problem connected to the size of the contributions but not from an asset management point of view, because even with a small amount of money you can still make a good portfolio, but rather for the insured persons," says Dimitrov. "To give them an adequate pension they have to have accumulated enough in their individual accounts. We calculate that in the compulsory universal fund contribution should be a minimum of 8.5% just to ensure a 15-25% replacement rate, depending on the individual's age. There is a risk that when we start to pay the first pensions, people will ask what it is, it will be such a small proportion of their salary. This will be psychologically bad and also bad for the pension reform effort and for the pensions industry as a whole in Bulgaria."

"While [neighbouring] Macedonia started with 7.5% of a salary at the beginning of its reform we started with just 2%," says Marinov. "It is still not enough because of our demographic situation - we have one employee covering the pension for one pensioner with the PAYG system - and because salaries are very low. So the next step should be an increase of mandatory fund contributions to perhaps 7% to give a bigger pension in the future. And there should be a larger tax advantage for people making voluntary pension contributions."

But the investment regulations have been relaxed.

"Recent amendments to our social security code made significant changes," says Marinov. "Previously we were obliged to have at least 50% of the assets of the mandatory pension fund, which is our biggest, in local government bonds. Changes introduced at the end of February 2006 and at the beginning of this year with our EU accession and which were intended to align our legislation with the EU directive, allow us to diversify more."

"We are now allowed to invest up to 20% of our assets in a currency other than the Bulgarian lev and the euro," says Pavel Sokolov, managing director, CCB Sila. "We can invest in OECD members and can invest up to 20% in equities, 25% in corporate bonds, unlimited EU government bonds and up to 25% of deposits. But we also have a ceiling on how much we can have from one issuer, so if we wanted to buy both equities and bonds from Lukoil the total cannot be more than 5%, and we cannot take more than 7% of the issue, whichever it biggest because from some funds 5% of their assets might be more than 7% of the full issue.

"And we cannot invest in derivatives except for hedging purposes, and in such cases we have to prove that the derivative instrument hedges a particular real instrument. We have to establish this on the basis of international accounting standards, with an 80% to a 120% difference in the price. Our supervision commission set the restrictions so strictly because we still do not have good risk management systems. We are starting to build ours this year."

"Last year we immediately began to widen our investment portfolio," says Strahil Vidinov, executive director at Allianz Bulgaria Pension Fund Management Company. "We don't have any other choice but to invest abroad and diversify because the amount of assets under management in Allianz Bulgaria would account for too high a volume of the local stock exchange. Our reported data for 2006 shows our investment portfolio abroad is about 5% of the total.

"The recent changes opened up many choices to invest in different investment asset classes. For example, we were allowed to invest in REITs and mutual funds managed by foreign, European or other asset management companies registered for public offering and trading in Bulgaria through a certain procedure at the state commission of securities."

"We have started the transition of our portfolio and we have more investments abroad," says Marinov. "Although we have the required expertise for local investments we are taking our first very cautious steps into foreign markets where we lack this experience. But the current legislation does not allow us to give out mandates so we have more passive investments such as structured products, mutual funds and ETFs. We need the regulations to be changed to enable us to give segregated mandates to international asset managers. I believe it will be done within the next year."

But challenges remain.

"We need changes to the investment restrictions because new investment products are appearing in developed markets but here changes are very slow," says Vidinov. "The challenge is to convince the regulator not to control us on the execution of administrative requirements, but on risk control requirements and risk control policies. At present the relationship between the regulator and the pension fund companies is based only on formal requirements for execution on our side, not on risk assessment and monitoring procedure."

 

Vidinov highlights another issue: "Local regulations do not allow us to invest in instruments issued by economically linked entities, especially those provided by investment intermediaries and the brokerage services we are using and the depository bank. For example, our depository bank is DSK, an OTP unit with a wide branch network, so we cannot buy OTP bonds. It's a good issue but we are restricted. We have a contract for intermediary brokerage services with UniCredit Bulbank, so similarly we cannot buy Unicredit shares, which would have been a good position for us."

"We have several problems," says Sokolov. "First we are in a constant process of changing legislation, people from the World Bank or wherever you can imagine go to our parliament or the regulator or whatever body could have an impact on the legislative process and suggest that they change this or that. And so small changes more or less occur constantly and we then have to change our internal rules and regulations. But I hope that now we are in the EU this will stop, this year we will probably have a massive wave of legislative adjustments but I hope it will be over by next year."

"For the pension companies a major challenge is how to attract more people with higher contributions into the voluntary pension funds," says Dimitrov. "Now only around 11% of people who can make contributions do so. In fact one of the problems of the pension reform in general has been the lack of information given to the population about what were the reasons behind it and what are the advantages for them. "That is the reason most people are not interested. Most people don't know that they have individual accounts, they think just about the state system, and they are surprised when they receive their annual statement. Some think that this is some sort of deposit, they come to the pension companies and ask to withdraw the money."

For Sokolov this is a symptom of a wider malaise. "Of course there is corruption at many levels and the biggest and worst part of this is that people, individuals, don't really consider that the money in the pension fund is theirs," he says. "They see their mandatory contributions as a government tax that they pay, and that's all. So they don't know where their accounts are and they don't care. And this lack of interest is exploited as an opportunity by some of the funds to make fake transfers, they sign on behalf of people and transfer money from another fund to their fund without individual being informed."

Bulgaria's extensive informal economy is another problem. "The black economy is not just a problem for the pensions system but for the government and the economy as a whole," says Marinov. "These people don't pay taxes, they don't pay health insurance, don't pay pension contributions. But we also have a grey economy, people who work and pay some taxes and provisions but on a declared minimum salary threshold not on their real salary."

"Different economic institutes calculate the grey economy at between 20% and 40% of the economy, and this, not revenue flows into individual pension accounts, is one of the reasons for the deficit in the state system," says Dimitrov.

"There must be two preconditions for a person to receive his or her money into their individual account: first the employer has to pay the contributions and second give to the authorities a detailed list of these contributions and for whom they are paid. So there are several reasons why money is not distributed. There is a personal register in the national social security institute and then the money is distributed to us, we don't collect it directly, which is a good thing for us. But it is a slow process and people are losing yields from their money because of the delay in the contributions going into their accounts."

"The national tax authority, which is responsible for collecting the contributions, has problems with its system," says Sokolov. "There are long delays in the transfers, a huge amount of money is kept within the government pension fund because it is undeclared or the beneficiaries are not clear and they stay there."

Pension funds also have to improve their technology. "Good IT systems implementation is the biggest challenge before us and all the other pension funds," says Vidinov.