Bulgarian first pillar of retirement
provision is compulsory. It is a
typical PAYG system. The second
pillar is an entirely new area which
was given the necessary legal framework
as from the beginning of 2000.
Participation is compulsory and it provides
supplementary retirement benefits.
There are two types of Bulgarian
second pillar pension funds: occupational
(providing early retirement
benefits to certain risky occupations)
and universal (providing supplementary
retirement benefits to employees
born after 31 December 1959).
The third pillar of retirement provision
(with employer and/or individual
contributions) has been in existence
since 1994. Participation is voluntary
and it provides supplementary
retirement benefits as well.
Second and third pillar pension
funds offer fully funded defined contribution
(DC) retirement schemes
with individual capitalisation
accounts. Management is done
through specific private pension companies.
Although supplementary retirement
provision (Bulgarian second
and third pillars) has been in existence
in the country for only 11 years now,
it has accumulated assets of about
€403m as at 31 December 2004.
There was 54% growth as compared
to December 2003. Being relatively
small but rapidly growing Bulgarian
pension funds could be considered
potential competitors to EU funds.
Excluding Bulgarian pension companies
from the scope of Directive
2003/41/EC (pension directive),
will allow EU pension institutions to
enter the Bulgarian pension market,
while Bulgarian pension companies
will not be able to operate throughout
the EU. If Bulgarian pension companies
are covered by the pension directive,
they will be able to enter the
enormous EU pension market, of
course facing an unseen and immense
competition.
Excluding Bulgarian pension funds
from the scope of Regulation
1408/71 (regulation) might open
the Bulgarian pension market to the
EU competitors in areas of retirement
provision that EU member states have
preserved under their national legislations,
ie, with no cross-border competition.
The risks of placing Bulgarian
pension funds under the regulation
are two-fold: conceptual and
operational.
From a conceptual point of view, coordinating
EU PAYG schemes with
Bulgarian fully funded schemes may
result in imbalanced money flows:
funded schemes are typically considered
more reliable sources of income
than PAYG vehicles.
From operational point of view,
placing Bulgarian pension funds
under the regulation will put extra
financial burden onto the pension
companies. The regulation will
require that the periods of insurance or
residence in other member states be
treated as if completed under the Bulgarian
legislation ie, additional expertise
and software will be necessary for
recognising and classifying periods of
insurance in certain occupations
abroad and their translation into the
Bulgarian categories of labour. (Of
course, the same burden lies with competent
EU practice). However, the
additional expenses in a PAYG system
are borne by the public while the extra
costs for the pension companies will
have to be covered by private shareholders.
Bulgarian pension funds provide
individual account holders full entitlement
to their account accumulation.
Therefore, theoretical amount and
pro-rata calculations, as envisaged in
the Regulation, are hardly applicable
in the Bulgarian case.
Unlike the EU, supplementary
pension schemes in Bulgaria
have been employee-related
rather than employer-based for 11
years, ever since their establishment.
Employees own individual retirement
accounts in a pension fund, which is a
separate and independent legal entity.
(It is separate and independent of the
plan sponsor and the asset manager.)
Contributions are credited to the individual
accounts regardless of whether
the payment is personal or at the
employer’s expense. This proved wise
in a period of economic restructuring
and change of ownership. It protected
pension fund members from unreasonable
and unsustainable promises
by employers during privatisation.
Although the pension directive does
not prescribe the type of scheme - DB
or defined contribution (DC) - from
an international point of view, the pension
scheme which allows for undisturbed
portability is more flexible.
Fully funded DC schemes, where all
the future payments depend on the
individual account accumulation,
demonstrate greater flexibility in comparison
to DB schemes where it is difficult
to transfer a certain pension
promise from one national legal environment
to another.
Though the DB tradition is still very
strong not only in the EU but
throughout the world, DC schemes
seem to gather more and more popularity
in the EU. However, while
member states will have to decide
whether and how to transform their
systems to such pension schemes, only
fully funded DC schemes are legally
regulated in Bulgaria.
Why have DC schemes been flourishing
in Bulgaria while DB ones have
been predominating in western
Europe? Having lived in a totally controlled
society with almost no risks -
the serf system of compulsory work
registration at the place of permitted
residence - as well as the central planning
and coupon system where financial
matters have been taken care of by
the authorities for more than 45 years,
in the 1990s (when the former communist
regime was abolished) Bulgarians
showed strong risk appetite, a
desire for job mobility (ie, work and
travel) and great interest in financial
independence.
On the other hand western European
citizens of free market economies
have been used to risks, professional
mobility and independent financial
decisions to the extent that they seem
to prefer the greater certainty, DB
schemes offer.
In brief, DB is a promise, while DC
is an opportunity. Being made
promises in their working life, eastern
Europeans opted for an opportunity
at retirement. Whereas, tired of
opportunities, western Europeans
welcome a promise for retirement.
Bulgarian legislation gave a farsighted
solution to the question of
pension portability on a national scale.
The individual accumulation in a pension
fund, used for the calculation of
pension benefits due, is kept in a pension
fund member’s individual
account with the fund and the account
holder cannot be deprived of it upon
change of employment. Vesting is
immediate. Pension fund members
have the right to change the pension
companies managing their funds once
annually.
Although last year the EU Commission
said that it would present a draft
directive on occupational pension
portability in the first quarter of 2005,
it is not available yet.
The accession risks related to the
scheme design lie in the policy to be
pursued: will the EU insist on Bulgaria
refocusing on DB company schemes
with problematic portability or will
EU become more individually oriented
with fully portable DC schemes?
Progress towards pan-European
pension schemes still needs to overcome
the national tax obstacles. The
large majority of member states have
what is described as the EET system.
In 2001, the EU commission invited
the council, the European Parliament
and the Economic and Social Committee
to consider broader application
of the EET principle within the EU.
So far Bulgaria has been following
the EET model in its voluntary pension
funds. However, at the end of
2001, Bulgarian legislative authorities
put forward the idea of making contributions
taxable and benefits tax free.
That would have entirely overturned
the Bulgarian EET model which had
been in existence in country for more
than seven years. The proposal
aroused a strong reaction from both
the public and business. For fear of
spurring uncertainty and distrust by
such a sudden and unexpected
change, the idea was soon abandoned
as being inconsistent with the established
pension legislation, practise and
expectations in the country. Preserving
the EET model calmed down the
public and business.
Tax amendments at the end of
2002, in force as from 1 January
2003, introduced a TEE system
parallel to the traditional EET one, ie,
pension fund benefits are taxed as long
as contributions have been deducted
and visa versa. For more than two years
now, the TEE has been just a legal possibility
rather than a real practice. For
obvious reasons, the taxation regime
that has been preferred by members,
and has therefore been practically
more common, is the EET one. Right
now, there are new discussions on tax
amendments. Income Tax Draft Law
was submitted for consideration to the
council of ministers in May 2005. It is
proposed that next-year’s maximum
tax-deductible contribution becomes
€307 annually (insignificant compared
with 10% of taxable income
now), whereas the benefits of tax-free.
There seems to have been a persistent
push towards a TEE model. This
would not be embarrassing if the TEE
model prevailed in the EU. However,
it is the EET that predominates in the
EU.
Let us assume that Bulgaria joined
the EU with a TEE model. It would
put us in the following situation: a
pension fund member who has paid
contributions under the EET model
in the EU would gladly retire in
Bulgaria under the TEE regime
thanks to the double non-taxation
possibility. By contrast, a pension
fund member who has paid contributions
under the TEE model in Bulgaria
would be unwilling to retire in
the EU under the EET regime for fear
of double taxation.
One could hardly resist the idea of
being welcomed to the EU to work
and contribute, but being discouraged
to stay after retirement. Improving
the EU demographic picture at
the expense of accession members
would turn some eastern European
countries into large old-age homes.
And no matter how rich EU retirees
are said to be, no country will be willing
to lose young consumers with
their large and varied needs and buying
potential.
Nickolai Slavchev is chief retirement
schemes analyst at Allianz Bulgaria
Pension Company AD in Sofia

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