Cause and Effect in European Politics and Law

How the pension reform in Bulgaria started and where is it now?

Petar Ganev, IME*, March 18, 2010

The pension reform in Bulgaria started 10 years ago. In the beginning of the new millennium, the pension system, a legacy from socialism, started hesitantly to walk on the path of personal savings. Together with the well known and obligatory state pension security contributions, an obligatory additional pension security contributions were introduced in universal and professional pension funds. The former was called 1st pillar of the pension system (state pension security), while the latter - 2nd pillar (additional pension security). There is a 3rd pillar to add up to the overall system - additional voluntary pension security contributions.

The terminology of the three pillars of the pension system is to some extent technical and is a problem to the people, who are "clients" to the system. This is why we will try here to avoid the official and unnecessary complex terminology and shall call things by their real names. As additional voluntary pension security contributions are not obligatory and do not play a significant role in the system throughout the years, so far we shall leave it aside.

Thus we have a model where the state pension security is complemented by private pension funds - the role of the state pension fund is leading and the role of the private funds is supporting. On the one hand we have a spending model in which the workers pay their pension security contributions in the state pension fund so as to finance the pensions of the current pensioners. On the other hand is the capital model - those are the contributions to the private pension fund, whose purpose is to ensure the old-age of the worker who is paying now.

The first one is a system of transfers, while the other is a system of savings. The former is a "contract between generations" and with the latter we have personal responsibility. This is the approach which started hesitantly to happen 10 years ago - a transition from state to private pensions. The key to this approach has always been hidden in the security contributions. In the year 2000 the security contribution for pensions amounted to 32% of the income which was an unbearable burden - the contribution was directed to the state fund, in other words - to the so called solidarity model.

The road to private pensions passed through reduction of the contribution and its direction to private pension funds. After 3 per cent reduction of the contribution in 2001, in 2002 a real reform was initiated - another 2 percentage points reduction of the contribution to the state and its transfer to private funds. Thus, the road to private pension funds has been opened - 27% contribution to the state and 2 per cent contribution to private funds.

Unfortunately the next several years were missed and the reform almost stopped - only in 2004 another per cent of the state contribution was reallocated to the private funds (26% for the state and 3% for a private fund). In 2006 the reform was again started - 6 percentage points reduction of the state contribution, followed by 1% transfer to private funds (19% for the state and 4% for the private fund).

In 2007 was the last, for now, transfer of another percentage from the state to the private pension funds, together with 1% reduction of state contributions. Now we have 11% contribution to the state pension fund and 5% contribution in private funds.

For these 10 years, the contribution to private funds has increased with only 5% of gross income. This is something quite theoretic, though, because even the private funds admit that with such a contribution they cannot ensure adequate pension even after 40 years of work and contributions.

The momentary situation of the Bulgarian pension system is difficult and the need of a change is more obvious than ever. The workers' contributions are not enough even for half of the pensions of the old people now, and the enormous gap is being covered by the state budget.

In the same time, this failed system continues to play a leading role, while the private funds are still supporting. The situation is such that the state finds it more and more difficult to realise its promises to the people, and the private funds cannot ensure adequate pensions, unless necessary changes are introduced.

To be continued ...

What are the necessary changes in the pension system of Bulgaria, we hope would become clear through a broad public discussion. euinside is determined to take part in it, firmly believing that this is one of the most important issues for our country at present and in the future.

*Petar Ganev is an economist from the Institutte for Market Economy, which is part of the new Independent Pension Reform Council