Incentives in the Bulgarian pension system

"I don't want to pay social security contributions while I'm working, and if I do, I want them to be as low as possible. I want to retire early and receive a large pension for many years."

Although clearly devoid of any economic logic, this would be the dream pension system of a large part of the population. Who wouldn't want to be a net beneficiary of the pension system, or in other words, to get more out of it than they gave it?

We have witnessed enough examples in the public sphere that clearly show purposeful and deliberate actions either towards “giving” less to the system or towards “taking” more from it. The position that a person has taken to “give” less or to “take” more is largely determined by whether the system is currently funding them or they are being funded by them.

On the one hand, the people who finance it (the insured) tend to conceal their real income in order to pay smaller pension contributions, and if they cannot do so, they start to exert political pressure to reduce the amount of the contribution. On the other hand, the beneficiaries of the pension system (the pensioners) are motivated to do anything, as long as it leads to a larger amount of their pensions. Increasing the number of disability pensions granted, the credibility of which is at least questionable, and the tendency to vote for a political party that promises a more generous amount of pensions, support this very behavior among them. And all this just so that a person is “in the game” of the pension system, and not “screwed up” by it.

The real problem, however, is not in people's behavior, but in the incentives that the current pension system has created. In fact, the behavior is simply an expected consequence of them, which should surprise no one.

With the adoption of the Code of Mandatory Social Security and the Law on Supplementary Voluntary Pension Insurance, since the beginning of 2000 the Bulgarian pension system has been operating according to the three-pillar pension model of the World Bank. Although two of the three pillars are based on the principle of capital gain, the leading pension pillar in Bulgaria is that of the Pensions Fund, part of the State Social Security (SSS), which is of the pay-as-you-go type and is administered by the public institution National Insurance Institute (NIS). It is no coincidence that the pension funds with capital accumulation in Bulgaria are united under the name Supplementary Pension Insurance (SPS), which suggests their additional, complementary, but not leading role in the entire pension model. It is precisely the first pillar that is the one in which the incentives provoke the participants in the pension system (insured persons and pensioners) to react in the manner described above.

It all comes from the fact that in the pay-as-you-go pension model, the pensions of current retirees are financed by the social security contributions collected by current workers. This principle is called "solidarity" between generations by the pay-as-you-go pension system, since it is obtained in such a way that the younger generation pays for the older one (is in solidarity with it) in the hope that in the future the next, not yet born generation will also be at least as solidarity with them.

Functioning in this way, the first pension pillar in Bulgaria provokes the following actions among its participants:

• Insured persons realize that the future is uncertain and that they may not live to retirement age at all, so they do everything possible either not to pay any pension contributions or to pay them at a minimal rate. In this way, their disposable income is now greater and is preferable to the blind hope that they will one day receive a pension if they decide to pay their contributions anyway. Even if insured persons have optimistic views about their life expectancy, which is completely normal, they still have little incentive to pay contributions, since their future pension will not depend as directly on the contributions made today by themselves as on the contributions that the future working generation will pay for them. In any case, the principle of “solidarity” in the public system does not encourage the current working generation to pay pension contributions.
• Pensioners believe that after working all their lives and paying their social security contributions, it is high time to enjoy their well-deserved rest and pension. Regardless of how long and in what amount they paid their social security contributions while they were of working age, the desire of pensioners is one – to receive the highest possible pension. Driven by this incentive, pensioners are largely inclined to vote for the political party that promises them the highest pension here and now. And the parties know very well that they have this power, since the management of the Pensions Fund in the National Social Security Institute is highly politically concentrated and is little influenced by external factors, such as the state of the economy, demographic processes, the health status of the working-age population, etc.

The desire of insured persons and pensioners to become net beneficiaries of the pension system is not only expected, given the incentives set in the pay-as-you-go pillar, but also natural. In fact, there is nothing wrong, strange or immoral in this. Securing old age is a type of financial investment and is no different in any way from any other. Any successful investment is precisely the one in which the generated benefits are more than the initially invested resources. In the context of the pay-as-you-go pension model, however, this difference creates a deficit in the system either at its input (less receipts from insurance contributions) or at its output (higher amount of pension payments). Namely, because of the principle of "solidarity", characteristic of the first pension pillar, the insurance contributions made by current workers cannot be accepted as a financial investment, since there is no accumulation, capitalization and individualization of funds.

The main drawback of the first pension pillar in Bulgaria is not so much rooted in the behavior of the participants in the system, but in the inability of the model as such to set the right incentives that would lead to a sustainable solution for ensuring adequate income for pensioners.

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