What is the problem with second (private) pensions?

This week, a huge hysteria broke out in the public sphere regarding the payment of "second" pensions from mandatory private pension funds. It became clear that the amount of the combination of state and private pension may turn out to be less than if you were to receive only the state one. And because no one explained what this was actually due to, hysterical materials (like this one ) immediately appeared in the media, in which the private funds were called a financial pyramid and a fraud. Some even began to claim that there is hope for a decent pension only in the National Social Security Institute, and there is no point in the second pillar. This is complete nonsense. Now I will explain why.

Why does a private plus state pension cost less?

What you need to know is that the combination of state and private pensions is less than just a state pension, not because private funds don't work, but because politicians decide to structure the system that way. Currently, anyone who is insured in a mandatory private fund will receive a lower pension from the National Social Security Institute than they would otherwise. By law, if you are also insured in a mandatory private fund, your pension from the National Social Security Institute is reduced by 20%. This effectively means that you miss out on the last few increases in state pensions.

This specificity of the pension legislation purposefully harms all those who are insured in both the first and second pillars of the pension system. With such a rule, it is actually unrealistic to expect that the combination of state and private pensions can be greater than the state pension alone. This is so for several reasons. First, the contribution to state insurance is much greater. Specifically, it is 3 times greater than the contribution to private funds for the lowest (3rd) category of labor. It is then quite natural that the state pension forms a larger share of the entire pension compared to the private one.

The calculation is not so straightforward, but let's say that we are talking about a share that is about 3 times larger. In other words, if 75% of our total insurance contributions go to the National Social Security Institute, it is logical that 75% of the pension should come from the National Social Security Institute upon retirement. Due to this fact, any reduction in the amount of the pension from the National Social Security Institute would have a much greater impact on the overall pension than variations in the amount we receive from private funds. It is obvious that 20% of 75% is more than 20% of 25%. If we add that, especially in the last few years, the growth of state pensions has far outpaced the profitability of private pension funds, it is not surprising that when this 20% of the state pension is cut, the entire pension comes out lower.

How much money goes into the state fund and how much into private funds?

But even that doesn't tell the whole story. As we know from calculations that were released earlier this year, the minimum pension from private funds for people who have been insured in them for the last 20 years or so is expected to be between 35 and 40 leva. Many people were scandalized by this number, because it is many times less than even the minimum pension. But in fact, it is not that scandalous at all. The minimum pension is currently 220 leva. Roughly speaking, 5-6 times higher than the 35-40 leva in question. But don't forget the difference in contributions to the state and private funds. The nominal difference is 3 times, most of us contribute 15% of our gross income to the state fund, and only 5% to a private fund, after the recent increases in contributions to the National Social Security Fund.

But the difference is even greater if we consider that there is a 50% deficit in the state fund, which is financed by other taxes and fees through the state budget. This means that, roughly speaking, the average taxpayer contributes about 30% of his income to the state pension fund. Proportionally, this is 6 times more than the contribution to a private fund. Does it still surprise you that the state fund is able to grant 5-6 times higher minimum pensions than private ones? Especially considering that pensioners have been insured in the state fund for about 40 years, and in private ones only 20?

Of course, the private funds themselves also have serious problems to deal with. But the insinuations that I have observed in recent days that they are almost a financial pyramid and it is safer to pay all your contributions to the National Social Security Institute are not only completely unfounded, but are also a complete lie. The real pyramid is precisely in the state pension fund, because money is not saved and accumulated there. The state pensions of current pensioners are paid through the contributions that come from current workers. In order to have a financially sustainable growth of pensions, the state fund relies on more and more new participants in the scheme to pay money. This is the typical structure of a financial pyramid.

What is a financial pyramid actually?

To claim that this is not a pyramid scheme, but private funds, where each worker's money is accumulated individually and belongs only to him (and his heirs), is a base lie. Do a very simple experiment. Contact your private pension fund, where you are insured compulsorily, and ask for information about what is happening with your individual account. You will be given precise information about how much money is saved there, down to the last penny. Then try asking the same question to the National Social Security Institute. What do you think will happen?

The National Social Security Institute will not even answer you. At most, they will laugh at your question. Of course, all this does not mean that everything is flowers and roses with private funds. In fact, we have often commented at the EKIP that there are serious problems there too that need an urgent solution. But first of all, we must all understand that what kind of pension you will receive from the second pillar depends solely on how much you have contributed. Private pension funds operate on the principle of "the more, the more". And in a mathematical sense, it is completely literal, given that in the long run they only manage to preserve the purchasing value of the savings contributed to them, but not to increase it.

You will ask – isn’t this a problem? Yes, it is somewhat a problem. It is certainly desirable that the profitability of these funds be higher. But the fact that the data shows that so far they are successfully protecting the value of our savings is in itself a success, and a great one at that. A success that the state fund cannot boast of at all. There you are relying solely on a political promise. Which can be fulfilled for now, but the deficit in the National Social Security Fund is already 50%. Over time, the situation will not improve, simply because the demographics are such that the old will become more and more, and the young less and less.

The problems with profitability in the second pillar are related to the inadequate regulatory framework. It is too restrictive and ineffective. It does not allow the necessary flexibility for private funds to offer pension products with higher returns. Not to mention that the licensing regime currently seriously limits competition in the sector. In short, the current state regulation limits consumer choice at all levels. This kills competition, which also kills the profitability of these funds. It is elementary.

Conclusion

I want you to understand three things from this article. First, the combination of a private plus state pension is lower than the state pension alone, because the system itself is structured that way. To claim that it is lower because private funds are a "pyramid" and the National Social Security Institute is not is a complete lie. Second, if you are going to be angry with someone that your second pension (from a mandatory private fund) is low, you should be angry with yourself first. Because in the current model, the more money you put in there, the more you will earn. If you are insured on a minimum wage, you will have a paltry pension. And third, the system needs reform, as is evident and as we have proposed. The first (state) pillar cannot withstand demographic pressure and is practically bankrupt, and the second suffers from serious problems in the regulatory framework.

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