The second pension pillar and the fictional pyramids

Every year, with the voting of each new state budget, the topic of the size of pensions is invariably raised. This year, the debate has been extremely heated, and it even reached statements that the second pillar of the pension system is a pyramid scheme. However, anyone who claims such a thing is lying to you, or simply does not understand its ideology well enough. Currently, 15 billion leva have been accumulated in the accounts of pension funds. And if for some reason you do not believe the "Financial Supervision Commission" about the truth of this statement, I will remind you that in 2017, a review of the assets of pension companies was conducted by external auditors, who confirmed their sustainability and this data. So any claims that your pension contributions in the second pillar are not there are unfounded.

It is very important to understand that the main function of pension funds is, above all, to preserve the purchasing power of the savings of the insured persons. For this reason, if the pension fund in which you are insured beats inflation, you can be satisfied and calm about the way your savings are managed. If you are looking for a higher return on your savings, you can safely look for it somewhere in a contractual fund that will not be restricted by regulation in how to invest your savings. The most important goal of pension funds is to preserve our savings, not to earn high returns, which is always at the expense of taking on higher risk. Since there has been a lot of talk in recent days that the second pension that pensioners will receive from 2021 is very low, I will systematize the main reasons for this.

1. The time period of 20 years in which pension funds were supposed to start paying the second pension is extremely insufficient to claim that the second pillar of the pension system is not working. For such an investment scheme to work, a time horizon of the order of 35-40 years is needed, which would actually cover the entire professional experience of an insured person. For this reason, there is simply no way that there will be large enough accumulations in the individual accounts of many of the insured.

2. When the pension funds were launched in 2002, the contribution was 2% of the insured income, and it was expected to gradually increase to 7%. In 2007, it reached 5% and has remained unchanged since then. The increase from 5% to 7% set at the start of the pension reform was transferred directly to the National Social Security Fund in order to limit the size of the deficits that form in it every year.

3. Another serious problem is that many of the insured's employers have not paid some of their workers' contributions over the years. This is another reason why the accumulations in the individual accounts of the insured persons are low.

4. The shadow economy over the years has also been a very important factor that reduces revenues in the second pillar. For years, employers and workers preferred to evade taxes, with both parties preferring to insure themselves at significantly lower levels. In recent years, however, we have witnessed a constantly increasing lightening of the Bulgarian economy. This factor, as well as the significant and constant increase in the average salary in the country, will continue to increase revenues in the second pillar. For example, in 2002 the average salary in Bulgaria was 260 leva. In September 2019, it reached 1266 leva. This actually means that a significant part of the people who should start receiving a pension from 2022 paid 2% of the average 260 leva in 2002. This is another key factor that explains the small amount of accumulations in the individual accounts of the insured.

5. The fifth extremely important factor is purely market and is related to the dynamics of the capital and debt markets. In 2008, we witnessed one of the most severe and long economic recessions. After the collapse of the markets during this period, we had a number of years of recovery accompanied by low profitability. When the insurance period is 40 years, such a temporary negative impact on the profitability of pension funds is smoothed out. Over 20 years, the impact of the 2008 recession is simply very large. An additional factor that has a negative impact on the low amount of accumulations in the individual accounts of the insured is that during economic crises, unemployment increases and wages reduce their growth rate. For reference, at the beginning of the 2009 recession, unemployment in Bulgaria was 5.1%, while in 2013 it was 13.8%. This is a period of 4 years during which some Bulgarian citizens did not receive any income into their individual accounts.

6. In order to reduce risk, pension funds are subject to daily control by the Financial Supervision Commission and the custodian bank. Their annual financial statements are certified by two independent auditors. And perhaps the most important factor limiting the profitability of pension funds is the heavy regulatory framework in which they are forced to operate. The Financial Supervision Commission imposes and monitors the implementation of heavy rules on what percentage of the money pension funds can invest in different asset classes, which greatly limits their ability to manage their investment portfolios in a sufficiently effective manner.

It is very important to note that it is extremely dangerous to oppose the first and second pillars of the pension system. The two pillars are complementary, not mutually exclusive. People should know that the accumulated funds in their accounts, which equal 5% of the gross monthly salary in the pension funds, are their real savings. They are inherited in cases of death. The money that comes to the National Social Security Institute, which amounts to 14.8% of the gross monthly salary, goes directly to the payment of current pensions. This is the so-called cost-covering model of pension insurance.

The main concern at the moment is that the second pension is too low. According to data from the Ministry of Social Affairs, about 55% of those retiring in 2021 are expected to receive a pension of 30 leva. This certainly seems low, but based on the facts presented above, it is clear why this amount is so low. When the accumulations in the individual accounts of the insured in the years after 2002 are low, unfortunately we simply cannot expect large pensions.

The article was originally published in the newspaper "Trud"

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