Why is the pension system doomed and what is its real burden on workers?

In this article, I intend to shock you. I hope to achieve this by telling you in plain language that our pension system is practically bankrupt. And I will repeat it several times to get it into your head. Bankrupt and therefore in need of urgent reform – a transition from the current system, based mainly on a state social pension pillar, to a completely private market system. Because, as we have explained in our report on the subject, such a reform is the only way to heal pension insurance in Bulgaria and avoid a collapse of the pension system in the long term.

The pension system is de facto bankrupt

Here is the current situation. The state Pension Fund has a huge annual deficit of over 3.9 billion leva. This is equivalent to about half of the pension fund's expenses (which total over 8.3 billion leva). The insurance contributions collected from workers are enough to cover only about 52-3% of the money needed to pay the pensions promised by the state. Where does the rest of the money needed to cover the deficit come from? From the republican budget, of course. By any conventional definition, an institution that is able to cover only 50% of its current expenses without external transfers is... de facto bankrupt.

As can be clearly seen in the graph, the long-term trend is not at all pleasant - from a deficit of 1.5 billion leva in 2007, the deficit tripled within 8 years to 4.5 billion leva in 2015. Yes, over the next three years we observe a certain decrease, but it is due to 1) the serious upswing in economic growth (which will not last forever) and, even more significantly, 2) the constant increase in the social security burden during these years.

Most of you probably don't realize the consequences of this broken pension system for your personal finances. Let me explain. Currently, 14.8% of the gross salary of workers in the third and 17.8% of the salary of workers in the second and first labor categories are taken away in the form of "insurance contributions" and put into the state pension fund. In fact, this money, in strict financial terms, cannot be categorized as "insurance contributions" at all.

They are neither saved in an individual "your" account, where they accumulate, nor invested. They are spent on current expenses - the payment of pensions to current pensioners. You have no savings in the "Pensions" fund and you never will. To receive a state pension in old age, you have to hope that there will be enough workers to support you, as you currently support current pensioners.

The real "insurance" burden is greater than you think

A rather unpleasant fact, but unfortunately, the troubles do not end there. Do you remember the deficit that I mentioned above, and how it is covered by the republican budget? Do you know who fills this budget? That's right - you again. That is, the real burden of the state pension system on your pocket is not only these 14.8% or 17.8% that are taken from you every month. Given that almost 50% of the expenses of the Pension Fund must be covered with money from the republican budget, by rough calculations the real (but hidden) financial burden of the system is on average about twice as high for each taxpayer. Accordingly, in reality, nearly 30% of the gross income for those working in the third and over 35% for those working in the second and third labor categories.

Are you feeling sick? There is more. Due to the fact that the system is "social" (i.e., cost-covering) and the negative demographic trends in the country, the deficit in it will become larger and larger over time. Because the country's population is aging and the ratio of pensioners (those who receive) to workers (those who pay) is steadily increasing in the long term. Due to this fact, the tax burden for maintaining the Pension Fund, which falls on each of us, will have to become higher and higher... and this is simply so that the value of pensions (especially the real value after inflation) can be maintained at its current levels.

In short, if it’s not clear to you yet – the state pension system is destroying money. In return for the billions that we are forced to pour into it annually, we only get one empty political promise. That is. A promise that one day there will be money for us too. And all the more so because we all agree – the current pensions are not impressive at all (and their low levels are precisely a consequence of the vicious structure of the system). However, this is a promise that will most likely not be fulfilled. Not just because politicians are liars (this is generally the case), but for objective economic reasons.

Why is nothing being done about it?

You are probably wondering now, if the situation is so bad, why is no one talking about it? Because, first of all, no politician has any interest in getting rid of the largest expenditure item in the state budget. This represents a huge resource for exercising and expanding power. The social system forms the most fundamental part of the entire state apparatus. This is very clearly evident from the fact that of all sectors, the social sphere always absorbs the most state spending. If politicians, as we know very well, do not like to part with even a small part of their power, what is left for the social system?

Secondly, solving the problems of pension insurance in Bulgaria requires a long-term and complex reform. Such a fundamental reform would certainly take more than one government term and requires careful long-term planning for decades to come. And, like any such reform, precisely because it is long-term and affects a huge part of the state's financial resources, there is always a risk of leading to public tension if it is not carried out qualitatively and carefully.

Ultimately - what kind of reform does the system need?

We have already written about this from the EKIP. Obviously, Bulgaria needs a pension system that is financially stable in the long term and is not susceptible to negative demographic trends. Only such a system can ensure a dignified old age for insured Bulgarians. The current public system, as we saw above, is exactly the opposite – de facto already bankrupt and completely doomed in the long term in view of demographic trends.

However, there is an alternative. In the private sector. The key is the insurance mechanism itself– in the state system it is cost-effective – current workers pay with their insurance contributions the pensions of current retirees. We have seen why this does not work. However, if the mechanism were instead capital-based, that is, one in which each worker accumulates insurance contributions in an individual account, which are invested during their working life – the system would be far more stable and certainly not susceptible to negative demographic trends. Because with such a mechanism everyone is insured individually, money is not transferred from one social group to another (workers to retirees) and, accordingly , whatever changes occur in the demographic picture, they have no bearing on the financial stability of the pension system.

This is the mechanism of private pension funds. That is why earlier this year, the EKIP proposed the abolition of the state pension pillar and the transition to a fully private-market system of pension insurance in the long term. Such a reform can be implemented smoothly, by gradually reducing contributions to the state fund and releasing them for investment in individual accounts in the private sector. Of course, the private pension funds themselves, which form the second pillar of the current pension model, are not perfect, and the system is not perfect, and there are many cracks in it. Regulatory reform is also needed to improve the quality of services offered by these funds, or at least to create real market competition in the sector, instead of maintaining a de facto cartel of a handful of financial institutions through regulatory barriers.

But the problems of the second pillar are a topic for a separate article (which we also touch on a little more specifically in the report mentioned above). Even with its current shortcomings, the second (private) pillar of the system is still more stable and in a better financial position than the first (public). At the moment, it may seem to you that there is no pressing problem, but, as is clear from the above, in the long term the current state pension system is doomed. Fundamental reform is needed, and as soon as possible, if we want to ensure a dignified old age for current and future workers. And the longer we postpone it, the more difficult it will be to implement it.

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