Against the background of education and health sector strikes, Bulgaria’s poorly managed and cash-strapped pension system has moved out of the spotlight. Yet the model is handicapped by serious deficiencies and short-sighted planning. Unless shortcomings are urgently addressed, it looks headed for financial collapse.
A reality check reveals a vicious circle. Pensioners receive just 35 per cent of their pre-retirement earnings, just half the amount of Romania, the second-poorest EU member state. Yet workers pay one of the highest social contributions worldwide (theoretically, intended to cover pensions spending in full), so they report only minimal earnings to pay less for social security. Hence the state Pensions Fund runs deficits for years and the budget surplus has to fill the gaps. Private pension funds, forming the second capitalisation pillar, suffer regulatory restrictions to their activity. They also operate on a small scale because they get a mere five per cent in mandatory pension outlays from the country’s younger population.
This situation, which has emerged since the transition period and persisted despite pension reform in 2000, is worsened by the burgeoning number of retirees in Bulgaria and the rapidly ageing population. Currently, one in three Bulgarians are pensioners, the same number as the economically active population. According to estimates from the Institute for Market Economics (IME), there will be two pensioners for every working person in Bulgaria within 40 years. A 2006 UN report confirms this trend. Currently, the average age in Bulgaria is 41.4 years. The country’s population is also ageing at the fourth-fastest pace worldwide, trailing only behind Japan, Italy and Germany. With the army of pensioners growing, the failings of the so-called spending-coverage pension system model can only become more glaring.
Current social security contributions only cover 46 per cent of total pension spending, according to IME data. The remainder comes from the state budget (37 per cent), state outlays (15 per cent) and other payments and interests. Under the present system, the situation is unlikely to improve. In fact, state spending will increase even further as the number of pensioners grows. Inevitably, this will undermine other “healthy” sectors of the economy. If public spending on pensions grows, it could eat into the country’s fiscal surplus, which Bulgaria is encouraged to maintain as a cushion against unforeseen expenditures and in the light of its ambition to join the eurozone. The Government has, however, avoided radical steps, preferring to maintain the status quo. It hopes that the high social security burden will result in more social security receipts by clamping down on evasion of payments and – in particular – the Bulgarian practice of declaring only part of their earnings in a bid to avoid high tax and social security payments.
Meanwhile, international and business pressure grows on the Government to reduce the untenable social security burden. The World Bank has repeatedly called for a reduction, saying it is one of the highest worldwide. International investors say likewise but more indirectly, by shunning investments in Bulgaria at the business environment research stage.
In a bid to ease pressure, the Government agreed to trim three percentage points off social security contributions as of October 1 2007. It also cut pension payments by one percentage point and unemployment outlays by two percentage points. Yet Bulgaria’s Labour and Social Policy Minister, Emilia Maslarova, has warned that no further cuts are envisaged for at least three years.
Currently, this burden is at 33.5 per cent of an employee’s gross salary, of which 17 per cent are mandatory social security contributions flowing to the Pensions Fund for people born after December 31 1959 (22 per cent for those born before January 1 1960) and five per cent going to the second capitalisation pillar, namely towards private pension funds.
Commentators also criticise the pension system’s inefficient management. They argue the Pension Fund acts more as a paying agent rather than as a viable counterpart to private pension funds. Re-directing money from the Pension Fund for alternative undertakings, then re-filling it again from other budget items – with no investment activity whatsoever – only underlines its woeful mismanagement. No wonder the state’s pension manager is always in the red, say critics.
A growing number of analysts have dubbed the present spending-coverage pension system unsustainable and have demanded immediate reform. Some believe that Bulgaria should adopt the capital formation pension system. Under this model the Pension Fund would act as an institutional investor or the state-run counterpart of private pension funds.
Another proposal envisages part-financing pensions from value added tax proceeds or streaming savings from pay to public officials made redundant. A third one sees cutting the outlays to the Pension Fund and raising the ones to private pension funds from five percentage points of gross salary to 10. A further possibility would give future pensioners more control over their pension commitments. Under this scheme they would be entitled to not only choose their own private pension fund and decide on a fund with a low-, balanced or high-risk profile, but also develop their pension portfolio. In this way, people could distribute their funds across an array of existing funds as a risk-hedging opportunity, the so-called multi-funding approach. Another – more radical – alternative snubs patch-up measures and sees the entire pension system going entirely private.
Yet none of these measures seems likely soon. Not only is the political will lacking but the International Monetary Fund has also warned the Government to curb costs when planning public sector reforms. Nonetheless, preparations for reform should take place now. Otherwise, a decaying system leaving pensioners to live in misery and business swaying under untenable social security pressure could collapse.
