The new pension paradigm: will it work for all?

The pension system is undergoing major reforms in response to the new financial, economic, demographic, political and social realities brought about by the transition from a socialist to a market economy. While the new three pillar pension scheme has corrected some of the shortcomings of the former system, it does not guarantee an adequate standard of living for the elderly, and has also been found to place women at a disadvantage.

Bulgaria has ratified the major international instruments on humanrights, which also address the right to social security. While the socialsecurity system corresponds to the goal of full universal coverage, the currentpension system still generates inequalities and poverty, and cannot reachcompatibility with the main International Labour Organization (ILO) standards onsocial security, such as a 40% income replacement rate for pensions. It is notaccidental that the government had not ratified any of the ILO conventions inthe field since the Second World War. The ILO Workers with Family Responsibilities Convention (C156) of 1981, recently ratified in 2006, has yet to be implemented in nationallegislation and practice.

Reform of the pension system has been underway since 2000, but the human rightsimpact of the relatively recent measures adopted can only be assessed in themedium and long term. The reforms were undertaken in response to the new financial, economic, demographic, political andsocial realities that confronted the country in the transition period,which brought about an urgent need for profound changes, adaptation andmodernization of both the legislation and the architecture and functioning ofthe pension system.


The move to a three-pillar system

Bulgaria’s social security scheme was formerly based on the defined benefitapproach with universal coverage, including employees from the private andpublic sectors, self-employed workers, and members of cooperatives andprofessional associations. The National Social Security Institute provided wideprotection for the contingencies of retirement, disability, death, employmentinjury, unemployment, maternity and illness. It also used to provide differenttypes of social assistance that are now disbursed by the national SocialAssistance Agency, such as family and electricity allowances.

Several significant efforts were made to solve the problems of social securityin the context of the transition to a market economy, without success. The newsocial insurance legislation adopted in 2000 was targeted at healing the mostpronounced and cost-consuming weaknesses of the incumbent legislation, whichwere also the source of the main problems in the pension system. These included:

• A chronic financial deficit, and stemming from this, the threat of aneventual financial collapse.
• The low collection rate of contribution payments and wide-scalecircumvention and avoidance of social insurance obligations.
• Overly liberal provisions for access to a pension, particularly in the caseof workers opting for early retirement rights.
• A high social burden on the working generation.
• Low pension rates relative to current costs of living.
• Growing distrust and a negative attitude towards social insurance as a wholeand the pension system in particular.

The new legislation adopted to address these and other problems in the pensionsystem brought about fundamental changes aimed at attaining a balance that will guarantee the achievement of the socialgoals of the pension system as well as the financial stability and viability ofthe system.

Under the financial direction of the international financial institutions(enforced through the conditioning of loans) and following the policiesimplemented in Central and Eastern Europe and Latin America, a whole new pensionsystem architecture was set up, based on three pillars. The new architecturecombines government and private involvement as well as both compulsory andvoluntary elements.

The first pillar is universal and mandatory and encompasses all groups ofemployed persons regardless of the type of employment and level of incomeearned. It is a typical pay asyou go (PAYG) public social insurance pension scheme, based on definedcontributions. The second pillar, also mandatory, is a supplementary,fully funded pension insurance scheme with individual accounts, while the thirdpillar is a voluntary supplementary fully funded pension insurance scheme. Thesecond and third pillars are privately managed, following the advice of theWorld Bank.

Pension benefit levels underthe ‘first pillar’ are calculated on the basis of a universal formulaapplied to all insured people, aimed at achieving a closer link betweencontributions and benefits. The formula takes into account both the incomeearned by the insured individual and the number of years of active employment.

Another change introduced by the legislation was an increase in the retirementage. The retirement age for women will be gradually raised from 55 to 60, whilethat of men will be raised from 60 to 63. In addition, the categories of workerseligible for early retirement were significantly reduced, decreasing theproportion of contributors entitled to this right from 20% to just 6%.

The concrete measures and policies set forth inthe pension reform legislation – higher requirements for admission to thepension system, restricting early retirement, improving the connection betweenindividual contributions and the size of pension compensation, improving controlon adherence to the legislation, involving all employed persons – are typicalof the measures and policies that havebeen followed in other countries that are contemplating pension reformsor have already undertaken them.


Income replacement rates fail to meet international standards

The new pension formula is supposed to guarantee a minimum 40% incomereplacement rate. Data provided by the National Social Security Institute showthat so far, the chosen formula has fallen somewhat short of meeting this task.The replacement rate, measured by the correlation of an average pension to theaverage work salary in the country, fluctuates between 35% and 40%. However, itshould be stressed that two thirds of pensioners in the country receive apension that is barely equivalent to or below the average pension. This is oneof the main reasons that Bulgaria has not ratified ILO Convention 102, whichsets out the minimum standards of social security (including a 40% incomereplacement rate for old age pensions), and the European Code of SocialSecurity.

On the other hand, the rates of all pensions, including the maximum pension, donot provide any guarantee of an adequate standard of living. As a result, themost frequent criticisms of the pension system, both on the part of those‘inside’ the system and of its future ‘users’, are primarily with regardto the pension rates. Although there are many more and different reasons forthis situation, and not all of them can be attributed to the formula fordetermining pension amounts, it has already been established that thesubstitution rate of lost occupational income achieved through the formula isinadequate. That is why the new pension formula should be revised in order toachieve an improved income substitution rate. A move in this direction isextremely important and necessary both for raising confidence in the system andin the reforms and in order to ensure its development.


Pension system places women at adisadvantage

The more direct link between contributions and pension benefits under thenew pension system places women at a distinct disadvantage. As shown by Table 1,the employment rate is significantly lower among women than among men. This canbe partially explained by the fact that women are far more likely to take timeoff from work to care for children and other family members. They are also morelikely to work only part-time, often for the same reasons. The lower pensioncontributions they make as a result of these factors and others are reflected inthe lower income replacement rate in women’s pensions.

TABLE 1. Basic indicators

Source:Based on data from “Gender Dimensionof the Pension Reform in Bulgaria”, <www.ilo.org/public/english/region/eurpro/budapest/download/socsec/gender_pension_bulgaria_eng.pdf>.

For its part, the gender analysis carried out bythe National Social Security Institute in cooperation with the Centre forWomen’s Studies and Policies points to four major sources of unequal treatmentfor women and men in the pension system:

Retirement age: Questions have beenraised as to whether the lower retirement age for women is actually an advantageor is in fact a disguised disadvantage in the broader context of the labourmarket. Namely, with the new, more individualized pension benefit formula, inwhich each worker’s own earnings are the direct basis for his/her own pensionbenefits, a shorter working life will simply mean lower pension benefits forwomen – and higher rates of female poverty in old age. Is this context, is alower retirement age an advantage for women or a subtle form of discrimination?

Individual savings versus socialinsurance: The individual savings accounts that constitute the second pillarof the new pension system magnify women’s general disadvantage in the labourmarket, since they have no solidarity or social welfare elements that help tocompensate for the gender wage gap. Thus, women’s lower average wages arereflected directly in lower pension benefits.

Life expectancy: The second pillarlegislation and regulations are silent on a key issue for all women, whetherrich or poor: how life expectancy will be used in determining future privatepension benefits. Internationally, private pension systems tend to pay lowerbenefits to women based on their longer average life expectancy, but there is nopublic system in the world that discriminates in this way. The new second pillaris a hybrid – publicly mandated and funded, but privately managed. Shouldpublic principles prevail in its design, or should these questions be left toprivate pension managers? In the event of the second scenario, what other groupswill face discrimination because of longer average life expectancy? Non-smokers,who outlive smokers on average? Members of ethnic majorities, who on averageoutlive minorities? Those who are free from predispositions to genetic diseases?In this sense, gender discrimination would create a dangerous precedent.

Child care and pension rights: Men whotake time off from work to care for their young children are treated lessgenerously by the pension system than women who do the same. This form ofdiscrimination penalizes men who share in child rearing activities and has beeneliminated in most countries across Central Europe.


Some concluding remarks

The realization of pension reform is encumbered by the long absenceof specially designed compensating measures and employment programmes, aswell as by its ‘overlapping’ with reforms undertaken in other importantareas: privatization and restructuring of the economy, health care, etc.

The application of a new pension formula, of a mechanism for an annual updatingof pensions, and of new kinds of benefits and occasional additional payments topensioners – at Christmas, for example – have improved the nominal amounts of pensions, but they still lag farbehind an adequate level for the majority of pensioners.

The first phase of the supplementarycompulsory pension insurance scheme has been declared successful, due to suchfeatures as public control, stable management and coordination with thepublic pension system. Representatives of trade unions and employers havereceived a relatively significant role in the implementation of thecorresponding regulations and the execution and tracking of policies, includingthe guarantee of the rights of employed persons.

In the context of pan-Europeanobjectives and values, the foundationhas been laid for achieving a more direct connection between strategy andpolicies in the pensions sphere and in National Employment Action Plans, witha view to raising the employment rate, restricting the inflow to earlyretirement schemes, increasing incentives for prolonging active employment andsetting pension systems on a stable financial footing.

The analysis of the Bulgarian experience so far provides grounds for theconclusion that there is room for acertain regulatory modification, particularly in light of the commitmentsensuing for the country from European instruments in the area of pensions andsocial involvement. Above all, in order to guarantee a dignified life for theelderly, pensions (both today and in the future) should not be a generator ofpoverty, and they should match the new individual needs created by changing.Finally, and perhaps most important of all, pension systems must be financiallyhealthy, autonomous, and sustainable in the long term.