What will happen to the second pension following the changes to the law? FSC Vice Chair Diana Yordanova speaks to FAKTI

If you work in Bulgaria and are insured for a pension, the coming months may change the way your pension savings are managed. The National Assembly adopted changes to the Social Security Code (SSC), which introduce the so-called multi-funds. If you were born after 1959 and work on an employment contract, you are also required to be insured in the so-called second pillar — a private pension fund (Universal Pension Fund, or UPF). Every month, 5% of your insurance income goes there — divided between the employer and you. Over 5 million Bulgarians have a personal account in such a fund. Until now, this money was managed in the same way for everyone — no matter whether you are 25 or 60 years old. The reform with multi-funds aims to change exactly this. And what else… Diana Yordanova, Deputy Chairperson of the Financial Supervision Commission (FSC), Head of the “Insurance Supervision“ department, spoke to FACTI.

- Ms. Yordanova, the changes to the Social Security Code and the introduction of the multi-fund model in the second pension pillar are already a fact. How exactly will this change affect people's future pensions?
- These changes are long-awaited and widely supported by the professional community. The fundamental goal for the development of capital pension insurance is to increase the funds of insured persons by enabling them to achieve better returns on their investments and reducing the fees and deductions collected, which will lead to more adequate payments from the second pillar. To ensure the achievement of this goal, it was also necessary to increase the capital requirements, specialized reserves, and staffing levels of pension insurance companies, so as to ensure responsible management and coverage of risks both in the period of accumulation of pension savings and in the period of payment. The changes should be considered in aggregate, as they are interrelated. According to our calculations, under conservative assumptions, the changes in the law show the potential for increasing the income replacement ratio to about 21% while maintaining the current contribution rate of 5%, which is an indicator of significantly higher adequacy of future supplementary pensions compared to the current model. In this sense, this is not just an organizational change, but a key mechanism for increasing the long-term efficiency of the system. Another extremely important circumstance is often not taken into account, namely, what is the share of workers who are insured on real incomes. In this context, the accumulations in the accounts also depend on the amount of contributions received and their regular payment.

It is important for people to know that one cannot expect that with a contribution on the minimum insurance income there will be accumulations like for contributions on the maximum insurance income.

Pension insurance is an investment with a long horizon and the result of the multi-funds will not be visible immediately. The goal is, after the multi-funds become operational from January 1, 2027, to see the result of the higher yield obtained in the personal accounts of all over 5 million insured persons in a few years. For the first time, the insured will have the right to choose how to manage their savings - because their personal accounts are their own money,

which are inheritable and cannot be lost - the gross contributions are guaranteed.

I want to draw attention to a very important topic, on which I hope the unions will also focus their efforts - what income the workers are insured for, whether they are on real income and, accordingly, making additional efforts to reduce the share of the shadow economy. Because the accumulations in the accounts, you know, are 5% of the insurance income and their volume also depends on the amount of the contributions received and their regular payment. It is important for people to know that one cannot expect with a contribution on the minimum insurance income to have accumulations like for contributions on the maximum insurance income. Because 5% of 1000 euros is 50 euros, and 2000 euros is 100 euros.

- The introduction of multi-funds means that insured persons will be able to choose between different investment strategies - conservative, balanced and dynamic. Are Bulgarians really ready to make such a financial choice?
- Guided by the understanding that each of us is responsible for our own future, I hope that the majority of people will make a conscious and informed choice of sub-fund, because these are personal funds that have an extremely important purpose - to replace our labor income upon the onset of inevitable old age, and upon death -

to be used by our heirs.

I am pleased with the fact that in the public space there is more and more talk about capital pension funds, as well as about the opportunities that the multi-fund system will provide. Activity in making choices for individuals can be expected after the active information campaigns conducted by both pension companies and you, the media, for which I thank you. I believe that over time, with clearly differentiated investment opportunities and results, a gradual increase in the commitment of insured individuals and a more active choice can be expected. The participation of insured persons in the sub-funds of universal pension funds is carried out in compliance with two basic principles:
-- Freedom of choice of sub-fund
-- Distribution according to the life cycle
Insured persons in universal pension funds can freely choose a sub-fund with a different investment profile in which to manage their funds.
Those of them who have not made an active choice of a sub-fund are distributed in sub-funds with a different investment profile according to their age:
-- in a dynamic sub-fund - until the age of 50;
-- in a balanced sub-fund - from 50 years to 3 years before retirement age
-- in a conservative universal sub-fund - persons who have 3 years left until retirement age, with the aim of preserving the accumulated profitability.

Upon reaching the specified age, persons who have not chosen a sub-fund are automatically transferred to a lower-risk fund. My advice to citizens is to find out which pension fund their accounts are in and in the fall from September 1 to November 30, to be active in their choice.

Multifunds come into effect from January 1, 2027 and everyone will be able to change their sub-fund once a year.

Let people not forget that these are their savings, which will provide part of their income upon retirement, and upon death - will be received by their heirs. I repeat this. It is a pleasing fact that young people entering the labor market are more active in investment planning. And this is very good news. At the same time, I am satisfied with the growing interest of insured persons and their heirs. A conclusion based on objective data, namely the inquiries, signals and complaints received by the FSC.

- Criticism has emerged in the public sphere that pension companies will retain a significant part of the profitability. Thus, the companies will be able to receive part of the achieved profitability. How will the interests of insured persons be protected?
- First of all, I would like to emphasize that the type and amount of fees and deductions collected by the pension insurance company (PSC) is strictly regulated by law. With the current changes to the Social Security Code (SSC), a gradual reduction (by nearly 50 percent) of the maximum allowable amount of deduction from each contribution has been proposed.

The new two-component fee structure aims to maintain balance in the pension system, while at the same time encouraging better management of pension savings.

The first component is determined based on the value of the net assets of the Professional Pension Fund (PPF) and the sub-funds in the Universal Pension Fund (UPF) depending on the period during which they were managed by the pension insurance companies. The second component is calculated based on the income generated from the investment of the funds. Given the high public importance of supplementary pension insurance and its socially significant role, I cannot agree with the numerous speculations on this issue, since what is set out in the draft law is the result of numerous calculations in the context of the other changes proposed by the draft law (e.g. increasing the guarantees in both the accumulation phase and the payout phase, capital requirements, information and personnel security, etc.). Following the historical development of the sector and the last changes made 10 years ago (SG, issue 61 of 2015, effective from 1.01.2016), the conclusion was undoubtedly that the reduction should be tied to the results of the management of the funds for additional mandatory pension insurance, with the ultimate goal being to optimize the accumulation of funds in the individual accounts of individuals. The most significant influence on the volume of accumulated funds was the investment fee, which was withheld regardless of the achieved investment result. The changes implemented an extremely fair and transparent solution for people, namely the linking of the management fee to the achieved results, to the achieved investment income. In this way, the remuneration of pension insurance companies is tied to a greater extent to the value actually created for the insured persons.

- Can a second pension fund go bankrupt and what happens to people's money then? Is it lost or is it protected…
- It should be noted that the pension fund, although a legal entity, is not a commercial company and cannot become insolvent. In the event of a pension insurance company becoming insolvent, the funds managed by it are transferred to another pension insurance company together with the specialized reserves set aside for these funds, which are not included in the bankruptcy estate.

The adopted changes to the Social Insurance Code have further developed the protections in such an unfavorable scenario,

namely, a regulation on an increase in the amount of the reserve for guaranteeing pension payments and in the reserve for guaranteeing the gross amount of contributions, as well as a significant change in capital requirements, which would contribute to the sustainability of the system in the long term and significantly reduce the possibility of a pension insurance company becoming insolvent.

- Some political forces question the very existence of the second pension pillar and even insist on its abolition. What would this mean for the pension system and for people who already have accumulated funds in universal funds?
- The allegations about gambling with pension money are, to put it mildly, speculative. And they clearly aim to create panic, which is unfortunate for those who make them. I am a numbers person and I believe in them. I am not a gambling type and I do not believe in the chance that gambling relies on. When it comes to pension fund investments, it is not serious to talk about gambling for a number of reasons:
-- Unlike gambling, where risk is taken and chance is relied on, when managing pension fund assets, the risk is taken in accordance with the detailed requirements of the law on investing funds
-- Investments are managed by pension insurance companies licensed for this activity, which have the necessary expertise, and the draft law on amending and supplementing the CSR has further strengthened the requirements for investment management. All risks, incl. investment risk, are currently monitored and managed by the pension insurance company
-- Daily control over investments is exercised by both the fund's custodian bank and the FSC as a supervisory authority
-- The risks inherent in investment activity are mitigated by the guarantee for gross contributions upon retirement provided for in the law

Even in the event of unfavorable market developments, the funds contributed by individuals are guaranteed. In most Central and Eastern European countries with similar pension systems, multi-funds have long been a fact and the results of their activities convince of the benefits of their introduction. I will dwell in more detail on the experience of Croatia and Slovakia. Given the good results of the introduction of multi-funds and the higher profitability of riskier investments in Croatia, additional legal changes have been undertaken to liberalize the investment regime, increasing the maximum age for participation in fund A (with the highest limit on investments in equity securities) from 55 to 60 years, eliminating mandatory participation in the most conservative fund C, etc.
In Slovakia, when multi-funds were introduced, insured persons initially participated by default in a conservative fund (for the period 2012 - 2023). After comparing the long-term investment results between the conservative and aggressive investment strategies, they reconsidered this decision and the default option is tied to the life cycle. The mistake we can make, but must avoid, is to “remove the second pillar“, referring to your question. The end result for the insured persons will be missed opportunities to realize the better profitability (and subsequently higher pensions), which the multi-fund system in the capital insurance, tied to the life cycle, would bring them.

The assets of the pension funds and the risk are managed reliably and transparently.

And the results achieved by them speak for the capacity built over the companies - over the last three years, over 5 billion leva in profitability has been achieved, distributed among the accounts of the insured persons. This is not a profit for the companies, but for the insured persons. I respect the institutions and the division of powers and would not allow myself to give unsolicited advice. But from everything that has been said, I hope that we have also helped your readers and have explained well the importance of introducing multi-funds.

To be continued…