Payout Phase in Supplementary Pension Insurance in Bulgaria - Current State and Perspectives

1. Payout Phase in Supplementary Pension Insurance in Bulgaria - Current State and Perspectives Valentina Dinkova Financial Supervision Commission Sofia, October 13, 2006

2. Content • Model, stakeholders, payment types • Risks during the accumulation phase and the payout phase • Problems and contradictions • International practice • Possible solutions for the Bulgarian model • Conclusions

3. A THREE-PILLAR MODEL Ist Pillar Mandatory social insurance PAYG NSSI NRA 2nd Pillar Supplementary mandatory pension insurance (SMPI) DC pension scheme managed by Pension Insurance Company (PIC) 3rd Pillar Supplementary voluntary pension insurance (SVPI) DC pension scheme managed by PIC Universal Pension Funds(UPF) – mandatory participation for persons born after 31.12.1959 (as of o1.o1.2002) Professional Pension Funds (PPF) – for persons working under heavy or harmful conditions category І and ІІ (as of 01.01.2000) Voluntary Pension Funds (VPF) (as of 1994) VPF under occupational schemes (as of 01.01.2007)

4. Projections of the Number of Insured Persons and of the Net Assets of UPFs, PPFs, and VPFs 1 EUR = 1,95583 EUR, exchange rate pegged to EUR under currency board

5. OBJECTIVES OF THE REFORM • Replacement Rate from the three pillars (final goal) – 70–75%: • 1st solidary pillar – 40%; • 2nd capital pillar – 15%; • 3rd capital – 10-20% • Accumulation of resources for pensions in individual accounts, personal motivation and personal choice in 2nd and 3rd pillars.

6. Projections of the Pension Size from UPF and the Replacement Rate Source: Insurance Supervision Division Note: 1. Based on the approved biometric tables on male and female mortality.2. Based on the technical interest rate of 3 %.3. Based on the AEAF projections of macroeconomic indicators and the annual profitability of 6 %.

7. SUPPLEMENTARY MANDATORY PENSION INSURANCE

8. SUPPLEMENTARY MANDATORY PENSION INSURANCE PPF contribution rates: • 12% of gross wages for the first category of work • 7% - for the second category of work • entirely paid by employer

9. SUPPLEMENTARY MANDATORY PENSION INSURANCE Right to pension: • UPF - a life pension for persons who fulfill the age and State Social Security contribution requirements (number of qualifying years) or up to five years earlier • PPF - a term pension for the period from early retirement till fulfilling the age and State Social Security contribution requirements(number of qualifying years)

10. SUPPLEMENTARY MANDATORY PENSION INSURANCE Right to payout from Individual Account before fulfilling pension age requirements • in case of permanent disability of 70.99 percent - right to a lump sum payout of up to 50 percent of funds accumulated in the IA • remaining funds in IA – for pension payout after fulfilling the pension age requirements Right to inherit funds in IA of a deceased person or pensioner • limited circle of heirs: survivor spouse, descending or ascending relatives • payout type - lump sum or deferred payout

11. SUPPLEMENTARY MANDATORY PENSION INSURANCE • Mizture of the accumulation and payout phases • Pensions are paid from the Individual Account (IA) in UPF or PPF • Insured persons and PIC share the investment risk in the accumulation phase • Upon exhaustion of funds in IA – life pensions are paid from a pension reserve accumulated in PIC • PIC assumes investment risk and risk of outliving in the payout phase upon exhaustion of funds in IA

12. SUPPLEMENTARY VOLUNTARY PENSION INSURANCE Insurance contributions – no ceiling: • at the expense of insured person • at the expense of employer • at the expense of other insurer • tax advantages up to a certain amount of contribution

13. SUPPLEMENTARY VOLUNTARY PENSION INSURANCE Right to pension: • old age pension - term or life-long • disability pension - term or life-long • lump sum or deferred payment – as chosen by person Right to withdraw accumulated funds: • from personal contributions - any time before attaining the right to pension • from employer’s contributions - cannot be withdrawn • from contributions of some other insurer – if the right is not limited by the insurer

14. SUPPLEMENTARY VOLUNTARY PENSION INSURANCE Right to inherit funds from IA • beneficiaries with pension rights – as stated in the insurance contract • lawful heirs – payout of funds – lump sum or deferred

15. SUPPLEMENTARY VOLUNTARY PENSION INSURANCE • Mixture of the accumulation and payout phases • Insured persons take the investment risk in the accumulation phase • Pensions are paid from the Individual Account in VPF • In case of lack of funds – life pensions are paid from a pension reserve accumulated in PIC • PIC assumes the investment risk and the risk of outliving in the payout phase upon exhaustion of funds in AI

16. Risks Covered by PIC • Investment risk during the accumulation phase with UPF and PPF (a reserve of 128 m BGN in 2020) • Risk of outliving during the payout phase with UPF • Risk of disability or death during the accumulation phase and risk of outliving during the payout phase with VPF

17. Problems and Contradictions • Mixture of the accumulation and payout phases - Defined Contribution and Defined Benefit • Mixture of various investment objectives in the pension fund – high profitability for insured persons and low risk for pensioners • Existence of IA in the payout phase, inheritance and payment of pensions with covered investment and biometrical risks • Accumulation of high risks to be assumed by PIC – risk of insolvency

18. Conclusions – Payment Type • Opportunities for annuitisation (a common pool of funds) • UPF – life term, monthly payments, participation in the profit and opportunities to postpone and terminate the pension plan • VPF – freedom of choice from a wide range of payment types as well as opportunity to cover biometrical risks in the accumulation phase through the participation of insurance companies in the process

19. Process of pension payout in the reformed insurance systems in Latin America Payout (passive stage) Accumulation (active stage) Event No Retirement Yes Funds accumulated in IA Death / Disability PIC Funds in IA Contributions Investment Fund PIC Annuity company Premiums in life insurance company Additional funds Life or term annuity Scheduled withdrawal Admin. cost Mixed formula

20. Scheduled Withdrawal - Pro and Contra • Funds are regularly withdrawn from IA as pension payment • Accumulated funds are reinvested • Suitable for persons with significant amount of accumulated funds in IA • At death the remaining amount of accumulated funds is inherited • Opportunities to purchase annuity at a later stage • Risk of outliving the assets • Risk of withdrawing the funds too fast • Risk of non-achievement of the expected profitability

21. Annuitisation - Pro and Contra • Reduces the risk of outliving • Effective use of funds to ensure a life income • In case of an early death, pensioners lose “all their money” but there are annuities with a guaranteed period, inheritable annuities • Annuities have a high cost • People with health problems would make a bad deal • Pension payment depends on the revenue on investment on the retirement day

22. Mandatory Annuitisation - Practices • Accumulated funds are used to pay out annuity • A limited lump sum or scheduled payment at retirement whereas the remaining sum is used for annuity payments • The remaining sum used for annuity payments must be sufficient to ensure a minimum amount of pension

23. Possible Solutions for Payment Types

24. Possible Solutions for Payment Types • Opportunities for a scheduled withdrawal in UPF with a mandatory annuity from an annuity company after attainment of a certain age and accumulation of a certain amount of funds in IA • Mandatory annuity from an annuity company (over a certain amount of accumulated funds) • Free choice of payout of accumulated sum from VPF • Life expectancy tables ? Unified tables by gender • Unified technical interest rate for UPF pensions

25. Discussion Topics – Institutions in the System (1) • UPF, PPF and VPF - at lump sum payout or scheduled withdrawal • Annuity company paying pensions of the 2nd pillar with the only line of business - state-owned, private or mixed type - subject to licensing, regulation and supervision - state guarantee for pension payments • Annuity companies paying pensions of the 3rd pillar - private companies - subject to licensing, regulation and supervision • Life insurance companies covering disability and death risks in the 3rd pillar • Problems related to solvency of life insurance companies for the period of 40 years

26. Discussion Topics – Institutions in the System (2) • Separate sub-funds at UPF, PPF and VPF - for the accumulation and payout phases • Sub-fund for the accumulation phase – principle of capitalization in IA • Sub-fund for the payout phase – solidarity principle • Problems related to the assumption of risks in the payout phase

27. Conclusions (1) Joint and comprehensive preparation for the reform of the payout phase: • Analysis of the “accumulation-payout” cycle and their final goal, i.e. adequate pensions • Analysis of institutions in the payout process – PF, PIC, insurance and annuity companies • Improvement of the coverage of employees, of the amount and density of contributions

28. Conclusions (2) The reform should yield: - accumulation of sufficient funds for payout of adequate pensions compatible with the country’s income level - a developed capital market with various opportunities for investment - sufficiently stable and solvent life insurance companies

29. Conclusions (3) The reform should make a review of: • Limits on the investment of reserves • Investment structure of funds for programmed withdrawal (a multifund system) • System guaranteeing a minimum income • Balance between state and private pension insurance • Adequate regulatory framework for the optimization of profitability and risk • Guarantees for the solvency of PICs as well as of insurance and annuity companies

30. Valentina DinkovaDirector at Insurance Supervision DivisionFinancial Supervision Commissiontel. +359 2 9404 591dinkova_v@fsc.bg