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

Valentina DinkovaFinancial Supervision CommissionSofia, October 13, 2006

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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

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Ist PillarMandatory social

insurancePAYGNSSINRA

2nd PillarSupplementary mandatory pension insurance (SMPI)

DC pension scheme managed by Pension

Insurance Company (PIC)

3rd PillarSupplementary voluntary pension insurance (SVPI)

DC pension scheme managed by PIC

A THREE-PILLAR MODEL

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)

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Projections of the Number of Insured Persons and of the Net Assets of UPFs, PPFs, and VPFs

Indicators Type of Fund for Supplementary Pension Insurance

Total UPF PPF VPF

Projections for 2010

Number of insured personsNumber of insured persons 3 605 000 2 750 000 205 000 650 000

Net assets Net assets (thousands of (thousands of BGNBGN)) 4 200 000 2 500 000 600 000 1 100 000

Projections for 2020

Number of insured personsNumber of insured persons 4 265 000 3 250 000 215 000 800 000

Net assets Net assets (thousands of (thousands of BGNBGN)) 16 300 000 11 500 000 1 300 000 3 500 000

1 EUR = 1,95583 EUR, exchange rate pegged to EUR under currency board

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OBJECTIVES OF THE REFORMOBJECTIVES 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.

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Projections of the Pension Size from Projections of the Pension Size from UPF and the Replacement Rate UPF and the Replacement Rate

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 %.

Women Men Women Men2005 319,5 374,722015 696,1782 4249,71 18,78 2,702018 876,409 6532,66 35,28 4,032020 1022,019 8494,53 42,14 4,122023 1275,076 12265,36 60,84 76,45 4,77 6,002030 2082,56 26489,01 117,04 143,06 5,62 6,872035 2791,042 43402,66 215,29 270,52 7,71 9,692045 4696,815 105668,72 369,12 486,7 7,86 10,362050 5676,446 158266,28 638,16 856,74 11,24 15,09

Pension Size Replacement RateYear

Average Wage

Amount at yearend

Source: Insurance Supervision Division

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SUPPLEMENTARY MANDATORY SUPPLEMENTARY MANDATORY PENSION INSURANCEPENSION INSURANCE

UPF contribution rate for 2006:

UPF contribution rate for 2007:

4 % of the gross wage: 5 % of the gross wage:

65 percent paid by the employer and 35 paid by the insured person

70 percent paid by the employer and 30 paid by the insured person

Self-insured persons pay the whole amount of the contribution

Self-insured persons pay the whole amount of the contribution

Starting 2009, the contributions ratio will be 50:50

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SUPPLEMENTARY MANDATORY SUPPLEMENTARY MANDATORY PENSION INSURANCEPENSION 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

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SUPPLEMENTARY MANDATORY SUPPLEMENTARY MANDATORY PENSION INSURANCEPENSION 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)

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SUPPLEMENTARY MANDATORY SUPPLEMENTARY MANDATORY PENSION INSURANCEPENSION 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

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SUPPLEMENTARY MANDATORY SUPPLEMENTARY MANDATORY PENSION INSURANCEPENSION 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

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SUPPLEMENTARY VOLUNTARY SUPPLEMENTARY VOLUNTARY PENSION INSURANCEPENSION 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

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SUPPLEMENTARY VOLUNTARY SUPPLEMENTARY VOLUNTARY PENSION INSURANCEPENSION 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 personRight 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

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SUPPLEMENTARY VOLUNTARY SUPPLEMENTARY VOLUNTARY PENSION INSURANCEPENSION 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

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SUPPLEMENTARY VOLUNTARY SUPPLEMENTARY VOLUNTARY PENSION INSURANCEPENSION 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

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Risks Covered by PICRisks 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

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Problems and ContradictionsProblems 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

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Conclusions – Payment TypeConclusions – 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

ContributionsInvestment

Fund

Premiums in life insurance

company

Admin. cost

Funds in IA

Additional funds

Death / Disability

PIC

Yes

NoEvent

Scheduled withdrawal

Life or term annuity

Annuity company

Retirement

Funds accumulated in IA

Accumulation (active stage) Payout (passive stage)

Process of pension payout in the reformed insurance Process of pension payout in the reformed insurance systems in Latin Americasystems in Latin America

Mixed formula

PICPIC

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Scheduled Withdrawal - Pro and Scheduled Withdrawal - Pro and ContraContra

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

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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

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Mandatory Annuitisation - PracticesMandatory 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

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Possible Possible Solutions for Payment Solutions for Payment TypesTypes

Payment Types UPF PPF VPF

Lump sum payout of accumulated amount from IA Yes Yes Yes

Scheduled withdrawal – from accumulated amount in IA Yes Yes Yes

Annuities: 1. Fixed-period annuity 2. One-life annuity - fixed payments - payments with fixed annual increase - inflation-adjusted payments 3. Inherited annuity 4. Annuity with profit participation 5. Life annuity with a guaranteed period

No

No

YesYesNoYesYes

Yes

No

NoNoNoNoNo

Yes

Yes

YesYesYesYesYes

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Possible Solutions for Payment TypesPossible 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

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Discussion Topics – Discussion Topics – InstitutionsInstitutions in in the System (1)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

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Discussion Topics – Discussion Topics – InstitutionsInstitutions in in the System (2)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

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Conclusions (1)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

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Conclusions (2)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

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Conclusions (3)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

Valentina DinkovaDirector at Insurance Supervision Division

Financial Supervision Commission

tel. +359 2 9404 591dinkova_v@fsc.bg