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Feature Story from March/April 2000

Getting Personal: A New Kind of Actuary for the Coming Millennium
By John M. Bragg

Reforming Retirement in an Emerging Free-Market Economy
By Ron Gebhardtsbauer

Life insurance agents do it. Financial planners do it. Even financial engineers do it. Now actuaries are positioning themselves as personal financial advisers. How will they compete?

A badly-needed new role is emerging for the actuarial profession--the role of personal actuary.

A personal actuary provides service to or about individuals. A personal actuary is really not so different from a personal physician, and the connotations are similar. Both the personal actuary and the personal physician are professionals who must operate strictly in the interests of individuals, with no conflicts of interest.

Before I proceed, let me say something about my career. I have just celebrated my 50th anniversary in the actuarial profession. During those 50 years I've seen the profession grow twenty-fold. At the start, we were a small band, almost overwhelmed by the effort to serve our publics: insurance companies and defined benefit pension plans. Throughout those 50 years, we've maintained that our obligation was to serve the public at large. We said it verbally and even in our constitutions. But in reality, we've served the larger public only indirectly.

Now we're no longer overwhelmed. We have the forces. And the public's need for direct actuarial services has grown enormously. That's why the personal actuary is an idea whose time has come.

Why personal actuaries rather than other kinds of financial advisors? Only actuaries are experts as the life and health contingencies that can happen to anyone. Their analytical minds and ability to take the long-range view make them particularly suited to sorting out complicated financial programs for the people who benefit from them.

Sound-Bite Definitions

It's hard enough to define exactly what an actuary does, but it's vital for personal actuaries. The first question a personal actuary inevitably hears from a prospective client is, "What is an actuary, anyway?"

The answer has to be immediate, short and understandable. The perfect sound bite! The complicated definitions we tend to come up with when we're defining ourselves to ourselves just won't work. Throughout my career, I've had to answer that question thousands of times. It was the first question my future wife asked me in 1946. I must have come up with a short, satisfying answer, because the marriage lasted 49 years!

Here's the answer I favor: An actuary is a professional who designs and operates security plans of all kinds. Those security plans include all forms of health insurance, retirement plans, life insurance and property/casualty insurance. Because we design those plans, we can help people understand them, and clear up whatever problems they might be having.

"So that's what you do," the prospective client says. "I always thought you were some kind of obscure back-room mathematicians!"

I've actually had conversations just like this when I've tried to explain personal actuarial services to senior citizens. I've found they're usually surprised to discover what we actually do, and they're immediately grateful that someone has come along who understands those complicated security plans and is willing to help them--someone who's strictly on their side.

But that's not the end of the questions. "So what's a personal actuary, then?"

Here's where the sound-bite definition comes in handiest.

"A personal actuary," I say, "gives actuarial advice to or about individuals rather than corporations or big pension plans."

"OK," says the prospect, "but can a personal actuary still be a professional?"

The answer is: Absolutely. The attributes of professionalism include consummate skill in the area involved, humility and honorable conduct. And here's something not always understood: A true professional gives service to the public when it's needed, regardless of whether he or she is compensated.

Now is also the time for the personal actuary to explain that one does not become a professional actuary overnight. It takes, on average, eight years to become an actuary. An actuary must acquire deep knowledge of mathematics, health care, finance, investments, law and contingent events. Fundamentally, an actuary must learn to evaluate long-term human security needs, and then see that the investments required to cover those needs are secured and correctly managed. Our technical term for that double-barreled duty is "funding." It's a daunting responsibility. It's all part of our role in designing and operating security plans of all kinds.

The Need for Personal Actuaries

Personal actuaries, you'll recall, give advice to or about individuals. Advising individuals is relatively straightforward. When an actuary is giving advice about individuals, he or is advising the individual's advisers. Today's business schools have come up with the term B2C (Business to Customer) to describe the first concept; and B2B (Business to Business) to describe the second. It's possible that the B2B concept will predominate for a long time in the practice of personal actuaries.

Though there may be a shortage of personal actuaries at the moment, there's no shortage of professional advisers. These include financial analysts, financial engineers, bank trust officers, lawyers (including divorce and trial lawyers), clergy doing pastoral counseling, accountants, psychologists, insurance brokers and agents, other actuaries who aren't personal actuaries, and others. These professionals are the second B in B2B. Personal actuaries should consider such people as friends, not competitors. They can help these other professionals serve their clients better.

Personal History

The role of personal actuary has existed for a long time, but in an obscure way. I've known many actuaries, mostly company officers, who have advised their elderly relatives on actuarial matters. (Presumably there's no conflict of interest within the family!) Also, actuaries have been providing expert testimony for a long time. I myself gave expert testimony about life expectancy as early as 1950. What's new, however, is the existence of a personal actuarial service and its recognition as a new practice area for the actuarial profession.

In 1949, Arthur Hunter, a famous actuary, foreshadowed the emergence of the personal actuary in his final address to the profession. He had been an actuary for 50 years and was a past president of the Actuarial Society of America.

"There will be a need for men and women with analytical minds," he said, "with a deep knowledge of their subjects, with ability to understand the needs of people, and with a sympathetic point of view to individual problems. Is there anyone who can be more useful in the future than the actuary with these qualifications? Is there any profession whose members have had as high a standard of honorable conduct as we have had?"

Many years later, in June, 1992, I presented a paper at the International Congress of Actuaries in Montreal. It was called, "Actuarial Counseling: A New Role," and it outlined the concept of personal actuarial service. Four years later I published an article in The Actuary ("A Fledgling New Service: Actuarial Counseling") that sparked a worldwide response. Part of that response was an actuarial counseling assistance kit that I distributed widely, and a Society of Actuaries task force on actuarial counseling that I chaired.

At its first meeting in January 1997, the task force was well attended from around the United States and Canada. Since that time, the term "actuarial counselor" has been superseded by the more descriptive term "personal actuary" and the task force has been renamed the Task Force on the Personal Actuary.

Personal actuarial service immediately sparked the interest of the Actuary of the Future section and the Nontraditional Marketing Section of the SOA, as well as the formation of a new committee to study the marketing of the actuarial profession.

Recently, the SOA's Committee on Finance Research funded a market research study of the need for personal actuarial service, led by Teresa Winer. The committee conducted two focus groups, one with senior citizens and the other with financial analysts, bank trust officers and lawyers.

Categories of Personal Actuarial Service

Personal actuarial service is a broad field, with plenty of room for both generalists and specialists. Here are some of the categories.

  • Personal evaluation. One of the many ways clients want to know about themselves is a new actuarial concept developed in 1999 called health expectancy. People don't really want to know how long they'll live, but they have an intense interest in speculating on how long they'll remain healthy. Personal actuaries can work with an individual's health history and age, sex and smoking status to provide reasonable estimates of future health. People can use this in their planning process.

  • Personal risk management. This covers the entire gamut of the client's need for security plans of all kinds, such as retirement income, health care, disability income, property and casualty coverage and life insurance. It also covers the client's specific needs for such things as college payments, care of dependents and retirement income. The personal actuary determines all these needs, then use various product rating systems to evaluate and explain the security plans that are commercially available.

Product rating systems

  • Claims and entitlement. Client want to know what benefits they're entitled to and if their benefits were determined correctly. Are changes in their plan depriving them of some potential benefit? Clients going through a divorce settlement often want to make sure they're being treated fairly. (See sidebar.)

    Another entitlement area that has grown recently is viatical settlements and senior settlements. These involve the purchase, by investors, of life insurance policies on sick or terminally ill individuals. Personal actuaries, who can calculate proper life tables for sick insureds, can do invaluable service in seeing that such settlements are fair. (I have recently advocated actuarial certification on such cases, by properly accredited personal actuaries.)

  • Actuarial advice about investments. Human security needs are long-range. For 150 years, actuaries have been helping companies balance their needs against their investments. Individual portfolios need the same kind of balancing. A new and specifically actuarial way to address long-term investment strategy, in real world terms, has emerged. It was discussed in October 1999 by the Conference of Consulting Actuaries. It is applicable to individuals as well as large funds, studying the past and using the results to project the future. The actuarial approach is long-range, so it differs from the typically short-range projections of financial planners and portfolio managers.

  • Expert testimony. Expert testimony can involve divorce settlements, or any legal proceeding in which life or health expectancy is involved. Frequently, the individuals involved are disabled, and yet incorrect population-average life expectancies are being used. Personal actuaries, who have studied expectancies across the entire range from extremely healthy to severely disabled, can give valuable advice either at trial or to the lawyers and other professionals involved.

  • Additional roles. These include advice on tax planning, wills, and gifts; career choices; and advice to seniors about the fairness of lump-sum entrance fees of continuing care retirement communities.

Personal Actuaries in Action

Case A: Jim, a wealthy individual, was trying to decide between two very large life insurance products offered by two different companies. One was universal life plan, the other was a whole life plan with term riders. A personal actuary ran a product rater on both products. The product rater is a rating system, similar to the one used to rate movies, capable of cross-comparing all life insurance products, whether new or in-force. One product rated 89 and the other 106. Both ratings were within the range of acceptability. What's the difference? Jim wanted to know.

The personal actuary pointed out that the lower-rated product didn't perform as well in the early years. Though Jim decided to buy the lower-rated product anyway (he liked the agent better), he was highly complimentary of the personal actuary because he had "explained the situation." The personal actuary was somewhat astonished, but on reflection knew that he had earned his $300 fee. Though he had no control over the client's final decision, he knew he had provided the best analysis possible.

Case B: A young woman, whom we'll call Gloria, arrived at my office door unexpectedly. She was accompanied by her two very young children. (She said that I was the first actuary in the Yellow Pages.) She felt she was being mistreated financially in a divorce settlement and asked if I could help her determine whether she was getting enough interest on a pension fund calculation.

As an enrolled actuary, I felt qualified to take the case. She was indeed right. She was being shortchanged by $6,000. I wrote a letter to the lawyers involved, and the mistake was corrected. Gloria was very pleased. I offered to do the work pro-bono, but she wanted to be charged. A couple of days later, when the office was closed, Gloria put my fee ($150 in cash) through the mail lid on the door.

Case C: Roger was a 10 year-old boy who had been seriously injured in a go-cart accident. There were life-long injuries to his stomach and other internal organs. The parents were suing the go-cart operators, who had a liability policy with a $1,000,000 limit. They needed an estimate of Roger's future medical costs, so they approached a personal actuary.

Using known actuarial and medical information, the actuary determined Roger's life expectancy and medical care costs far into the future, with and without the accident. The then wrote a long and detailed report describing the results, the methodology and the sources of data that was used in court to ensure the fairness of the claim being made. The actuary's fee of $5,000 was negotiated with the plaintiff's attorney.

Building a Practice

It isn't easy to build a personal actuarial practice. Personal actuaries have to stick to certain niche specialties and rely on referrals and repeat customers. They cultivate sources of work, such as bank trust officers, insurance brokers, financial planners, lawyers, accountants, senior citizen organizations and other actuaries who are not personal actuaries. Organized institutional publicity and advertising would be invaluable in popularizing personal actuarial service. (That's how other professionals have built their practices.)

Compensation for personal actuaries is evolving rapidly. As the need for the service becomes more evident, new answers to this question will emerge. Payment through the internet may be one such answer. Large corporations, not necessarily connected to the insurance or pension worlds (but interested in human well-being), might be glad to finance personal actuarial services (such as product rating or health expectancy) for their potential or actual customers. Or organizations of senior citizens could finance personal actuarial services for their members.

Then there are the direct payment models. These include fees for service paid by the client or fees negotiated with other professionals involved with a case. As I mentioned above, the business schools divide these into B2C and B2B models. B2B may become especially important to personal actuaries. The "B2B" model will also include cases where both B's are personal actuaries. The first B will simply be providing the second B with tools (even including peer review and second opinions).

Of course, this new practice area for the actuarial profession needs to be recognized by the profession-at-large and then by the public. In order for that to happen, we actuaries need to work on our people skills. The old back room attitudes will no longer suffice.

In addition, there are other urgent needs, all of which fall within the existing framework of the actuarial profession at large:

  • Standards of practice
  • Qualification rules; who can practice as a personal actuary?
  • Listings of those who are qualified
  • Development of a referral service for the public and also for professionals
  • Training, including seminars, literature and examinations
  • Continuing education, including credits
  • Licensing
  • A professional designation such as "A.P.A." (Accredited Personal Actuary)

To meet these goals, major grants should be secured to build the necessary professional infrastructures. Such grants could come from various sources within the actuarial profession. They might also come from outside sources that have an interest in building personal actuarial service, such as large private foundations and government research grants.

Personal actuarial service is a vast new field. Its development can greatly enlarge the scope of the actuarial profession. It can help to allay public criticism in its many forms. But most important, the public needs it.

John M. Bragg is chairman of John M. Bragg & Associates Inc. in Atlanta.

A Day in the Life of a Personal Actuary

I've been self-employed as what is now referred to as a "personal actuary" for just over a year. I generally represent individuals. My services have ranged from the review of pensions on behalf of participants of defined benefit pension plans, to financial evaluations of individual life insurance policies, to expert testimony work. The expert testimony work is usually in connection with the division of pensions in a divorce and other issues relating to the loss of income.

I've obtained clients by networking with personal acquaintances, other actuaries, and business professionals such as accountants, financial planners and attorneys. I have also given presentations to professional organizations, businesses and at colleges and universities.

In individual pension cases, I review the pension to ensure that the participant is receiving all that he or she is entitled to. If requested, I explain the various benefit payment options to help the participant make the most informed decision.

The subject creating the most noise in the pension community these days is the onslaught of cash balance plans. Many large employers have converted their traditional defined benefit pension plans into cash balance plans, outraging employees who feel they're being hurt by the plan conversion. The conversions often hurt older, long-service employees approaching retirement. This is caused either because these employees don't accrue benefits as quickly as they would under the traditional pension plan or because they don't accrue additional benefits for several years. (Or in some cases both.)

News articles and lawsuits are proliferating. Employees feel deceived and ill informed and it's likely that greater disclosure requirements to employees will also be mandated. So far, Congress hasn't yet figured out how to address these problems. It appears certain that IRS regulations are forthcoming, but we don't know when.

One thing is clear: Many participants of these plans don't understand how these changes impact their pension. Many would love to have counseling if they knew where to get it.

I have just recently begun my first pension reviews for two plan participants of two different cash balance plans that were formerly traditional defined benefit pension plans. These converted plans, from my observation, are more complex than they appear at first blush. There are so many different issues to wrestle with, such as:

  • IRC 401(a)(4) plan design issues: to ensure the plan is deemed nondiscriminatory
  • IRC 411(d)(6) protected benefits: to ensure accrued benefits are not reduced, early retirement benefits and subsidies are not cut back, and optional benefit forms are not taken away
  • ERISA 204(h) notices, due to reduction of future benefit accruals
  • Opening balances at effective date of plan conversion
  • Grandfathered accrued benefits
  • Determination of accrued benefit
  • Interest crediting to account balance
  • IRC 411(b) backloading of accrued benefits: to ensure benefit accruals in later years of employment are not in excess of what is allowed
  • IRC 417(e) minimum lump sum distributions are provided
  • Actuarial equivalence related to alternative plan distribution options

It all appears to be a web of endless detail. The plans I'm currently reviewing may not correctly apply what's presented in IRS regulations and IRS Notice 96-8. My analysis is far from complete and I'm uncertain what the outcome of my review will be, but one thing is certain; Congress will have a lot more to say about cash balance plans before the controversy settles down.

--Gary J. Mevorah

Gary J. Mevorah is a personal actuary in Norcross, Ga.

Let's Get Personal

In 1999, I was privileged to be able to conduct marketing research for the Committee on Finance Research of the Society of Actuaries. We held two focus groups, one with a group of retirees and the other with several targeted professions.

There is clearly a great need for independent, fee-based actuarial counselors. The lack of knowledge by some of the individuals in our study was surprising given the number of financial advisors, brokers, accountants and lawyers that exist. One of the primary needs the study revealed was knowing when and how much money to withdraw from retirement accounts. Incorporating the probabilities of death, disability and sickness could help people evaluate different scenarios in their future.

We asked individuals in our study where would they look to find an actuary. A large number said they would ask the Society of Actuaries for a recommendation, as well as look in the Yellow Pages. But many actuaries don't advertise in the Yellow Pages since it may appear negative for actuaries seeking expert witness or legal work. This would indicate a large opportunity for the SOA to promote actuaries to the public and offer assistance in identifying those actuaries wishing to counsel individuals. Registration and/or classification of actuaries as actuarial counselors would help connect them with those in need.

Most people don't necessarily know how an actuary could help them. Until the public becomes more aware of actuaries in general, those looking for work with individuals in the counseling field may be more successful linking up with financial planners, lawyers, accountants, brokers, and the like. The SOA could organize this new specialty and make a link on its Web site so professionals and individuals can locate an actuary in their geographical or specialty area.

One major trial firm represented in our professional focus group was one that recently took state tobacco litigation to trial. The experienced trial attorney had recently searched for an actuary to help in another case, but was unable to a find one or a consulting firm willing to go against the insurance companies involved. Actuaries willing to cross that road would presumably find a lot of work.

Another attorney, specializing in family practice (divorce, etc.), felt that actuaries would be very useful as advisors and/or expert witnesses involving benefit calculations, life expectancy, health expectancy and financial asset calculations. Actuarial advice would be particularly helpful in the retirement/benefits assessment area, alimony projections and the like. This market should be the domain of actuaries, but again, the lawyers tend to look to other experts such as economists, statisticians or mathematicians.

In order to operate as an expert witness, one needs impeccable credentials, "lots of letters behind their name," and even endowed chairs at universities for handling the top cases. Presumably there would be many cases where actuaries should be involved. Unfortunately, the only way to "advertise" to this group is to speak at national association meetings or by word of mouth. The SOA could help greatly by providing some sort of referral service.

Full-time employment would be a great possibility for an actuary teamed up with a financial planning firm. Financial Planners seem almost desperate for someone to help them decipher insurance illustrations. They also would like software that appropriately reflects many contingencies in investing their clients' money.

Whether operating on a fixed-cost or hourly basis, actuaries are most understood by these professions. A financial planner is making recommendations and giving advice on a wide range of financial decisions for their clients. An actuary with superb communication skills would be able to approach this market. Some financial planners would like an actuary to talk to their clients while others would prefer the actuary be only in a "back office" role.

Actuarial expertise is most needed in the financial planning field today. One of our participants, an investment advisor with a math degree, has already incorporated mortality assumptions into a spreadsheet modeling program operated on his laptop computer. The advisor is using Group Annuity Mortality tables in 30-year projections of investment scenarios. Monte Carlo techniques are used to randomly generate some of the assumptions. Mortality tables are adjusted with arbitrary factors. This particular advisor is planning to market his program to the industry. In his words, "I don't know that I have the best mortality or the right mortality, but you know what? I guarantee my users don't know."

The credentials of those working in the financial planning field vary greatly. Actuaries could add much more legitimacy and discipline to this field by lending their expertise. Actuaries should capitalize on their broad education and superb credentials. As in all careers, much will be learned outside of the actuarial examinations, but this could occur easily on the job.

Financial planning firms are not the only place to provide actuarial support work. Banks provide financial advisory services in their estate administration and other divisions. With restrictions being lifted for bank holding companies to own insurance companies, actuaries may be able to create new avenues into the banking side.

It's clear from both of the focus group discussions that actuaries are not visible enough. For the professional group, a concerted effort needs to be made for actuaries to develop continuing education materials and associated presentation materials for certain professions that could bring actuaries into the picture. Additionally, actuaries could offer much in the way of software to help financial planners better understand their clients' risks and help communicate these risks to individuals.

Actuaries need to find short, catchy "sound bytes" to describe what they do. Terminology such as "modeling contingent events" may be good for some markets, but not all. An actuary needs to be able to shake someone's hand and describe what he or she does in simple terms. More marketing research would be helpful in developing terminology for the individual market.

There are so many bright and talented people in the actuarial profession, a group with high ethics and integrity and a love of learning. Being able to pass exams gives us confidence in our knowledge and our ability to meet the challenges of the 21st century. We need to be creative and apply all of our knowledge to help businesses, not just those in the insurance industry, in new ways.

For more complete information on this valuable study, including the full report, focus group transcripts and survey results, contact the Society of Actuaries at (847) 706-3500.

--Teresa Winer

Teresa Winer is an actuary with Chastain Financial Services in Atlanta.



Reforming Retirement in an Emerging Free-Market Economy

The Academy's Senior Pension Fellow went to Bulgaria to conduct a seminar on pension reform. Here is his story.

"Prosperity is not a direct, automatic corollary of democracy." From a speech given two years ago by Bulgarian President Petar Stoyanov (after a year of 1000 percent inflation).

Most Bulgarians understand the above quote now, but it wasn't always the case. Initially, hopes were high after the Bulgarians threw off decades of communist rule. They thought democracy would automatically bring them a successful free-market economy. So when the economy didn't improve right away, they voted the communists back in. That didn't help either, so now they're back with the free-market democrats who are trying to embark on many difficult reforms.

One of the steps the Bulgarian National Assembly is taking is to reform the country's Social Security system, primarily in order to get more help from the International Monetary Fund (IMF) and the World Bank. A major World Bank paper, entitled "Averting the Old Age Crisis," critiques social security systems such as Bulgaria's, systems that have only one pillar--the central government.

The Bulgarian social security system probably made sense under communist rule when most employers were owned by the state, but it doesn't make sense now. The World Bank strongly encouraged a diversified three pillar system that also includes a mandatory employer pension system (Pillar II) and a voluntary personal or private one(Pillar III).

Our Job, Should We Accept It

That's where Mike Sze and I come in. Mike is a retired Canadian pension consultant from Hewitt Associates and a former Society of Actuaries board member. Over the past year, Mike and I each taught a delegation of Bulgarian actuaries and policymakers about our retirement systems. We must have done a good job, because the head of their National Social Security Institute (NSSI) invited us to come to Sophia, the Bulgarian capital, and teach a two-week course on how to set up a new Pillar II.

I had never been to Bulgaria before but I was lucky. My next-door neighbors are from Bulgaria. He works in the Bulgarian embassy in Washington, D.C. and she teaches the Bulgarian language at Georgetown University. And they have two wonderful kids.

When I asked them if Bulgaria had insurance companies, they said yes. How about a stock or bond market or mutual funds? As I expected, investment markets were in their infancy and very small. Evidently, I could probably double the daily transactions on their markets all by myself.

That caused me to follow up my first question: Exactly what kind of insurance did they have in Bulgaria?

"Oh, you know," they said, "the kind you buy at the airport before you get on the plane."

That's what I figured. How could they have long-term contracts such as annuities, if they didn't have investment markets?

I realized our job was going to be more difficult than I'd first thought.

Trust

What comes first? I wondered. Investable assets or companies that needed assets? Perhaps it's iterative and builds on itself. Companies can't start unless they can find ready access to money, and people won't develop an investment ethic unless there's a ready-made place where they can put their money and trust that they'll get something worthwhile back someday. One place to get money is pension funds, which is one reason for creating a second pillar. Another source of capital is international funds, but until now there have been restrictions on foreign ownership. That may be changing soon though.

So I added new material on investments and annuities to my handouts. I printed information on various U.S. mutual funds from my Morningstar CD, so I could talk about stocks and how higher return goes with higher risk, and how bonds go up and down with interest rates.

My neighbors were somewhat knowledgeable about investments due to living in the United States, but stocks and mutual funds were way off the radar screens of most Bulgarians. They saved in jars because they didn't trust banks. I never realized how important trust is to us in this country because it's so basic to everything we do, particularly contract law. Did communism erode whatever trust had been built up over the centuries? I don't know. But it's going to be a big task for Bulgaria to get it back.

I also discussed immunization of annuities. I figured that immunization (holding the appropriate assets so the insurance company is immunized against surges in interest rates) would be a new word for them, and in fact I was right. My translator had to come up with a word for it in the class. What surprised me was that my neighbors (and even some in the class) weren't familiar with the word annuity either.

Learning Curve

I asked my neighbors about how Bulgarian social security worked, but since it's such a huge and complex system they didn't know many details. So I had to undertake an intense study myself, and it didn't take me long to realize that "complex" was an understatement!

As outlined by the International Labor Organization under Convention 102, the system not only pays retirement, survivor, long-term disability and medical benefits, it (not the employer) also pays sick leave from the first sick day as well as workers compensation. It pays maternity benefits--medical expenses and 100 percent of your wages--from three months before expected delivery until up to six months after delivery, and minimum wage until the child is 2 years old.

In addition, Bulgarians get family benefits of one year's minimum wage for having the first child, two year's minimum wage for the second child, three year's for the third child, and one year's minimum wage for each child thereafter. It also pays unemployment/layoff benefits and sometimes covers decreases in your wages if you switch to a "more appropriate job" based on your skills and health.

Retirement benefits are payable at age 60 for men and age 55 for women. Benefits equal 55 percent of one's average wages (with a minimum). The benefits are pretty small for most people, however, due to Bulgaria's recent hyperinflation.

I think one reason why Bulgarians don't know much about their social security system is because they don't pay much into it--only 2 percent of their wages. Their employers, however, pay 37 percent of wages! Employer contributions are higher for employees in dangerous jobs (52 percent of wages) and physically demanding jobs (47% of wages)! Workers compensation costs the employer another 10 percent of wages and unemployment compensation costs 5 percent, for a total of 52 percent for the typical worker and up to 67 percent for hazardous jobs. The higher contribution pays for retirement ages that are 5 to 8 years younger than the usual retirement ages. The high contribution rates result in a high unemployment rate and a large informal (black market) economy that avoids paying these high taxes.

Due to the deficits in the social security program, the high contribution rates and the large informal economy, the reforms Bulgaria plans to make include gradually increasing the retirement age (using a service + age point system), increasing women's retirement age to that of the men, eliminating the special rules for the dangerous/demanding occupational classes, reducing contributions to the Pillar I system and instituting a mandatory contribution to an individual account system, similar to the Pillar II systems in other European countries.

Most of this contribution will come from employees. The Bulgarian National Assembly thought this would encourage employees become more involved in their retirement decisions. Most funds will be invested in government bonds to ease the transition, but 30 percent must be invested in stocks and corporate bonds. Employees in dangerous and/or physically demanding jobs will pay more to a supplemental pension system in Pillar II.

Bulgarian Hospitality

Sophia's time zone is 8 hours earlier than ours, so we arrived at the airport on Saturday, September 25th dead tired. It was hot, but Natalia Andreeva (one of our two translators), Zoya Slavova (the NSSI policy director), and their husbands picked us up at the airport and immediately whisked us up the mountain overlooking the city, where the cool air refreshed us and enabled us to sleep well that night.

The next day, Toni Gancheva (an NSSI actuary) joined our group. We drove to Koprivshtitsa, frequently speeding past western sports cars and farmers in donkey-drawn carts. Koprivshtitsa is a National Revival town, where people still dress in native costumes. Their homes are preserved as they were 100 years ago when they threw off the Turks after almost 500 years under Ottoman rule. Other popular Bulgarian tourist spots are Rila Monastery (in the mountains near Sophia) where over 1,000 years of Bulgarian history is preserved; Plovdiv, home of ancient Roman ruins; and Varna, a 3,000-year-old summer vacation city on the Black Sea.

Bulgaria is the poorest country in Europe, but that's not to say they don't have expensive shops. I found Cartier jewelers, Godiva chocolates, and many others in Sophia. I just wonder who in Bulgaria has the money for those items. Maybe they were for the tourists, but I don't think there are enough of us yet to keep them in business. The Sheraton, where I was staying, was full of Americans helping Bulgaria in their transition to a free-market economy. Everyone wants to learn English and their kids are all learning it in grade school.

Both our translators and most of the people in our class were women. The top person at the NSSI was a man, but all three of his deputies were women. Though the women in the city dressed up very fashionably for work, most of the men wouldn't even qualify as business casual. Many men, in fact, didn't appear to have jobs. Whether this was from a lack of jobs or a cultural thing was unclear. Perhaps it was due to Middle Eastern and Arabic influences.

Our hosts, however, were wonderful! They were constantly showing off their city and country. One or two would go to lunch and dinner with us after every class. They would start every meal with a drink called rakia, and a toast-- nazdravia! -- their word for "cheers!"

During one meal with Natalia, the rakia helped bring out more information than usual. Her father, I learned, was an independent thinker who had difficulty getting along with the communist regime. Her early upbringing was tougher because of that, and she had a difficult time getting into a good school. And since I probably talked too much too (in rakia veritas) we became good friends. I was very happy that night when I returned down their main street (Vitosha Boulevard) to the Sheraton, because I now had a real friend in Bulgaria and didn't feel so alone anymore.

Teaching Each Other

The classes Mike and I taught went very well and we had lots of lively discussion. I think we learned as much from them as I hope they did from us. It's always interesting to see how things work in other countries where the culture and rules aren't the same as ours. A minor difference that kept throwing me off when I was teaching was the Bulgarian custom of shaking one's head for yes and nodding for no. Often, the smartest pupil would be shaking her head back and forth while I was talking. Even though I knew she was agreeing with me, it could be disconcerting. I would mess up too. When I answered questions from the class, I invariably nodded my head up and down to show I agreed with them. I found it very difficult to reverse my body language.

There were other cultural differences, particularly since Bulgaria was formerly communist. Bulgarians are much more inclined to go with collective decision-making, corporate responsibility over individual responsibility, and relying on someone else to make sure everything is OK. The second pillar of their social security system, for instance, is supposed to go into effect on January 1, 2000, whereupon each workers' contribution will go up. (In fact, the contributions will be withheld before any decisions are made on where the contributions are to go).

I suggested that maybe the Bulgarian people need to know that their contributions are going up; that it's better to get them thinking and debating this now rather than on the day they notice that their pay checks are smaller. Some other countries have been successful in doing this, but the employees demanded that employers increase their pay because the employer's contribution would go down.

When it comes time for a company to select a fund for their retirement contributions, the new Bulgarian law requires that all of the company's employees vote for one mutual fund which their company will use. (Yes, that's right--just one fund). I pointed out that though this may reduce the employer's administrative expenses and fiduciary liability (since the employees choose the fund), there may be good reasons why employees might want a choice of funds. Younger employees, for example, may want stocks while older employees may want more secure assets such as bonds.

I also suggested they phase in the new system by starting out with just their government employees and/or teachers in urban areas. This way they could have a successful model that other groups would want to join. I don't know how they can do a good job for everyone if everything starts on January 1. I noted that our Social Security system in the United States didn't start up with everyone from the beginning.

Furthermore, I said, investment education will be needed immediately and continuously thereafter. Employees will need information on each mutual fund before they vote and each year thereafter. If a fund fails to perform as anticipated, they may want to switch to a new fund.

Instead of each fund sending out information and sales agents, we agreed that one brochure from the NSSI comparing all funds would be better, less expensive and less likely to cause the sales fiasco that happened in the United Kingdom.

They agreed in principle, but insisted that the information didn't need to go to each person. A mass mailing to individuals would be ridiculous in Bulgaria. Instead, they would publish the information in their financial newspaper, the normal way in which people get their financial information in Bulgaria.

We had another lively discussion on investment guarantees. The draft law wasn't real clear on this, but we assumed it provided for a minimum return each year. Mike and I discussed how this was expensive and the risk to the system would be complex to protect against. We suggested they look into the Asian model, where the guarantees are on cumulative returns, not each annual return.

Furthermore, I said, guarantees could distort the markets because it would give advantages to people who invested in risky stocks and junk bonds. Not only would it encourage poor investment techniques, it could mean government was supporting certain risky industries over others. In addition, government might want to investigate a company's financials in order to charge their investors the appropriate risk premium for the guarantees.

Our arguments must have been winners. The class said they didn't want any more back-door socialism. They'd had enough of it in the past and no longer wanted government distorting their fledgling free market. (According to one of our students, members of the National Assembly who had heard about our classes, requested our handouts and decided to drop the investment guarantees from the legislation.)

Of course, we had lots of other issues to discuss, such as an overview of a mandatory individual account system, a timetable for implementing the draft law, employer responsibilities, communication, administration, and record-keeping, the NSSI clearinghouse, the pension funds, investments, investment education and guarantees, insurance companies and mandatory annuities, trustees and trust law, transition issues, the key players and who would do what, taxes and how they'll affect decisions in the voluntary Pillar III, etc.

For the most part, I think our students generally agreed with the wisdom of an open democracy, though they were less sure about how to make that happen, especially since they had such a short deadline from the IMF to implement Pillar II. I tried to console them by noting that, unfortunately, democracy takes longer and even the United States didn't get it right the first time. The Revolutionary War left us with huge debts and the Articles of Confederation, our first attempt at a democratic republic, failed.

They acknowledged that democracy may not produce the desired results as quickly as expected, but expressed the hope that it wouldn't have to take them 200 years to get to where America is today.

It shouldn't. The Bulgarians have a history of strength and perseverance, borne out through a millennium of adversity. Whatever happens, and however long it takes, I'm confident they'll work it out.

Ron Gebhardtsbauer is the senior pension fellow of the American Academy of Actuaries in Washington, D.C.


American Academy of Actuaries