Social security

Mongolia’s pensions challenge calls for careful reform not radical change

In common with many countries around the world, Mongolia needs to make difficult decisions regarding its pension scheme. Nuno Meira Simoes da Cunha, the International Labour Organization’s Senior Technical Specialist on Social Protection explains why reforming the current system would be a better approach rather than making radical changes.

Comment | Ulaanbaatar, Mongolia | 15 September 2022
Social security service in Mongolia. © ILO
Pension reforms are never simple or easy. Wrong decisions made today can have real and lasting impacts both tomorrow and long into the future.

On a recent mission to Mongolia, I had the opportunity to engage in a series of very open conversations on the topic. While the discussions were rich and allowed me to learn a lot, they also raised some concerns, particularly the fact that some ideas were grounded on significant misconceptions.

The first regards individual accounts.

Fully funded individual accounts refer to schemes in which individuals’ benefits are calculated based on what individuals have paid into these accounts, plus any returns on the investment of these funds.

Nuno Meira Simoes da Cunha, Senior Technical Specialist on Social Protection. © ILO
In some discussions, stakeholders said that they wanted to see a “real” implementation of individual accounts in Mongolia while also saying that the government should increase the value of benefits.

What needs to be clear is that in a regime based on fully funded individual accounts, the government does not define the value of benefits. What each person receives depends on what he or she has contributed. The government can only stipulate what the level of benefits will be for schemes based on collective funding.

If the expectation is that the government should define (in this case increase) the level of pensions, fully funded individual accounts are not the best way to do so. And let’s be clear. For most workers in Mongolia, moving towards individual accounts will result in a reduction in the level of pension benefits, not an increase.

With a significant number of low wage earners, it is only the redistributive nature of the current system, including the minimum pension, which provides a decent amount to live on. For low earners, a pension based solely on their contribution would lead to a drastic decrease in what they receive.

In addition, in times of high instability in the financial markets, individual accounts represent a significant transfer of risk to workers. In countries with a labour market characterized by low wages, job instability and vulnerable forms of employment, relying on individual savings accounts, as Singapore does, would most likely result in greater income insecurity for many elderly people in Mongolia.

The shift towards individual accounts is also often a measure portrayed to help governments dealing with the financial sustainability of public pensions. This may not materialize in the case of Mongolia, at least in the short to mid-term. A move towards a new fully-funded scheme would see new contributions locked in respective individual accounts. It will therefore not be possible to use these funds to pay benefits to existing pensioners. The result? An immediate and significant cost for government accounts.

While there is no reason for immediate alarm, the reality is that the current system requires reform and the later these start the more painful they will need to be. As in many other countries, the population in Mongolia is ageing. Unfortunately, unpopular measures may be required, such as an increase of the retirement age. For some groups of workers this might be harder than for others, but sooner or later increases will be needed. There are ways to support specific groups, like for instance workers in the mining sector, and it is possible to design mechanisms that allow earlier or later retirement. What should be at all avoided at all costs, is an option allowing workers to opt between different retirement rules established under different laws. There is a risk of everyone opting for the regulation that allows for earlier retirement. This would undermine system sustainability rather than strengthen it.

Another issue that should be discussed is the expectation that private pension funds can be the solution to problems of pension adequacy. While in Mongolia I heard suggestions that some of the current contributions to the public scheme should be transferred to private pension funds. However, it must be understood that the pension system already utilizes all contributions made by workers to the public scheme to cover the costs of current benefits. In recent years there have been insufficient funds in the public scheme, resulting in the government having to subsidize benefits. Transferring any contribution to private pension funds would result in the government choosing between increasing the level of subsidization, reducing the level of benefits, or drastically increasing the retirement age.

Evidence from other countries, for example Chile, shows that privately managed pensions tend not to provide higher benefits. Those with higher incomes also usually benefit most. Therefore even options like the provision of tax incentives, might in practice become an indirect subsidy to those who need support least.

One final recommendation is to keep pensions as pensions. The government should avoid the temptation to use pension funds for other uses. The provision of loans or housing benefits may be popular or help solve other issues. However, there are very real risks associated with these solutions which can negatively impact the ability of pension systems to meet their primary goal, to ensure income security for the elderly.

In Mongolia, as in many countries around the world, pension reforms are necessary. The longer they are left, the harder they will be. It is however vital that the correct decisions are made to ensure that Mongolian citizens receive he support in old age that they truly deserve.

For further information please contact:

UN House 604
United Nations Street 12
Sukhbaatar district
Ulaanbaatar 14201, Mongolia