Pension system requires overhaul

As we grow older, we can’t help but worry about our pension. How much pension will I get when I retire? Will it suffice for my everyday needs and more? Is there a way to increase it?

Over 330,000 people are receiving pension in Mongolia today and 80 percent of them are said to receive pension that is less than the current minimum monthly wage of 420,000 MNT. According to lawmakers, 91 percent of pensioners receive less than 500,000 MNT, while 53.8 percent receive less than 350,000 MNT. The minimum full pension is about 320,000 MNT, which is by no means enough to live a decent life with commodity prices and inflation rate constantly on the rise.

Take Bayanzurkh District resident Ch.Tuya for example. She retired last year and the Pension Insurance Fund now gives her 340,000 MNT a month as pension. After paying her utility bills, around 150,000 MNT on average each month, she’s left with 190,000 MNT to buy food and other necessities. But people need money to buy clothing, medicines and other miscellaneous items. Yet the pension she receives is not sufficient for basic living expenses, not to mention ensure a decent living.

This is something that most elderly people in Mongolia experience – scraping by to make ends meet and constantly worrying about whether they’ll have food on the table tomorrow.

It’s much harder for those with chronic illnesses because they have no choice but to depend on their children or relatives to buy necessary medication. Basically, once people in Mongolia retire, they’re stamped with borderline poverty status. This is the disheartening yet true image of the current pension system in Mongolia.

N.Bayarbat, a 56-year-old resident of KhanUul District, says he plans to delay his retirement as much as possible and retire in seven years when he’s 63. Since he was drafted to the military in 1982, N.Bayarbat has been working in the private sector for 38 years and centralized total of 103.2 million MNT to the Pension Insurance Fund under his name. This is considerably high compared to the average. Over the next seven years, he plans to centralize around 40 million MNT more, increasing his contribution to the fund to over 140 million MNT. The hardworking man hopes for the legal environment to change so that he could get 30 percent of this money he accumulated in the fund at once and receive the remaining as monthly pension benefit.

“I wish the authorities would give me a onetime allowance of 40 million MNT when I retire but still allow me to get a pension of 700,000 MNT per month,” he said.

On average, pensioners receive benefits for 17 to 26 years, according to the National Statistics Office. If N.Bayarbat were to receive monthly pension of 700,000 MNT, his contribution would suffice for nearly 12 years. Nevertheless, this amount of pension would allow him to make savings, invest in financial instruments, and enjoy his retirement while indulging in his hobbies or other things that would elevate the quality of his life.

This conversation with the 56-year-old sparked after the Democratic Party (DP) caucus in Parliament initiated a bill that would raise the minimum pension rate to 500,000 MNT per month. President Kh.Battulga first came out with this proposal in September, but it was struck down by lawmakers who believed it was an attempt to gain favor of the public. Now, it seems that the DP caucus plans to put this initiative into practice. If not 500,000 MNT, the minimum pension rate should at least be made equivalent to the minimum wage rate, according to the popular public opinion.

Why is the pension rate so low? Under the law, employees pay 8.5 percent of their wage to the Pension Insurance Fund and employers pay the same amount on their behalf. In other words, employees contribute 17 percent of their pension to the fund. Reportedly, 1.2 million people pay social insurance premium. With their premium, 330,000 seniors are sustained through pension. This year, the state budget offered 500 billion MNT to support and resume pension benefits without complications. Next year, the government has budgeted 2.3 trillion MNT for pension distribution, approximately 600 billion MNT of which is fiscal support.

This system that pays pension to the elderly from contribution of young people was advocated as an example of “solidarity” back during the socialist time. Should the pension rate be increased under the current system, higher social insurance premium will have to be imposed on workers, putting more financial burden on their shoulders. The Ministry of Labor and Social Protection even proposed to increase the premium rate by 2 percentage points to 19 percent earlier this year, but the president has placed a veto on it.

The DP caucus has decided to supplement the Pension Insurance Fund with large mining projects. For instance, the state will give up its dividend from production of Tsagaan Suvarga copper and molybdenum mine to the fund. This is said to be their source for raising the minimum pension rate to 500,000 MNT. However, this initiative poses great risks, starting from the volatile mineral prices and uncertainties concerning its profitability. Moreover, Parliament has already paid off pension-backed loans with future earnings of the Salkhit silver mine.

Undeniably, pension should be raised so that Mongolians can enjoy the “golden age of retirement” in the true sense. To do this, the pension system must be modernized for the 21st century.

To seemingly address this issue, lawmaker N.Uchral proposed a bill on private pension funds, which is currently under Parliament review. A number of experts, even the Parliamentary Standing Committee on Social Policy, criticized the bill, saying that it is “early for such a bill” or that it is highly risky. Some complained that they can’t trust private funds when the current integrated social insurance system is not making the best out of the current fund.

Still, the bill is gaining support as it would enable Mongolia to shift from a defined benefit pension plan, which promises to pay certain amount of retirement income for life based on a person’s earnings and years of service with an employer, to a defined contribution (DC) plan, which guarantees contributions but not retirement income. With this plan, the individual is responsible for investing all contributions to grow their savings.

“If the bill is approved, working young people today will be able to not only receive a state pension when they reach retirement age, but also receive a pension from their savings. This will be done by giving employees the option to accumulate 4 percent of their current 17 percent social insurance premium to a private pension fund for their own sake. In short, the bill would allow people to get an additional pension based on savings from their salary,” N.Uchral said during Parliament review on October 27. “Approximately 76 percent of Mongolia households don’t have savings and 55.5 percent have debts. They don’t have startup money to improve the quality of their life. Therefore, the bill includes an article that allow working individuals who are accumulating money for their retirement to put up their private pension fund savings as collateral for a mortgage. Their pension savings can also be spent on healthcare and inherited to their children.”

The bill on private pension funds restricts the total number of active private pension funds in Mongolia to no more than five. N.Uchral says this would “lessen competition” among private funds, making them more “reliable and sustainable.” He added that without a limit, anyone would be able to establish a private pension fund, create competition, drag each other down and constrict the development of the DC plan.

According to the bill, private funds will be operated as a joint stock company and run under investment fund principles, with up to 30 percent of total shares offered to strategic investors. It also stipulates that seven to eight companies will be allowed to own no more than 10 percent of a private pension fund and that the board of directors must comprise of 9 to 12 members. The bill initiator explained that allowing companies to buy shares of private funds is designed to have employees of companies enrolled into the pension scheme.

As opposed to resuming the current pension system that drags people to near poverty upon retirement, a switch to DC scheme is appealing, as it would give people the chance to invest and grow their money and have an additional source of finance when they retire. However, to ensure this plan doesn’t fail, lawmakers will need to lay a solid foundation for it by reviewing best practices of countries with DC plans and creating a comprehensive legal environment for it.

The DC plan is common in highly developed countries such as the USA, the UK, Germany and New Zealand. In Asia, this scheme is adopted in Japan, Singapore, South Korea and Australia. Singapore's national pension fund, the Central Provident Fund, ranks among the world’s largest DC schemes with over 3 million members. Singapore has Asia's top retirement system and ranks seventh in the world, according to the Mercer CFA Institute Global Pension Index report. It would be a good practice to localize as it is found to have good governance and wide coverage of all employed Singaporean residents.

The Organisation for Economic Co-operation and Development (OECD) assesses that retirement savings pension plans such as DC plans are increasingly an integral part of most countries’ overall pension system, while for some countries, they are the main component of their pension system. It made a roadmap that identifies elements of good design and public policy to assist countries to strengthen retirement income adequacy in an environment where pension benefits result from assets accumulated during working life.

Recommendation in the roadmap include:

• Ensure the design of DC pension plans is internally coherent between the accumulation and payout phases and with the overall pension system.

• Encourage people to enroll, contribute and contribute for long periods.

• Improve the design of incentives to save for retirement, particularly where participation and contributions to DC pension plans are voluntary.

• Promote low-cost retirement savings instruments.

• Establish appropriate default investment strategies, while also providing choice between investment options with different risk profile and investment horizon.

• Consider establishing default life-cycle investment strategies as a default option to protect people close to retirement against extreme negative outcomes.

• For the payout phase, encourage annuitization as a protection against longevity risk.

• Promote the supply of annuities and cost-efficient competition in the annuity market.

• Develop appropriate information and risk-hedging instruments to facilitate dealing with longevity risk.

• Ensure effective communication and address financial illiteracy and lack of awareness.

Looking at the current pension system in Mongolia, it is definitely time to modernize it for the fast-evolving 21st century. Due to population aging, more and more people are living on pension and the Pension Insurance Fund is struggling to stay afloat. As a solution, the government should adopt pension fund governance practices found to be associated with improved investment performance, better align pension fund service provider incentives with the clients’ long-term interests, and expand risk identification and management practices. Reform of the pension system has been a topic of discussion for nearly a decade. Now is the time to take action or we risk poverty in old age.