Pension

The National Pension Act was amended in 1998 to provide for fiscal assessment of the National Pension Scheme. The level of benefits and pension contributions is to be adjusted to secure the long-term financial balance of the National Pension Scheme, based on which a comprehensive plan on the overall operation of the Scheme can be made every 5 years. The first fiscal assessment was carried out in 2003, the second in 2008 and the third in 2013.

Considering the fact that the pension benefit has been reduced from 70% to 40% (by 2028) through two reforms already, there will most likely be a mid to long-term raise in the pension contributions rate. The 1998 amendment lowered the benefit rate from 70% to 60% in the case of an average income earner that has been insured for 40 years. Further, the contribution rate of the current 9% (amended rate of 2007) is to be maintained while the benefit rate was reduced from 60% to 50% in 2008. Since then, it is to be reduced annually by 0.5% to 40% by 2028.

What is noteworthy is the steep change in the scale of the national pension scheme that is expected in the future. If the current framework is maintained, the reserves are estimated to be exhausted in 2060. Although the income replacement rate was reduced to 40% through two prior reforms, an actuarial balance could not be struck. At present, the National Pension Fund is going through a transition period towards exhaustion. In the midst of an aging population, neglecting fund exhaustion or switching to a pay-as-you-go system would create a generational conflict as the future generation is left with a greater burden of contribution.⁶

6 Yun, H. et al (2015. 5), “Need for fiscal Goal of National Pension and Improvement of Governance Structure for Operating Fund,” KDI Focus, Korea Development Institute, p.2.

Table 10. Financial Flows Projections

(Unit: billion won, %)

Source: Actuarial Projection Committee, (2013.10), “Long-term Actuarial Projection for National Pension.”

In order to minimize worsening actuarial conditions of the pension fund, it is not only necessary to cope with the situation agilely and professionally at each stage of the fund scale, but also consider diversifying investment strategies, including investing overseas. For that to be successful, a systemic structure that forces decision makers to respond to changing market conditions to their utmost capacity is necessary, in addition to professionalism of the decision makers. Transparency in operating the fund is another important factor. As the proportion of domestic equities in the fund grows, influence of particular firms on the fund operation will increase. This should not allow the managers of the fund to pursue private interest or allow the government to use it as a tool of controlling private firms.

It is well known that asset allocation strategies should change at different stages of asset accumulation and that aggressive fund management is beneficial during the period before arriving at fund maturity. Since until then, there is no need to maintain liquidity for benefit disbursement.

That is, unlike the period when the fund should be liquid so that the proportion of bonds (fixed income) has to be increased, neither the principal nor the profits from the reserves need to be used.

Therefore, aggressive management that takes advantage of long-term investment, where rate of return increases in proportion to the duration of the investment, needs to be employed.

In the past, the National Pension Services has been criticized for its passive management of the fund. This is due to the governance structure of the fund which prevents managers from active engagement.⁷ For example, at the end of April 2015, the proportion of bonds (fixed income) in the National Pension Fund recorded 58.5%, which is far greater than any other foreign pension fund, except that of Japan which has already arrived at maturity. Moreover, considering the fact that in 2004, the “National Pension Fund Operation Masterplan” suggested the ideal level of

7 Yun, H. et al (2015. 5), supra note, pp.3-4.

investment overseas to be 38%, and recommended a target of 25% in 2014, the current investment overseas ratio of 16.3% is too low (see Figure 2).

Note: 1. Domestic fixed income includes domestic bonds and shorter term funds. The welfare sector includes welfare town (Chungpoong Resort), child care and senior citizen facility rentals, credit recovery support funds, and emergency loans for old age (silver loan). Others represent acquisition costs of buildings, deposits for rent and money held temporarily for the next day’s operation by the settlement bank.

2. Alternative investments include investment into real estate, social overhead capital, private funds (venture, CRC, private equity), in contrast to traditional financial investments such as listed equities and securities.

Source: National Pension Research Institute (2015.6), National Pension Statistical Yearbook.

When rates of return from overseas investment and alternative investment by NPS are compared with those by major foreign pension funds, investment in overseas equities generated higher rates of return than domestic equities did. However, the rate of return from overall equity investments or total rate of return was lower than foreign pension funds. The rate of return for alternative investments also display low levels. Compared to the Canadian CPPIB’s recent rate of return from investments in overseas equities and domestic equities, which were 27.4% and 16.6%, respectively, NPS demonstrated a mere 9.4% and -5.5%, respectively.⁸

The most essential reform needed is establishing a fiscal objective. A fiscal objective serves as an important index that indicates whether the pension scheme is planned out from a comprehensive perspective. For example, Canada, which is evaluated to have the most advanced

8 Yun, H. et al (2015. 5), supra note, p.4.

0.03%

54.4%

4.1%

19.7%

12.2%

9.4%

0.2%

Figure 2. National Pension Fund Investment Portfolio

Welfare Sector

Domestic Fixed Income Foreign Fixed Income Domestic Equities Overseas Equities Alternative Others

fund management governance structure, had set a fiscal goal of increasing the reserve ratio (asset/loan) to 20% by 2017. Predicting that it would need an operational rate of return of 4% to achieve such a goal, Canada established the CPPIB (Canada Pension Plan Investment Board) in 1997. By doing this, Canada established a clear range of roles to be undertaken by the fund managing entity, and ascertained the importance of setting a rate of return goal. More importantly, this was part of a bigger goal Canada had set out: “a reform to create an operating governance structure that would not leave the burden to future generations.” Another good example of setting a fiscal objective is New Zealand, where the target rate of return is explicitly stated in law, thereby authorizing a definite range of roles to be undertaken by the fund manager. As for Japan, it went through an extensive pension reform in 2004 in view of its aim to achieve fiscal balance for the next 100 years.⁹

The fiscal burden of NP due to aging is a relatively long-term issue, but realistically, it is a difficult problem to resolve since NP also provides welfare for the elderly. It is projected that the burden of aging on the National Pension finance will be realized after 2020. In preparation, the debate on reforming the National Pension Scheme is expected to continue.