Structural Problems of Korean Public Pensions

and Suggestions for Policy Revision

Young Jun Chun

Hanyang University

November 25, 2021

 Background
• Population aging is the problem faced by many countries.
• Korea is experiencing the same problem, moreover, the speed of the
aging is the fastest in the world, and it is likely to become the most
aged country in the second half of the 21st century.
• Public pension is important policy concern in aging societies.
• Public pension provides important source of post-retirement
consumption.
• Korean public pension system consists of two separate systems:
• National Pension (NPS) covers most of Koreans
• Occupational Pensions covers 3 groups of workers.
• government employees (PCS)
• private school employees (PPS)
• military personnel (PMP)
• NPS was introduced in 1988 (PCS 1960, PMP 1961, PPS
1970).
• High elderly poverty rate is known partly due to the late introduction of
NPS, even though reliable empirical evidence has not been presented
yet.
• A wide range of elderly age groups have not covered by NPS, that is
designed to cover most of Korean populations.
• The questions are:
• Will maturing NPS reduce the poverty of the elderly in the future?
• i.e. does NPS has proper structure to protect the elderly from the risks resulting
from aging (uncertainty of life expectancy)?
• Whether the NPS is financially and politically sustainable?
• If it is not, the sustainability is recoverable?
• What are the policy measures available, even though they are not
expected to fix all the problems.
• We attempt to address the structural problems of Korean public
pensions, and to suggest selectable measures to fix (at least
alleviate) the problems.
 Structural Problems
• Level of contributions and benefits
• Lack of Target Efficiency
• Entitlements for Younger Generations and Female workers
• Fiscal Unsustainablity and Generational Inequity
• Pension Fund Management
 Level of contributions and benefits
• Level of Pension Benefits is lower than average OECD level
and that of many other counties.
• Replacement ratio of Korea as of 2016: 39.3%
• 52.9% (OECD), 55.8% (Sweden), 56.6% (Finland), 60.5%(France), 72.3%
(Spain), 83.1% (Italy)
• 38.3% (US), 34.6% (Japan), Chile (33.5%)
• Benefit expenditure as % of GDP is much lower than major OECD
countries.
• Benefit expenditure gap is much larger than that of replacement ratio.
• Because of short-history of National Pension (NPS), which covers most of Korean
labor force
• # of benefit recipients is small and the benefit amount per recipients is not large.
• Benefit amount is set proportional to the length of participation, and the average
length of current benefit recipients is short.
• Contribution revenue as % of GDP is smaller than major OECD
countries.
• As of 2017, 6.9% (Korea), 9.2% (OECD), 10.0% (Sweden), 12.8%
(Finland), 16.7% (France), 11.3% (Spain), 12.8% (Italy), 6.2% (US),
1.4% (Chile), 12.8% (Japan)
• Reason:
• Statutory contribution rate is low: 9%
• Proportion of labor force is still higher than many OECD countries.
• Is it possible to raise the benefit replacement ratio with proper
adjustment of contribution rate?
• Probably not!
• Because of rapid population aging:
• Korea will be the most aged country in the world in the second half of the 21th
century.
• Low level of replacement ratio but high contribution burden may be
inevitable
 Lack of Target Efficiency
• Role of public pensions?
• Protect from the uncertainty of life expectancy.
• Those who live longer than expected but did not accumulate sufficient wealth will
face poverty.
• Government intervene to the market because of market failure
(adverse selection)
• Target groups should be the disadvantaged including lifetime low
income groups and the handicapped.
• Have target groups been correctly selected?
• Neither at present nor in the future.
• At present,
• National Pension (NPS)
• Proportion of the aged 70+ pension benefit recipients is very low.
• Proportion of full-old-age pension recipients, whose participation period is 20 years
and longer, is extremely low.
• Because most of the demographic groups are not covered by the NPS.
• NPS started with funded system not pay-as-you-go.
• The benefit amount per benefit recipient is small
• Average Monthly benefit amount is lower than 1 million won (equivalent to 100,000
Yen)
• Because of short history of NPS (Introduced in 1988), the participation length of
current benefit recipients are short.
• Pension for Government Employees (PCS)
• The benefit amounts are quite high for most old age groups.
• PCS has longer history (introduced in1960) than NPS. The participation period is
long.
• Statutory replacement rate is high and inflation indexing was more generous than
NPS
• Other occupational pensions (PPS and PMP) has similar structure.
• Lack of Target efficiency:
• Benefit level for government employees and private school employees
is much higher than NPS participants.
• The employment stability is much higher for government and private
school employees than the private sector workers.
• In the past, the wage level of the former group is much lower than the
latter group. Generous pension schemes were regarded as
compensation for their low wages.
• But pecuniary and non-pecuniary compensation of the former group
have rapidly approached to those of the latter.
• The relatively disadvantaged groups, whose employment status is
unstable, are less covered by public pension, and their pension amount
is smaller.
NPS benefit structure

Source: National Pension Statistical

Yearbook, 2017
 PCS benefit structure

Source: Statistical Yearbook of Pension for Government Employees, 2017

• Weak role of public pensions for risk protection for the
disadvantaged is partly due to short history of NPS.
• Short history results in small proportion of the elderly with entitlements
to NPS pension benefit and low level of pension amounts.
• Then, will the role be reinforced in the future?
• In the future, the number of the elderly with benefit entitlements will
increase, the length of participation will accumulatively increase, and
the overall pension amount will increase.
• However, there will still be blind spots of pension coverage, especially
for the advantaged groups.
• The proportion of participants among the disadvantage groups
is low.
• The groups include non-regular workers (vs. regular workers),
temporary workers, non-fixed-term workers (vs. fixed-term workers),
part-time workers (full-time workers).
• The employment stability and wage level are low, and their length of
NPS participation will be short.
• The level of wage of NPS participants is close to that of workers in the
Employment and Labor Survey, that survey on the employment and the
labor activities of workers in workplace with 5+ workers.
• The survey covers workers earning relatively high wages.
• These group of workers are less likely to acquire the pension benefit
entitlements, and to receive large amount of pension benefits.
 Entitlements for Younger Generations and
Female workers
• Recently, in the labor market throughout the world, low
employment rate, more frequent spell of unemployment, and
prolonged employment period are observed.
• Korea is not an exception.
• Younger generations’ employment rates in 20’s are lower than older
generations.
• 1995-1999 borns’ employment rate at age 20-24 is lower than 1975-1979 borns
by 6.7%P.
• 1990-1994 borns’ employment rate at age 25-29 is lower than 1970-1974 (1975-
1979) borns by 5.0%P (8.5%P).
• Partly due to longer period of post-secondary education and late entry
into labor market.
• Younger generations’ employment stability is being deteriorated.
• Proportion of non-regular employment is rising.
• Large gender gap in employment and its stability
• Female workers’ employment rate is rising. But, it is still much lower
than male workers.
• 51.6% (female) vs 70.7% (male) in 2019
• Female employment rates fall in 30’s, due to child birth and care.
• Hard for those, who experienced career break, to be re-employed.
• The low employment rates and unstable employment of
younger generations and female workers will reduce the
opportunity to acquire the pension benefit entitlements and will
lower the level of pension amount.
Source: Labor Force Survey, each year
 Fiscal Unsustainablity and Generational Inequity

• Imbalance between contribution revenue and benefit

expenditure
• At present, the basic budget balance of public pensions as whole is
surplus.
• The balance will soon turn deficit and the magnitude of deficit will be
large, if the current public pension policies are maintained.
• Generational Accounts for public pensions shows serious
generational inequity.
• Large amount of tax burden will be shifted to future generations.
• If current public pension policies are applied to current generations and
fiscal imbalance is absorbed by future generations,
• The PV of net contribution burden (=contribution-benefits) is negative for all the
current generations, and positive for future generations and the absolute value is
not small.
• To recover the long-term fiscal balance (PV of benefits = PV of
contribution in infinite horizon), the overall contribution rate
needs to be more-than-doubled, if contribution rate is adjusted
in 2020.
• Delay of the adjustment increases the magnitude of adjustment.
• Will the contribution adjustment be politically supported?
• Probably not entirely impossible, but will be difficult.
• Net contribution will increase for all the cohorts
• Delay in adjustment from 2020 to 2030 reduces net contribution burden
of majority of current cohorts.
 NPS Fund Management
• NPS fiscal projections has presented large change in NPS fund.
• The magnitude as % of GDP Increase to about 50% around 2035
• Decrease afterwards to be exhausted around 2060.
• More recent projections predicts earlier exhaustion of the fund.
• Risks of excessive fund accumulation
• NPS fund is not a small player in financial market in Korea.
• The rate of return of equities and bonds is directly affected by the
decisions of NPS fund.
• NPS fund holds large share of major private corporations excises
voting rights on the private firms’ management. This undermines the
freedom of economic activities.
• Risks of rapid fund decrease and exhaustion
• Prices of equities and bonds that should be liquidated will fall because
the financial market participants will strategically react to the fund
magnitude change.
• Lack of fund management strategy and expertise.
• NPS Fund Management Committee, top governance organization,
consists mainly of political representatives rather than financial experts.
 Suggestions for Revision
• Constraints for reform
• Policy Objectives
• Enhancing system stability
• Parametric Reform
• Fundamental Reform
 Constraints for Reform
• Conflicts between policy objectives
• Financial stabilization → Pension Fund ↑ → Distortion of financial
market ↑
• Political Support
• Increase in contribution rate is hardly supported by younger
generations.
• Reduction of benefits is difficult to be supported by older generations.
• Population aging make the median voter older, which make the policy
revision even harder
• Future generations may approve revisions for financial stabilization, but
they do not have voting rights, moreover they have not been even born.
• Growth effects
• Contribution rate ↑ for financial stabilization lowers GDP level (level
effect) and growth rate (growth effect), undermines the well-being of
future generations.
 Policy Objectives
• Enhance the system stability
• Increase income security of the disadvantaged.
• Reset target groups to lower income groups, the handicapped, younger
generations.
• Minimize the financial market distortion
• Minimize NPS fund magnitude increase
• Minimize contribution rate or tax burden increase
• Minimize growth impediment
 Enhancing the system stability
• Enhancing financial stability
• Division of labor of public and private pensions
• Dominating role of public pensions for the disadvantaged
• Reinforcement of redistributive element of public pension formula
• Increasing role of private pensions for middle-high income groups
• Reducing benefit amounts for middle-high income groups
• Enhancing target efficiency to promote the role of public
pensions
• Targeting the disadvantaged groups (low income groups, the
handicapped)
• Integrating role of other income security programs (basic pension,
minimum Living Standards Security) to guarantee minimum income of
the disadvantaged
• Source of fund?
• Increase dependence on tax-financing.
• Recognition and claiming the entitlement right for pension benefits will
be reduced.
• Then government will have more discretion to pension benefit
adjustment, including adjustment of pension benefits for high-income
groups.

Those taxes were never a problem of economics. They are politics all the
way through. We put those payroll contributions there so as to give the
contributors a legal, moral, and political right to collect their pensions. With
these taxes in there, no damn politician can ever scrap my Social Security
Program.
---- Franklin Roosevelt
 Parametric Reform
• Enhancing Financial Stability
• NPS
• Raise contribution rates within limited range to minimize growth impediment
• Maintain average effective replacement ratio of NPS benefit, because it has been
lowered to 40%.
• Implementation of this scheme may increase the NPS Fund and this may
deteriorate the distortion of financial market.
• Need revision of fund management strategy and method.
• Need to withdraw voting rights regarding the private firm management
• Occupation Pensions
• Lower effective replacement ratio of Occupational Pensions (PCS, PPS, PMM) to
eventually equalize its level to that of NPS.
• Enhancing target efficiency
• Integrating role of other income security programs (basic pension,
minimum Living Standards Security) to guarantee minimum income of
the disadvantaged
• Reinforcement of redistributing elements in Pension formula.
• Raise the effective replacement ratio of the disadvantaged
• Lower the replacement rate of the middle-high income groups.
• Induce middle-high income groups to depend more on private pensions
(occupational pensions, personal pensions)
• Provide tax incentives for this purpose?
• Probably not? The effective tax rates of pension income is low (0.4% as of 2019),
because various tax incentives are already allowed.
• Instead, enhancing private pension system stability by reinforcing eligibility
conditions for tax relief for private pension.
• The eligibility will provide signal for private pension plans being reliable.
 Fundamental Reform
• One-account-per-person Defined Contribution Scheme?
• Allowance of portability
• Expected effects
• Reduce financial instability because of DC scheme
• Reduce intergenerational redistribution causing generational inequity
• Intragenerational inequity?
• Can mitigate this by minimum income guarantee implemented by integrating
public pensions and other income security programs.
• Market risks born by pension participants (account holders) because
the scheme is DC.
• Implicit collusion of financial corporations may reduce the rate of return
for account holders, because of small domestic financial market and
resulting oligopoly market structure.
 Summary
• We address the structural problems of Korean public pension, and
suggest reform plans.
• The current system:
• Suffers from lack of target efficiency, fiscal unsustainability
• has risks of causing malfunction of financial markets
• We suggest selectable measures including:
• Parametric reform measures
• Including reinforcement of pension entitlement for socially disadvantaged groups;
reduction of pension benefits of high-income retirees; and improvement of private
pension market
• to resolve the problems without causing severe intergenerational redistribution
inducing political resistance and deterioration of financial market deterioration.
• Fundamental Reform
• One-account-per-person defined contribution scheme.