Raising the National Pension Investment Return — Easier Said Than Done

[Hankook Ilbo · Opening the Morning · August 3, 2023]

Yun Suk-myung, Research Fellow at the Korea Institute for Health and Social Affairs (KIHASA) and former President of the Korean Pension Association

The financial projection system, introduced through the amendment to the National Pension Act in 1998, aims to examine the long-term health of the National Pension every five years starting from 2003 and to prepare appropriate measures. I have participated in the National Pension Financial Estimation Committee on five occasions, from the first projection in 2003 to the fifth in 2023. Consequently, I feel that the areas of focus within the Financial Estimation Committee have shifted over time.

The first financial projection, implemented for the first time in 2003, seemed to be the most enthusiastic Financial Estimation Committee (then called the National Pension Development Committee), despite many ups and downs. As it was the first time a financial projection was conducted, we diligently studied foreign cases to determine how to execute it properly. Because an official committee was formed to conduct the first ultra-long-term financial projection, the tension within the committee was quite high. There were nerve wars not only between experts and committee members representing interest groups but also among government ministries.

While serving as the secretary member of the System Development Expert Committee under the National Pension Development Committee, I once received nearly 50 phone calls from government ministries in a single day. This was due to the positions of government ministries that felt the secretary member was not maintaining neutrality. It was also because they judged that their positions were not being properly reflected on certain issues. These objections stemmed from differences in perspective between ministries that prioritized fiscal stabilization and those that believed the adequacy of old-age income security should be considered alongside fiscal stabilization.

Following considerable controversy, the first National Pension financial projection in 2003 set the fiscal evaluation period to 70 years and established "a reserve ratio of two times at the end of the fiscal evaluation period as the fiscal stabilization indicator." This means that for the National Pension to be seen as maintaining a state of fiscal stabilization, it must secure enough funds to pay pensions for two years from the end of the 70-year evaluation period—that is, by the end of 2073 (70 years after 2003), it must have funds for two more years, meaning through 2075.

As almost no committee members supported the position I took as secretary member at the time—which favored a fiscal evaluation period of "80 years"—70 years was eventually set as the fiscal evaluation period for our National Pension as a compromise. From the second Financial Estimation Committee in 2008 to the fourth in 2018, I advocated for extending the fiscal evaluation period. Initially, I argued for a 10-year extension to 80 years, and during the fourth financial projection in 2018, I argued that the evaluation period should be extended by another 30 years to 100 years, but the projection period remains at 70 years. Japan, from which we learned about pensions, adopts a 100-year projection period and secures funds to pay pensions for one year even in 2123, maintaining a reserve ratio of one time. This stands in stark contrast to our situation, where reserves are depleted in 2055. Despite the significant increase in life expectancy over the past 20 years, there has been no extension of the fiscal evaluation period. As life expectancy increases, the period for receiving pensions lengthens, making an extension of the fiscal evaluation period inevitable.

Despite these circumstances, during the fourth Financial Estimation Committee in 2018, an absurd fiscal stabilization measure emerged suggesting that the fiscal evaluation period be shortened by 40 years, from 70 years, so that only a 30-year period would be evaluated. The fourth financial projection showed that the National Pension Fund would be depleted in 2057. The reason for shortening the fiscal evaluation period from 70 years to 30 years was to argue that strong fiscal stabilization measures were unnecessary, since 2048 (30 years added to 2018) falls before the depletion of the National Pension Fund. A proposal so poor it is embarrassing to even call a trick was suggested as the very first fiscal stabilization measure at the fourth National Pension Financial Estimation Committee in 2018. Although it is easy to see in hindsight that it was an utterly absurd proposal, such a ridiculous fiscal stabilization measure could be presented without hesitation given the political situation at the time.

The reason for recalling the past four financial projections is that during the process of the fifth National Pension financial projection, incomprehensible events are occurring that evoke a sense of déjà vu regarding the trick fiscal stabilization measure of 2018. Because pension reform was not carried out during the five years of the Moon Jae-in administration, contributions must be raised by an additional 1.8 percentage points to achieve the same level of fiscal stabilization. If the Yoon Suk-yeol administration also fails to take proper fiscal stabilization measures, factors that have deteriorated further than they were five years ago could create a need for an additional increase of more than 2 percentage points. In summary, if proper fiscal stabilization measures are not implemented under the Yoon Suk-yeol administration, it means that in just 10 years, contributions would need to be raised by approximately 4 percentage points to achieve the same level of fiscal stabilization expected from the National Pension 10 years ago. Considering that the National Pension contribution rate of 9% has not been raised by even 1 percentage point over the past 25 years, this can be seen as a significant burden.

Despite these circumstances, sufficient discussion regarding fiscal stabilization measures is not taking place within the Financial Estimation Committee and the National Assembly Special Committee on Pension Reform. Although the time for discussion is greatly constrained because multiple topics are being handled simultaneously, more time is being allocated to incidental topics rather than focusing on the preparation of fiscal stabilization measures themselves. This is because arguments are prevailing that if fund investment returns are increased through better fund management, fiscal stabilization can be achieved while raising the contribution rate less than what is required for fiscal stabilization in the fifth financial projection announced this March, and more time is being spent on discussions supporting these arguments.

No expert would oppose the argument that the National Pension Fund investment return must be increased. The problem is that while our efforts are important, increasing the fund investment return can be more heavily influenced by external factors. This is because, unlike policy tools such as extending the eligibility age or raising contributions—which are difficult to implement but bring certain fiscal stabilization effects once successfully introduced—increasing the fund investment return is an exogenous variable outside of our control. Even if the fund asset portfolio is well-constructed to increase the expected return, there is a high possibility that results different from the original projections will appear depending on changes in external conditions.

The National Pension, which must be responsible for the old-age security of all citizens, must not be excessively exposed to the risk of such "projection errors." Even if there is a probability of over 90% that the target can be achieved, it is because there would be no way to remedy the situation if a projection error increases due to an unexpected change in the surrounding environment. I say this because it seems highly likely that the National Pension, which has already missed the golden time for reform, will cling to the "false hope" that fiscal stabilization can be achieved through increasing fund returns, instead of making efforts to adopt the few remaining painful policy tools to ensure sustainability.

The National Pension, which targets all citizens, differs significantly in nature from private corporate pensions or public pensions for special occupational groups, such as government employees pensions in foreign countries. To use an analogy, rather than being a speedboat that can respond agilely to rapid changes in surrounding conditions, it has characteristics similar to an aircraft carrier, for which a rapid response is difficult due to political constraints and other factors. The National Pension, likened to an aircraft carrier, requires more time to avoid unexpected obstacles. If the National Pension, with the nature of an aircraft carrier, relies too heavily on high returns from capital markets where future predictions are uncertain, there is no guarantee that an irremediable situation will not occur. Nevertheless, it is deeply concerning that arguments are overflowing that increasing fund investment returns can be one of the definitive primary means for the fiscal stabilization of the National Pension. This is because if we fail to achieve the high returns set in our scenarios, difficulties beyond imagination could ensue.

Currently, within the Financial Estimation Committee and the National Assembly Special Committee on Pension Reform, arguments are repeatedly being presented that investment returns can be raised even higher than those suggested by the financial projection expert committee in March of this year, during the fifth projection. I find it difficult to agree with these arguments for the following reasons. Above all, it is because they are predicting the future returns of our National Pension based on past return data from small foreign nations or special occupational funds, such as the Government Employees Pension, that have managed their funds well. One of the reasons the entire world was able to achieve high economic growth over the past few centuries is that it chose an unsustainable path through the destruction of the global environment. We are experiencing, through the global climate change that has become evident recently, that such high growth will no longer be sustainable. For sustainable growth, it will be inevitable for companies to operate in a direction that protects the global environment—meaning a direction that incurs more costs than the methods used until now—and this will soon lead to a decrease in corporate profits. This is the background for the projection that high growth like in the past will no longer be possible.

There is another reason why fund investment returns are expected to fall compared to the past from a mid-to-long-term perspective. As the elderly population increases, the size of pension funds to be managed worldwide will also increase accordingly. When investment capital increases, there is a high possibility that the investment return rate will decline. This is because it is a rational judgment to view assets that can serve as investment targets and provide high returns relative to the investment capital as being limited. This is why I believe the 'prediction error' of optimistic future projections—which suggest that our National Pension can achieve higher fund investment returns every year for the next 70 years than it does now, based on past foreign data—could increase.

Despite this situation, higher future fund investment returns for the National Pension than in the past and present are being taken for granted. It seems it is time for our society to look around more carefully and listen to various opinions regarding the validity of these arguments. This is why I judge that achieving fiscal stabilization of the National Pension through increasing fund investment returns should be referred to only as one of the conceivable scenarios that can help with fiscal stabilization, rather than as a fiscal stabilization plan itself.

The Netherlands' Government Employees and Teachers Pension (ABP, National Civil Pension Fund), which invests in companies practicing sustainable (ESG) management ahead of any other pension fund, and Japan's Government Pension Investment Fund (GPIF), the world's largest public pension fund, tend to have lower returns compared to the Canada Pension Plan (CPP), Norway's Government Pension Fund Global (GPFG), and the California Government Employees Pension (CalPERS). ABP adopted a philosophy of investing in companies with excellent ESG performance based on "respect for human rights" before other pension funds. In particular, it is actively investing in related fields, judging that climate change and natural resource conservation will be major themes until 2050. Japan's public pension fund, which uses the motto "For All Generations," has also adopted an investment strategy since 2015 as an ultra-long-term investor to distance itself from the "pursuit of short-term profits that cause negative externalities," such as the destruction of the global environment. The relatively low returns of the Dutch and Japanese pension funds can be seen not as a result of poor fund management, but as a phenomenon resulting from fund investments focused on companies practicing sustainable management and investments that consider the characteristics of a public pension for all citizens, which functions like an aircraft carrier.

Considering the domestic and international realities facing our economy, which is export-led and centered on manufacturing, it seems realistic to set fund investment returns lower than in the past from a mid-to-long-term perspective. This is because we are witnessing environmental changes—or rather, environmental disasters—to an extent that most people on Earth can experience, due to centuries of high growth that caused global environmental destruction. As corporate management in a sustainable direction spreads worldwide, it is time to carefully examine the investment behavior of major pension funds that are ahead of us, in terms of the path the National Pension Fund investments must take. I say this because, although we must urgently prepare fiscal stabilization measures for the National Pension—which will be quite painful since we postponed such measures for the past 16 years—there is a high possibility that the argument that fiscal stabilization can be achieved by raising fund investment returns will be misused as a means to dilute the desperation and urgency of fiscal stabilization measures.

Source: Hankook Ilbo (original article)