[Yun Suk-myung's Perspective] Delaying the Major Overhaul of Pensions Is Nation-Ruining Populism

[JoongAng Ilbo · Yun Suk-myung's Perspective · November 14, 2023]

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

The 'Watered-down' National Pension Reform Plan

The reform of the National Pension is going astray. Following the proposal of as many as 18 overhaul plans at a public hearing on September 1, a 'watered-down' Comprehensive National Pension Operation Plan (draft) was released on the 27th of last month.

I would like to cite Finland as a role model for pension reform. Finland effectively overhauled its Basic Pension and reformed all public pensions to pay the same amount of pension. Furthermore, it utilizes a life-expectancy coefficient to ensure a sustainable pension scheme. The life-expectancy coefficient works by keeping the total lifetime pension payment identical, but deducting from the monthly pension amount as the payment period increases.

The unfunded pension liability of the National Pension is estimated to be three times GDP by 2090; the Government Employees Pension and Private School Teachers Pension are even more serious than the National Pension. Without reform, deficits will worsen, making future pension payments uncertain. Contributions must be raised, and the right to work until age 65 must be guaranteed.

Finland, which fell into a severe economic crisis in 1991, cut the share of older people receiving the Basic Pension from 93% at the time to below 45% in the early 2000s, ten years later. Older people receiving the full-rate Basic Pension account for less than 8% of all older people. Most Basic Pension beneficiaries receive only a portion of the Basic Pension amount depending on their earnings-related pension amount. The state provides a guaranteed pension to vulnerable older people. Additional housing allowances are paid to low-income older people in the lower-middle bracket who struggle to maintain an appropriate standard of living in old age.

Government Employees and Private School Teachers Pensions: Paying Less and Receiving More

In Finland, the earnings-related pension is the core scheme, and the contribution rate is 24.4% (over 28% including government support). There is no severance pay or retirement pension; instead, the employer bears two-thirds of the contributions. The pension accrual rate (income replacement rate divided by the contribution period) is 1.5% (a 60% income replacement rate based on 40 years). When the life-expectancy coefficient is applied, it drops to 1.1% (a 44% income replacement rate). Finnish people strive to maintain their income replacement rate by working longer to increase their contribution period. The contribution rate for the Finnish Government Employees Pension exceeds 28%, paying only a pension accrual rate of 1.5% (a 60% income replacement rate based on 40 years), identical to general citizens, without the retirement allowance paid to our civil servants (which is up to 39% of private severance pay). In contrast, the Korean Government Employees and Private School Teachers Pensions have a low contribution rate of 18%, yet the pension accrual rate reaches 1.76% (a 70.4% income replacement rate based on 40 years).

Sweden switched its payment method to a defined contribution (DC) type in 1999. Under this system, contributions are attributed to the contributor's own account, and the pension is received based on the amount paid. The monthly pension is paid as the sum of the total lifetime contributions plus interest (Sweden's real economic growth rate). By the very nature of the system's operation, pension fiscal stabilization occurs automatically. If life expectancy increases, the eligibility age is adjusted to alleviate factors causing fiscal instability. This is why Sweden raised the eligibility age to 67 starting this year. Germany and Japan adopted the Swedish model in 2004. Through this, Japan secured funds to be paid until 2123, achieving a '100-Year Robust Pension'.

Korea is the country that needs high-intensity reform because its demographic structure is worse and its pension imbalance is more severe than those of these nations. Nevertheless, some oppose the introduction of Swedish or German-style pension systems, claiming it is premature. Even after setting the financial projection period to 70 years, they do not disclose what happens after fund depletion. They criticize demands to disclose the cumulative deficit after fund depletion as 'fear marketing.' According to the '2019 Fiscal Verification Results,' Japan's Employees' Pension Insurance has reserves of 22.9 trillion yen (approximately 200 trillion won in 2019 present value) in 2115. This is a figure that can be known because the situation 100 years from now was disclosed.

Failure to Disclose the Cumulative Deficit Ratio of the National Pension

Professor Jeon Young-jun of Hanyang University announced at a Pension Future Forum seminar on the 7th that the unfunded pension liability of the National Pension is estimated to be 1,825 trillion won (80.1% of GDP) in 2023 and 44,385 trillion won (299.3% of 2090 GDP) by 2090. If the income replacement rate is raised to 50% (from the current 40%), the unfunded liability in 2090 is estimated to increase by 24,000 trillion won to 68,324 trillion won (460.7% of 2090 GDP). Professor Jeon estimated that the cumulative deficit of the National Pension will reach 14,000 trillion won (applying a 4.5% discount rate) by 2093, 70 years from now.

At the Financial Estimation Committee's 22nd meeting on the 13th of last month, it was agreed to add the cumulative deficit ratio of the National Pension relative to GDP up to 2093. Content was added stating that if contributions are raised by 3 percentage points to 12% and the income replacement rate is raised by 10 percentage points to 50%, the cumulative deficit ratio relative to GDP in 2093 will reach 95% (discounted using the fund investment return rate). If discounted using the government bond interest rate, which the Committee had originally agreed upon, it surges to around 180%. Because it is this sensitive to the discount rate, I am saying that figures should be disclosed as they are in Japan. The problem is that this information is missing from the 5th Comprehensive National Pension Operation Plan (draft). Because the most important item is missing, nation-destroying populism is allowed to run rampant.

National Pension Income Replacement Rate Is Too Generous Relative to Burden

Kim Il-cheon, a former Director General of the Ministry of Health and Welfare who is 90 years old this year, expressed his frustration, stating that the reality of our pension discussions is stifling. He pointed out that the income replacement rate of the Korean pension is excessively generous, noting, "The average annual salary of a German worker is 47,700 euros (approximately 67 million won) before taxes, while the average monthly pension for men in the former West Germany is 1,212 euros (approximately 1.71 million won, as of 2021); thus, even after contributing for about 40 years, the income replacement rate is only 30.49%."

According to data released by the Japanese government last May, as of 2021, the average amount for the Japanese Government Employees Pension is 173,000 yen (approximately 1.5 million won) per month, and the average amount for Employees' Pension Insurance is 149,000 yen (approximately 1.29 million won) per month. These amounts include the Basic Pension. This is the amount received while bearing a burden of 18.3%. That is why they have money to pay even 100 years from now. The projected pension income replacement rate for 2050 recently submitted by the German government to the European Union (EU) is 37%. For Sweden, it is 33%.

Looking at foreign cases, it can be seen that the core of the problem lies in the labor market, not the income replacement rate. The actual contribution periods for public pensions in Germany and Sweden have already exceeded 40 years. In Korea, people suggest raising the income replacement rate further while claiming that the contribution period will not exceed 27 years even 50 years from now. Such claims are made because they are unaware of the latest trends.

No other country has such a long gap between the retirement age and the eligibility age as we do. The government must feel a heavy sense of responsibility. The government also seems active in solving this problem. This is why the Economic, Social and Labor Council under the President operates the 'Research Group on Continued Employment in a Super-Aged Society.' The extension of the retirement age can only achieve a soft landing if it begins in earnest after the employment ice age for young people has eased. Instead, it is time to guarantee the right to work until age 65 in the form of 're-employment after retirement,' receiving a monthly salary at about 70% of the level just before retirement. If the retirement age is extended to 65 around 2033, one can work an additional five years until age 70 in the form of 're-employment after retirement' at that point. By doing so, the contribution period for the National Pension can be extended by another 10 years. The problem of short contribution periods can be solved this way.

National Pension Contributions Must Be 12% or More of Income

Hardly any OECD member countries operate their national pensions with an income redistribution function. If the National Pension is converted to a 100% earnings-related pension and the applicable income for the pension is raised to 8.6 million won per month—the recognized income for the Government Employees Pension—the National Pension income replacement rate would rise significantly to 42.5%, rather than the 31% announced by the OECD. The National Pension amount for middle-to-high-income earners would increase dramatically. For low-to-middle-income earners whose income replacement rate would decrease as a result, a higher income replacement rate (for example, 50%) could be applied to diligent contributors, as is done in Germany and France. The required financial resources should be sourced not from the National Pension, but from taxes saved by changing the selection criteria for the Basic Pension. For vulnerable groups who remain as Basic Pension beneficiaries, the state can ensure the sustainability of the system while allowing all income classes to receive more pension benefits by paying a minimum pension amount set by the state that is higher than the current level.

This is the direction of pension reform through which we can survive. To achieve this, the imbalance between revenue and expenditure of the system must first be resolved. This is why contributions must be raised to 12% or more quickly. Contribution support measures to alleviate the burden on low-income earners resulting from the contribution increase must also be implemented in parallel. On the premise of contribution increases and labor market reform, the life-expectancy coefficient—a Finnish-style semi-automatic adjustment mechanism—can be activated from 2033 onward. In the long term, a transition to a Swedish-style defined contribution system is inevitable. This is to secure the consent of young people for the contribution increase. Young people will agree to higher contributions only if they are confident that the contributions they pay will accrue to them. A plan for the integrated operation of the Government Employees Pension and Private School Teachers Pension with the National Pension, as recommended by the OECD, must also be prepared promptly. It is impossible to persuade the public to reform the National Pension while leaving the Government Employees Pension and Private School Teachers Pension, which suffer from far more serious fiscal instability than the National Pension, as they are.

Source: JoongAng Ilbo (original article)