The National Assembly Special Committee on Pension Reform Should Form a Consultative Body With the Ruling Party, Opposition, and Government to Discuss the "Government Pension Reform Plan"

[Asia Today · Yun Suk-myung Column · September 8, 2024]

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

On September 5, the day after the government announced its pension reform plan, the Pension Future Forum, to which I belong, issued a position statement stating that the government's reform plan is insufficient. There is a reason why the Pension Future Forum remains critical despite agreeing with the three principles of the government's reform plan: sustainability, intergenerational equity, and old-age income security.

We need stronger reform than any other country. This is because to prevent the unfunded pension liability (the shortfall in reserves compared to the promised pension amount) from increasing further even if the income replacement rate is maintained at 40%, contributions of 19.8% must be collected. Considering that "an equivalence where a 1 percentage point increase in the contribution rate corresponds to a 2 percentage point increase in the income replacement rate" applies when the pension system has achieved a balance between contributions and benefits, contributions of 20.8% must be collected to achieve a balance with an income replacement rate of 42%. This means that to avoid increasing the already existing unfunded liability (estimated by the Pension Future Forum at 1,825 trillion won), contributions of 20.8% must be collected.

The government's "42% income replacement rate—13% contribution rate" plan generates additional liabilities every year equal to a 7.8 percentage point shortfall in contributions. This is woefully insufficient to achieve fiscal stabilization. The government proposed a plan to increase the annual fund investment return by 1.0 percentage point for 70 years and to adjust the pension amount payable linkage method after the first benefit payment begins, which would delay fund depletion by up to 32 years.

Even with the current National Pension investment portfolio, negative returns are expected once every three years. To increase the annual return by 1.0 percentage point, more frequent negative returns are inevitable. If a financial crisis were to strike, we could face results beyond imagination. During the 2008 financial crisis, the one-year loss of overseas pension funds with aggressive portfolios reached 20–30% of the principal. It is doubtful whether the National Pension can endure such losses or whether our society would tolerate such an investment portfolio!

There are not a few experts who claim that it is not difficult to increase the annual average return by 1 percentage point for 70 years. This position overlooks political risk, which is the greatest risk factor in the operation of public pension systems. It means that if an unexpected event occurs and the aggressive portfolio stops functioning, everything will fall apart. I am reminded of the content that remained on the National Pension Service (NPS) website for a long time: "Pensions will be paid as long as the state does not collapse, and it is natural to transition to a pay-as-you-go (PAYG) system (where all pension expenditures for the current year are funded in the current year) after fund depletion." This optimism is the background that prevented contributions from being raised by even 1 percentage point for 26 years. This is why I view the "false hope" that fund returns can be increased as similar to past behaviors that caused us to miss the golden time for reform.

The government's automatic adjustment mechanism, which I initially rated highly, is an automatic adjustment mechanism in name only that adjusts only the pension amount linkage method after the first pension is finalized, without a direct connection to the adjustment of the income replacement rate. It is not the method urgently needed right now. Most OECD member countries correct errors that deviate from projections while in a state of balance between contributions and benefits. We, however, are attempting to adopt a method of correcting errors despite being in a situation where the gap between contributions and pension benefits is woefully wide. Instead, we rely on increasing fund investment returns by 1 percentage point every year for 70 years. We are indulging in false hope that fiscal stabilization effects can be secured through the improvement of returns, which are determined exogenously. This is why I judge that the government's "combination of income replacement rate and contribution rate" is inappropriate.

The government's proposal for "differential contribution burdens by generation" seems appropriate. This is because it can demonstrate an attitude of reflecting on the fact that previous generations operated the system laxly for a long time. This is why my evaluation differs from those groups who denounce this as "dividing generations." On the other hand, the plan to "increase the Basic Pension to 400,000 won" must be reconsidered. Increasing the amount to 400,000 won for low-income older people is desirable, but the plan to pay 400,000 won to all 70% of older people should be withdrawn. The OECD evaluates our Basic Pension as "a system with very little effect on alleviating elderly poverty relative to the input cost." This is because one-third of Basic Pension beneficiaries are not impoverished older people, yet they receive the same amount as those who are.

If the Basic Pension is increased to 400,000 won, 640,000 won will be paid even with the 20% reduction for couples. Since the average National Pension amount is around 650,000 won, a weakening of the incentive for the lower-middle income class to join the National Pension is inevitable. This effectively means the government is encouraging the expansion of coverage gaps in the National Pension. This is why the increase must focus on low-income older people. A significant portion of Korea's problem with low pension amounts stems from a dual and rigid labor market. Through simultaneous reform of pensions and the labor market, the government must implement the "five-year extension of the mandatory contribution age to 64" as soon as possible. This is because, according to the OECD, a five-year extension of the mandatory contribution age has the effect of raising the income replacement rate by 13%.

The introduction of a payment guarantee provision that lacks effectiveness seems irresponsible. This is because a state guarantee of benefit payment can only be possible if the long-term sustainability of the system is secured. Establishing a pension that is sustainable for 100 or 150 years, like in Japan and Canada, is the proper way to guarantee payments. I oppose it because it is evident that codifying the payment guarantee will act as a mechanism to neglect efforts toward pension reform. This is because it will ultimately make things harder for the young and future generations.

There is a prerequisite before discussing the government's reform plan. It is the transparent disclosure of information related to the National Pension. Only through proper disclosure can the correct prescription be derived. A forum for discussion that can be led by a rational group of experts must also be established. This is because the participation of experts with objective perspectives, independent of specific political factions or social forces, is urgently needed.

Because the Public Deliberation Committee conducted discussions while excluding future generations, it reached the disastrous conclusion of increasing the income replacement rate. In future discussions, an institutional foundation must be established so that all generations can have an equal level of voice. It must become possible to represent the positions of future generations who are not yet born, and for the sake of securing intergenerational equity, the middle-aged and older generations must also share the burden of pain. If one properly understands the position statements of the Pension Future Forum, the OECD policy recommendations, and the details of foreign reforms mentioned thus far, one cannot simply criticize the government's reform plan. This is why we must hurry to conduct proper reform discussions by forming a Special Committee on Pension Reform and a consultative body consisting of the ruling party, opposition, and government.

Source: Asia Today (original article)