Population Aging and the Direction of the National Pension Overhaul

[Seoul Economic Daily · Op-Ed · December 11, 2012]

Yun Suk-myung, Research Fellow at the Korea Institute for Health and Social Affairs (KIHASA)

The National Pension scheme, which had been quiet for some time since the 2007 reform, is receiving attention once again. This is because the conditions for operating the system are deteriorating due to the continuous increase in life expectancy. Coincidentally, the Financial Estimation Committee, which forecasts the long-term fiscal situation of the National Pension every five years, was launched in June. Based on the results of the financial projection, the National Pension System Development Committee plans to review various alternatives for system improvement next year.

Since the introduction of the system in 1988, through two pension reforms in 1998 and 2007, the National Pension income replacement rate (the ratio of the first monthly pension payment received relative to final remuneration) is scheduled to decrease to 40% (based on a 40-year contribution period) by 2028. The reform measures for the National Pension system, which focused on fiscal stabilization, were implemented so rapidly that they are rarely paralleled in world history; consequently, they face criticism for neglecting old-age income security, the very purpose of the system's introduction. Currently, the National Pension income replacement rate is 48% (24% for those with a 20-year contribution period), but the effective income replacement rate for most contributors, whose contribution periods are much shorter than this, is very low. This is also why the need for additional pension reform is increasing due to low fertility and population aging, which are progressing faster than anywhere else in the world.

National debt surges as Japan and others delay their response

From the perspective of the government ministries responsible for operating the system, it is burdensome to face criticism that the government only cuts benefits or raises contributions when the majority of the population belongs to generations that have not yet received pensions. However, the worse the surrounding circumstances become, the more alert we must be and the more urgently we must overhaul the National Pension system. This is because South Korea is experiencing the fastest population aging in the world, and its fertility rate is at the lowest level globally. The average life expectancy in our country, which was only 58 years in 1960, now hovers around 80 years, and the mode age of death—the age with the highest mortality rate among older people—is projected to far exceed 90 years within a few decades. To prevent the unfortunate situations being experienced by many European countries and to create a pension system that is sustainable for future generations, we have no choice but to revise the system.

What, then, is the desirable direction for the National Pension overhaul? Considering that there have already been two benefit cuts, it will likely be an increase in contributions. The National Pension contribution rate of 9% is far too low to maintain the current system. The government made constant efforts in 2007 to raise the contribution rate to 12.9%, but this was not realized due to opposition from various stakeholders. If contributions are not increased, the latent liabilities inherent in the system will surge accordingly. Conversely, the sooner contributions are raised, the lower the level of contribution burden will be from a long-term perspective.

Regarding the issue of increasing contributions, there is room for different calculations to operate between generations. The class that has already become older people and the generation whose retirement is near will likely want to delay the timing of contribution increases as much as possible. This is because their pension amounts are already fixed, so they benefit the more the timing of the increase is delayed. Shrewd politicians would not miss such a situation. This is why contribution increases are delayed in most democratic societies.

However, Scandinavian countries, which are advanced welfare states, are not evading their responsibility in terms of burdens. Despite providing a high level of welfare, including pensions, the debt of these countries does not exceed 50% of gross domestic product (GDP). In contrast, Japan, which responded late to population aging, saw its national debt-to-GDP ratio rise from the low 30% range in the early 1990s to over 200% currently.

This is why Korean society, which is following Japan with a time lag of about 20 years in terms of social systems and demographic structures, must remain alert. The pension system is such that if one procrastinates for various reasons, the suffering of the majority of the public is inevitable. Regarding the problem of population aging, preemptive response when one has the capacity to cure it yields greater effects and minimizes side effects.

Raise contributions and ease income redistribution

There are also many matters to consider alongside a contribution increase. First, on the premise that the tax-financed Basic Old-Age Pension is run with a focus on low-income groups, the National Pension's income redistribution function needs to be weakened from its current level so as to minimize resistance from the middle class and higher income groups. We must also widen the low-income groups eligible for contribution support and hurry to introduce a quasi-public private pension for low-income groups, like Germany's Riester pension.

The upper limit of the standard monthly income used to calculate contributions, which is currently operated far from reality, must also be substantially updated. This is because, in a situation where the income replacement rate is low, the only way to increase pension amounts is to raise contributions and the income ceiling while extending the contribution period. As life expectancy increases, it is also urgent to overhaul the labor market so that people can remain in it longer to extend their pension contribution periods, and to activate gradual retirement by securing various retirement paths such as partial work and partial pensions.

Source: Seoul Economic Daily (original article)