Release of medium-to-long term outlook on respective agenda based
on the analysis of pending macroeconomic issues

Public, Health and Welfare Economics

Research Monograph

A Pension Study Focusing on Public Pension Reform

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  • Author YUN. Heesuk, KIM. Dohyung
  • Date 2015/12/31
  • Series No. Research Monograph 2015-07
  • Language Korean
SUMMARY Chapter 1. Tasks for Sustainable Multi-pillar Retirement Income System
 The consequences of changes in economic circumstances combined with long-term demographic strains have raised profound policy-related questions about the sustainability of pension and retirement income. Countries are growing increasingly uneasy about their capacity to deliver retirement income to the elderly, and the debate about pension provision has shifted back to individual responsibility.
 In Korea, where the extended family was the major sources of supplemental old-age income support, the common three-pillar system of retirement income hardly ever exists. Formal social security and pension systems are relatively underdeveloped in both coverage and protection.
 The difficulty is that we should keep the elderly out of poverty by expanding public pension at the same time as we pursue pension reform to make it more efficient.
 Against this backdrop, this study looked at the provision of retirement income through public pensions, occupational pensions, employe/individual saving in Korea and then tries to design the reform path in prospect. The reform experiences around the world were examined, and obstacles for developing each pillar were identified.

Chapter 2. Pension Reforms Around the World
 In this paper, we provide an historical and international perspective on the worldwide pension reforms since the 1980s. In response to the persistent declines in mortality and fertility rate as well as the labor force participation rate among the elderly during the twentieth century, it was inevitable to adjust the PAYGO public pension systems across the world. In the late 1990s and the early 2000s, many Latin American countries and the ex-communist countries introduced the mandatory funded individual accounts, but those policy experiments put too much emphasis on the marginal benefits such as enhancing economic efficiency and providing more choices to individuals, not on consumption smoothing, poverty relief, and insurance, all of which are the ultimate objectives of any pension system. After the 2008-9 international financial crises and the ensuing economic downturns, some of those countries which implemented the funded individual accounts returned to their pre-reform PAYGO system by making the funded individual accounts smaller or by abolishing them because the marginal benefits are limited at best whereas the transition costs were generally high. More recently, some countries implemented innovative pension reform which maintains the PAYGO financing to minimize the transition costs while mimicking defined contribution system, which can help to enhance work incentives. Those reforms include the Notional Defined Contribution system topped up with a small funded component, and a variety of automatic adjustment mechanisms. The recent trends in pension reform appear to converge to a single model of quasi-defined-benefit system which ensures sustainability by adjusting benefits and pensionable ages in accordance with changing economic environments, while providing basic retirement income to the elderly in order to close the coverage gap. However, it is recommended that, in response to the population ageing, each country should adjust the public pension system in a way that best suits its own policy objectives and initial conditions, as there is no first-best solution to pension problems.

Chapter 3. Challenges and the Future Reforms of the National Pension Scheme
 There faces a crisis of the old-age poverty which is driven by immature national pension, and a crisis of the financial sustainability in pension scheme as a result of population ageing in Korea. However, comprehensive alternatives have not been analyzed to solve these crisis synthetically. This study is initiated to diagnose problems of the national pension system(including the basic pension system), and examine the recent experience in reforms of developed countries, including their pension system. Based on the analysis, This study provides a parametric and structural reform of the national pension system, including possibilities and limitations regarding these reforms.
 Results of this study are as follows; Both parametric and structural reforms have their own limitations and advantages, therefore cautious social consensus is needed when the pension reform is implemented. Specifically, the parametric reform in its primary focus on financial stabilization of the pension can contribute to improving financial sustainability in the national pension scheme, but has an operational problems in huge funds as well as problem in the old-age poverty, including the blind zone. On the other hand, by restructuring the pension scheme, the structural reform has advantages that can resolve the poverty in current generations of the elderly and secure the long-term financial sustainability in the pension scheme. But the structural reform has a fiscal burden in the pension scheme, and the resistance as a result of reforming the national pension system.

Chapter 4. Reform Direction and Tasks for Korea’s Occupational Pension Schemes
 The impact of the 2015 parametric reform of the Government Employee Pension (GEP) will be less than significant. Taking place over a 20-year period, the effect of the lowered income replacement rate on driving down the cost-benefit ratio will be slow and incremental and insufficient to steer the GEP to a balanced benefit-contribution structure. From the financial perspective, the reform implies a positive impact―a cut in the amount the government has to pay in subsidies (from general tax revenues) by 40 percent over the period between 2016 and 2085. It can also be viewed as a move toward equity across public employees of different generations and income levels, as the GEP now factors in a redistributive element in its benefit formula.
 The reform has brought a number of achievements. First, it has brought the issue of GEP into the realm of public discussion with increased demand for transparency. Second, the reform can be taken to have laid a systematic procedural framework. Third, it has helped improve the comparability of the GEP with the other public pension schemes. Fourth, by trimming down the short- to mid-term burden of financing the GEP, the reform has established a foundation for further reform. Fifth, the reform has frozen the benefit amount for current GEP recipients and, to a substantial extent, cut the future benefits of current civil servants.
 Several limitations remain, however. First, no basic financial framework has yet been established for structural pension reform. Second, an adequate framework has yet to be laid for multi-pillar old-age income security. Third, the reform still leaves much to be desired in terms of its impact on long-term financial sustainability. Fourth, the reform process has been mechanical at best and dominated by particular interest groups. Fifth, proceeded in lockstep with the interests of political parties, the reform has engendered social tension to a needless degree. Sixth, the financial projection on which the reform has been based is limited to national mortality database. Seventh, the reform has done little to ensure equity across different participants of different public pension schemes.

Chapter 5. The Reform of Korean Private Pension
 In order to establish strong three pillar retirement system, Korean private pension should be focused and enhanced because Korean National Pension system has inherent instability of partial funded system. However, Korean private pension system which consists of 2nd pillar mandatory occupational pension and 3rd pillar personal pension also has severe problems, too. The problems are low sustainability, low income replacement ratio, pension dead zone, low rate of return in investment, lack of financial education for pension consumer, and inefficient pension supervision system.
 In order to dissolve these problems, it is necessary to introduce subsidy to low income class like Riester pension of Germany, to change governance of private pension by introducing Board of trustees system, to give extra incentive for additional contributions. For consumer protection, it is also necessary to educate pension consumer about pension products and risk management, and to introduce more sophisticated default option. It may be better to introduce discretionary investment scheme into private pension.
 The most important thing to do is to prohibit early withdrawal in private pension. In Korea, people can withdraw money from pension account almost without limitations. It impedes private pension to work as retirement income for the future. In order to improve the efficiency of private pension system, the portability of pension between financial companies should be allowed. The new method in withdrawal stage such as programmed withdrawal is needed in order to discourage lump sum payment. The total integrated pension supervision system including National Pension and private pension should be established for better and efficient pension management.
 Korean government has given priority on Korean National Pension rather than private pension until now. However, Korean National Pension’s future is not optimistic because it is expected to be depleted in 2060. So the role of private pension should be emphasized and enlarged. Korean government need invent new way of integrating three pillar pensions.
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