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Equitable and Sustainable Pensions
Chapter

Chapter 11. Providing Adequate Old-Age Pensions in the Republic of Korea

Author(s):
Benedict Clements, Frank Eich, and Sanjeev Gupta
Published Date:
March 2014
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Author(s)
Seong Sook Kim

Introduction

Since its introduction in the 1960s, the Korean public pension system has grown rapidly. This growth has paralleled the country’s economic growth during that period. However, the framework was developed in a very short period and the system still needs to tackle various challenges. One of the most urgent issues is the expansion of coverage in each of the pillars of the system. Although the national pension provides comprehensive coverage by law, its application excludes a number of vulnerable groups.

Korea’s public pension systems have faced difficult challenges as they attempt to expand coverage and alleviate poverty among current and future elderly populations, while at the same time ensuring their own long-term solvency. With limited resources, resolving the conflicting challenges is extremely difficult. A broad social consensus is necessary to push ahead successfully with these tasks.

This chapter examines the evolution of the national pension system in Korea and evaluates possible options for additional reform.

Description of the Public Pension Systems in Korea

Current Structure

Korea has a multipillar income security system (Table 11.1). The national pension system is by far the largest pillar, covering 19.9 million people as of December 2011, while the public occupational pension systems (for civil servants, private school teachers, and military personnel) cover 1.4 million people. The number of people affiliated with private pension systems (retirement and individual pensions) is still quite small. Meanwhile, the basic old-age pension, which is a means-tested benefit, covers 70 percent of the elderly. The so-called national basic livelihood security system is a safety net and social assistance program. It was transformed in 2001 from a livelihood care system dating back to 1960 to a top-up benefit program.

Table 11.1Overview of Income Security Systems in Korea (December 2011)
Covered GroupsEmployeesSelf-employedOthersCivil servants, private school teachers, and military personnel
0 pillarBasic old-age pension

(70 percent of persons ages 65 and older, 3.8 million beneficiaries)

Enacted 2007, Enforcement 2008
National basic livelihood security (1.5 million beneficiaries)

Transformed from a livelihood care system in 2001
1st pillarNational pension

(19.89 million insured persons)

Enacted 1986, Enforcement 1988
Public occupational pensions (1.4 million insured persons) Introduced 1960
2nd pillarRetirement pension

(3.3 million insured persons)

Introduced 2005
3rd pillarIndividual pension (1.6 million insured persons, December 2009)

Introduced 1994

Historical Developments

Trends in coverage and membership

The national pension and private pension systems were all introduced within the past 20 years, and they competed for new members. However, with the advent of substantial increases in longevity and a growing understanding of the importance of financial preparation for old age, the national pension has emerged as the most appropriate solution to the universal provision of income security in old age.

Starting in 1988 with slightly more than 4 million insured workers and applying only to workplaces with 10 or more employees, the national pension soon began to expand compulsory participation. It was applied to rural areas in 1995 and to urban areas in 1999, covering the total labor force between the ages of 18 and 59. With the expansion into urban areas, participation in the system jumped from fewer than 7 million in 1998 to more than 16 million in 1999. Following the 1997 Asian financial crisis, the number of insured members dropped temporarily, but since then it has continued to grow. The global economic and financial crisis that erupted in 2007 did not dampen the upward trend of participation. In fact, the number of insured persons has been rising even more quickly as a result of increasing concern about financial security in old age (Figure 11.1).

Figure 11.1Number of Insured Participants in the National Pension System (December 2011)

(Thousands)

Source: Statistical database, National Pension Service (2011).

At December 2011, the proportion of citizens insured by public pension systems was 57 percent of the working-age population (those ages 15 to 64 years) and 90.6 percent of those active in the labor force (ages 15–64). However, the proportions contributing were much lower because many individually insured persons under the national pension had no earnings with which to pay them—the proportion of current contributors to public pension systems was 40.4 percent for the working-age group and 64.2 percent for the labor force (Table 11.2).

Table 11.2People Insured by Public Pension Systems, December 2011
Number (thousands)Working age: 15–64 (percent)Labor force: Age 15–64 (percent)
(A) Working age: 15–6437,233
(B) Labor force: Age 15–6423,421
(C) Number insured under public pensions21,22757.0 (C/A)90.6 (C/B)
National pension19,823
Public occupational pensions11,404
(D) Current contributors of public pensions15,02440.4 (D/A)64.2 (D/B)
National pension113,620
Public occupational pensions21,404
Sources: Statistical data from National Statistical Office (2011, for A and B), National Pension Service (2011), Government Employees Pension Service (2011), Korea Teachers Pension (2011), and Ministry of National Defense (2011).

Total does not include those who are exempt from contributing because they had no earnings and those who had reported earnings but had not made their contributions for more than a year.

Public occupational pensions include those for civil servants, private school teachers, and military personnel.

Sources: Statistical data from National Statistical Office (2011, for A and B), National Pension Service (2011), Government Employees Pension Service (2011), Korea Teachers Pension (2011), and Ministry of National Defense (2011).

Total does not include those who are exempt from contributing because they had no earnings and those who had reported earnings but had not made their contributions for more than a year.

Public occupational pensions include those for civil servants, private school teachers, and military personnel.

The proportion of beneficiaries ages 65 and older covered by public income security systems reached 82.5 percent at the end of 2011 (Table 11.3). Most received the basic old-age pension. The number of dual beneficiaries—those who receive both the basic old-age pension and the national pension—is increasing every year as a result of increased participation in the latter.

Table 11.3Beneficiaries of Public Income Security for the Elderly, December 2011(Thousands)
Total population ages 65 and olderRecipients of basic old-age pension (BOAP)Recipients of national pension (NP) and/or public occupational pension (POP)Nonbeneficiaries
5,701 (100.0%)3,796 (66.6%)1,813 (31.8%)
999 (17.5%)
Total: 4,702 (82.5%)
Sources: Residents registration statistics, National Statistical Office (2011b), National Pension and Basic Old Age Pension Database; Government Employees Pension Scheme; Private School Pension Scheme; Military Personnel Pension Scheme.Note: Beneficiaries electing to receive their national pension payments as a lump sum are excluded.
Sources: Residents registration statistics, National Statistical Office (2011b), National Pension and Basic Old Age Pension Database; Government Employees Pension Scheme; Private School Pension Scheme; Military Personnel Pension Scheme.Note: Beneficiaries electing to receive their national pension payments as a lump sum are excluded.

Reforms and implementation

The national pension was introduced in 1988. In 1997, a committee for national pension reform was established to address concerns about the system’s long-term sustainability. Although the national pension’s financial position was solid in the short term—the ratio of annual expenditure to accumulated funds was 20.7 at the end of 1998, reflecting the relative immaturity of the scheme—the fund was projected to be depleted by 2031, owing to a mismatch between contribution rates and benefit generosity, and the rapidly aging Korean population (National Pension Corporation, 1998). Even though the majority of the committee members favored structural reform that would change the national pension into a dual system of a basic pension and an earnings-related pension, the revised act of 1998 contained only parametric reform.

In the 1998 reform, the national pension’s income replacement rate was reduced from 70 percent of earnings for a person with average earnings and 40 qualifying years to 60 percent. The contribution rate was kept at 9 percent, and the pensionable age was raised to 65 years from 60 years. A five-year review system was introduced to project the national pension’s long-term finances and suggest measures to improve the system and ensure its sustainability.

The first national pension financial review in 2003 showed that the pension fund would be depleted by 2047 (National Pension Development Committee, 2003). The government proposed a bill that would increase the contribution rate and reduce the benefit level, but it did not pass. Instead, through the subsequent 2007 reform, the national pension income replacement rate would be reduced from 60 percent to 50 percent in 2008 and then gradually to 40 percent by 2028. Along with this reform, a basic old-age pension system was introduced, which applied to 70 percent of the elderly population and paid a benefit of 5 percent of the average earnings of the population covered by the national pension.

As a result of the second reform in 2007, the pension fund’s depletion was projected to occur in 2060. However, because the reform was accomplished without social consensus on the definition of “financial stability” or agreement on the system’s long-term financial goals, it is not clear that the national pension fund has actually achieved long-term financial solvency. Some experts have argued strongly that the national pension needs further reform to ensure its financial solvency for the long term. Meanwhile, some civil rights activists, social welfare experts, and politicians have insisted that reducing elderly poverty and securing adequate benefits should be the pension system’s social priorities. The two previous reforms were pushed through in response to reforms being made in advanced economies rather than in response to identified domestic needs. Additionally, many people did not have a clear understanding of the national pension’s role as an income security program because most had not yet received any benefits. Additional restructuring of the national pension and the basic old-age pension is a priority to further develop Korea’s income security system, but will likely be harder to accomplish than in the past.

Future Challenges

Changes in Population and Family Structure

Korea’s population is aging rapidly. The population 65 years old and older accounted for 3.1 percent of the total population in 1970, 5.1 percent in 1990, and 11 percent in 2010. The share is projected to increase to 37 percent by 2050 (Figure 11.2).

Figure 11.2Population Aging in Korea

Source: NSO (2011a).

During the same period, life expectancy at birth increased from 61.9 years in 1970 to 81 years in 2010 and is projected to reach 84.3 years in 2030 and 87.4 years in 2050, according to 2011 population projections (NSO, 2011a). By contrast, the total fertility rate, which stood at 4.53 children per woman in 1970, dropped sharply to 1.08 in 2005. It has increased since; reaching 1.23 in 2010, but it is not expected to get much higher. Because of the increase in life expectancy and the low fertility rate, the old-age dependency ratio (the number of people ages 65 years and older as a share of the number of people ages 16–64 years) is projected to increase from 15 percent in 2010 to 71 percent in 2050 (NSO, 2011a).

Urbanization and an increase in the number of nuclear families have led to the growth of single households. Because of their increased life expectancy, many elderly people are now living alone. The proportion of elderly single households was 24.0 percent in 2000 and 25.4 percent in 2010; it is expected to reach 29.7 percent in 2020 and 39.8 percent in 2030 (NSO, 2011a). Additionally, elderly people are less likely to be supported by their children than in the past; future generations should plan to support themselves when they are old.

Poverty among the Elderly

In 2008, the Organization for Economic Cooperation and Development (OECD) reported that the poverty rate of the elderly (ages 65 and older) in Korea was 45.1 percent, the highest among OECD countries. The relatively sudden appearance of poverty among the elderly is the result of population aging, the rapid increase in the number of nuclear families, and the subsequent collapse of the traditional family support system. Most elderly people in Korea did not expect to live so long and thus did not prepare financially. Traditionally, Korean parents have invested in their children, who then took care of them in their old age.

When the national pension was introduced in 1988, the proportion of the elderly in the total population was only about 5 percent, and average life expectancy was 70 years. People did not realize the importance of preparing for their old age. The national pension is a social insurance system, in which benefits are paid only after a person has fulfilled the qualifying conditions; elderly people who do not meet the employment criteria do not receive pension benefits. Meanwhile, fewer young people believe that they are obliged to support their parents. The proportion of private transfers in total retirement income among the elderly decreased from 54.8 percent in 1990 (Ministry of Home Affairs, 2002) to 44.7 percent in 2008 (Ministry of Health and Welfare and University of Kyemyong, 2009).

Inadequacy of Income Security

The old-age pension under the national pension is paid to an insured person who has fulfilled the minimum qualifying years (years of contributions) for receiving the pension and who is 61 years old in 2013. The qualifying time is set at 10 years, but was temporarily five years during the initial period of the national pension system. Owing to the short insurance period, the average old-age pension was equivalent to only 15.4 percent of the average earnings of those who were insured at end-2011.

Although the national pension is maturing and the average number of contribution years is increasing, because the statutory benefit level is going down, the average pension amount is not expected to increase much in the future. The benefit reduction that was part of the 2007 national pension reform reflects general acceptance of the multipillar system as a way to enhance income security. However, this system faces challenges. The national pension benefit is low and is anticipated to be kept low in the future, while private pensions are still in their infancy. The second-pillar retirement pension introduced in 2005 covered 46 percent of all regular employees as of December 2012 and is rapidly developing. However, the program’s history is very short, and no pensioners have emerged out of this scheme yet. Furthermore, the low coverage and high cancellation rate of individual pension contracts by insured individuals are creating a substantial challenge.

The basic old-age pension seems to be a good idea for elderly people who did not have the opportunity to be covered by a public insurance pension system. However, despite the 70 percent coverage, the low benefit level does little to ameliorate poverty among the elderly (Yoon, 2012). Many civil activists and lawmakers are calling for an immediate increase in the benefit level; however, funding for a higher benefit level and universal coverage is not easy to find.

Sustainability of the National Pension System

The sustainability of the national pension system depends on its financial stability, fairness, and participation level.

Financial stability and adequate size of the fund

Even after two reforms to ensure long-term financial stability, funding for the national pension is still projected to run out by 2060 (Table 11.4). Most advanced economies reformed their public pensions when their funds were nearly exhausted (Kim and Shin, 2010) the national pension in Korea was reformed when its assets were still accumulating. However, although the fund will remain solvent for decades, the future of the national pension is uncertain because no plan is currently in place for what to do once it is depleted.

Table 11.4The Third Long-Term Financial Projection of the National Pension in 2013
YearAssets(A) (billion won)Revenue (billion won)Expenditure (billion won)Balance (billion won)Assets/ExpenditureContribution RateAssets (2010 constant price)
TotalContributionsReturnsTotal(B)Benefits(A/B)(percent)(billion won)
2013417,72752,21732,13520,08214,55614,03237,66126.19384,179
2020847,171109,09854,07355,02533,92333,48775,17522.89621,361
20301,732,381186,91395,04191,87289,95389,17696,96018.29963,104
20402,494,494258,427141,595116,832213,773212,56344,65411.591,119,973
20432,561,489277,586156,765120,822267,328265,96310,2589.591,083,720
20442,558,741283,749162,747121,003286,498285,076−2,7488.991,061,331
20502,200,519309,781203,282106,498414,088412,288−104,3085.69810,491
2060−280,716263,375263,3750657,820655,155−394,4450.29−84,818
2070358,101358,1010948,255944,311−590,1549
2080477,892477,89201,263,6501,257,811−785,7579
2083518,944518,94401,388,5391,381,971−869,5959
Source: National Pension Financial Projection Committee (2013), the 3rd National Pension Long-Term Financial Projection.Note: Dashes reflect the fact that the national pension fund will run out of assets by 2060, with returns falling to zero. From then on, it is also no longer possible to calculate the assets-to-expenditure ratio.
Source: National Pension Financial Projection Committee (2013), the 3rd National Pension Long-Term Financial Projection.Note: Dashes reflect the fact that the national pension fund will run out of assets by 2060, with returns falling to zero. From then on, it is also no longer possible to calculate the assets-to-expenditure ratio.

The new national pension financial projection according to the third financial review was officially announced by the government in March 2013. Based on the new projection, reform measures are being discussed by the committee to improve the system. If measures for long term-financial stability are enacted, they should be made more permanent because frequent reforms and conflicts have created enormous fatigue in the society.

Meanwhile, because the national pension fund has grown to a tremendous size, efficient operation has become a pressing issue. The fund is the fourth-largest public pension fund in the world. With this kind of growth, the importance of management has increased, along with the fund’s influence on markets. Issues raised include the short- and long-term policy direction of fund operation, and adequate asset allocation in domestic and foreign investments and in stocks, bonds, and other assets. The fund’s governance structure is also receiving great attention, including on the issue of exerting voting rights as a shareholder and whether the fund should make social investments. The fund will become much bigger if the contribution rate is increased in the interest of financial stability. If this happens, operations will be an even greater issue.

Fairness

Because of the system’s youth, the equilibrium pay-as-you-go contribution rate of the national pension was only 3.7 percent in 2013, much lower than the contribution rate of 9 percent. However, because the Korean population is aging fast and the number of pensioners will increase quickly, the pay-as-you-go rate will also rise rapidly (Table 11.5).

Table 11.5National Pension Pay-as-You-Go Rate(Percent)
201320202030204020502060207020802083
3.75.28.012.817.421.422.622.622.9
Source: National Pension Financial Projection Committee (2013), the Third National Pension Long-Term Financial Projection.
Source: National Pension Financial Projection Committee (2013), the Third National Pension Long-Term Financial Projection.

On the one hand, under the current structure, current pensioners receive a benefit that is greater than what their contributions would financially justify. Future generations will bear the cost of this gain, which could create conflicts between generations.

On the other hand, the benefit calculation formula makes the system redistributive across various income groups. The earnings used to compute national pension benefits are A (average earnings of the total insured) and B (each participant’s lifelong average earnings); thus, a person whose earned income has been less than A can receive a greater benefit.1

However, many low earners and elderly persons with no history of contributing cannot access the national pension, because it requires beneficiaries to have contributed. The biggest beneficiaries may be those who were first to apply to the new system. Meanwhile, future generations will bear a larger burden, while those generations who worked before the system was established will not receive any benefits. Those who failed to make their contribution payments will also be excluded. Thus, the public insurance pension might not cover a considerable proportion of the population.

These issues must be considered in any discussions about new reforms, with the goals of enhancing fairness between generations and among income groups, while providing better care for the less privileged.

Participation

To sustain the national pension system in the long term, people will have to be supportive and participate in the plan. Since the introduction of the system, the government and the National Pension Service have worked hard to improve participation. The media have covered the issue of the future of the system in great detail, as well as the coming of the so-called “homo hundred era” and income security for older people. As people have become more concerned about their future income security and have learned about the advantages of the national pension system, more of them are choosing to participate. The gradual increase of pensioners to more than 3 million as of the end of 2012 has increased recognition of and participation in the system.

The roles of the pillars

The income security system in Korea has become a multipillar system in a relatively short time, but it is still immature and inadequate with regard to coverage and benefit levels. Each pillar in the system is trying to improve its coverage as quickly as possible; however, pursuit of this goal has led to competition and even some conflict. For example, in 2012 the national pension began offering a subsidy to help low-income workers contribute; the retirement pension has tried to introduce a similar program to extend its coverage. Numerous public and private pension plans have been introduced, and they have not yet reached maturity or provide significant coverage. The most urgent task might be to define what the role of the basic old-age pension in the income security system should be. To develop a functioning income security system in Korea, a blueprint for the short and long terms must be created and then followed.

Reform Objectives and Options

Reform Objectives

The objectives of pension reform are to

  • Ensure adequate benefits and wide coverage;
  • Ensure equity between generations;
  • Enhance the sustainability of the system; and
  • Restructure the system for maximum efficiency and effectiveness. To succeed, reforms must also be socially acceptable and feasible.

Ensure adequate benefits and wide coverage

The minimum goal for a public pension system is to ensure that citizens are free from poverty. In Korea, many people are not covered by the social insurance national pension, so the basic old-age pension will be a necessary part of the system for a long time. If public pension systems function better in the future, there will be less need for the basic livelihood security program as a last resort. Both public and private pension systems need to improve simultaneously to ensure adequate benefit levels, but it is even more important to substantially expand coverage of the national pension and lengthen the average contribution period of insured persons.

Korea’s income security system has developed in a piecemeal manner, without a systematic plan. Before pursuing yet another reform, a blueprint must be created for both the short and long terms. Minimum adequate standards for income security should be clearly defined, although the fact that people occupy diverse income groups in society makes it difficult to reach a consensus. Benefit levels of basic pensions in some OECD countries are 15 percent to 25 percent of average income; this benchmark could be used to establish a minimum standard pension benefit. There is no common definition of an adequate income level for old age, but a benefit of 60 percent to 70 percent of preretirement income is often mentioned. However, the level will be higher for low-income retirees and lower for high-income retirees.

On the revenue side, measures to help the insured acquire longer qualifying periods should be introduced to enhance the adequacy of pension benefits. Individuals who have difficulty making contributions would benefit from programs such as provision of credits during periods when they are raising children or serving in the military, state subsidy to their contributions, and facilitating voluntary affiliation.

Ensure equity between generations

Currently, the income security burden in Korea is not large. As of 2011, the cost of the national pension as a proportion of GDP was only 0.8 percent, and that of the basic old-age pension was only 0.3 percent. However, as the national pension scheme reaches maturity and the population ages, the burden will increase. Reforms are needed to achieve greater sustainability of the public pension systems and reduce the burden on future generations.

Ensuring equity between generations is a complicated task in an aging society. So far, the national pension benefit level has been reduced considerably while the contribution rate has remained at a relatively low level. Increasing the contribution rate may be the best way to improve equity between generations.

Enhance the system’s sustainability

Public pension systems must be sustainable. Although the national pension fund will continue accumulating for the next several decades, it will eventually run out. The system must plan now to ensure its long-term financial stability.

Clarification of the long-term financial goals of pension reform would make the future more predictable. People will have greater confidence in the system if they know it will endure. The total amount of public pension expenditures as a proportion of GDP should be forecast and monitored on a regular basis.

Restructure the system for efficiency and effectiveness

The income security system needs restructuring to be more efficient and effective. The basic old-age pension exists in a vague area between social assistance and social allowance. It is not universal but has very wide coverage; however, the low benefit level does not ameliorate poverty. Moreover, there is no clear concept of its role in providing income security for the elderly. The ambiguity that surrounds the basic old-age pension affects the status of the national pension—positioning the basic old-age pension in the income security system influences the direction of the national pension.

Social acceptance and feasibility of reforms

The number of insured persons and pensioners has increased, and people have become more aware of the importance of early preparation for their old age, so reforming the pension system is likely to be more difficult than it was in the past. To succeed, any reform must be socially and financially acceptable. For example, the likelihood of longer retirements may mean increasing the statutory retirement age. Successful pension reform will require measures to deal with differences between the present system and the reformed one, especially compensation for the “losers” in the reformed system. Finally, as the national pension fund increases substantially over the coming decades, management and operations will be more complicated.

Reform Options

Parametric reform measures

If the national pension is reformed again to improve its financial stability, the priority policy option is likely to be raising the contribution rate. This option is quite effective for achieving long-term solvency, but people tend to dislike it. In the previous two reforms, participants expressed a clear preference for reducing the benefit level rather than increasing the contribution rate—the effect of benefit reduction might be far in the future, while an increase in the contribution rate is felt immediately. If the contribution rate is increased, the main issues will be the amount and the implementation schedule.

Table 11.6 shows three scenarios for increasing the contribution rate. The financial goal for all three is to achieve an asset-to-annual-expenditure ratio of at least 2 in 2078. The long-term financial goal is set relatively low to prevent over-accumulation in the pension fund and to keep the contribution rate from soaring.

Table 11.6Three Contribution-Rate Scenarios to Attain the National Pension System’s Long-Term Financial Goal
ScenarioSchedule for Increasing Contribution Rate (percent per year); PeriodConstant Contribution Rate at End of Scheduled Increases (percent)Final Ratio of Assets to Expenditure (2083)Assets/GDP (year: percent)
10.48; 2020-2913.82.52020: 39.4

2030: 27.2

2040: 72.9

2050: 75.7

2060: 68.1

2070: 50.8

2080: 26.6

2083: 17.7
20.62; 2030-3915.22.52020: 39.2

2030: 48.0

2040: 60.1

2050: 65.5

2060: 60.3

2070: 45.8

2080: 25.3

2083: 17.8
30.84; 2040-4917.42.22020: 39.3

2030: 47.8

2040: 47.7

2050: 48.4

2060: 47.1

2070: 36.6

2080: 21.6

2083: 16.1
Source: Scenarios were devised by author and projected by the National Pension Research Institute using the 2013 National Pension Projection Model and the same assumptions of variables use in the third financial projection.
Source: Scenarios were devised by author and projected by the National Pension Research Institute using the 2013 National Pension Projection Model and the same assumptions of variables use in the third financial projection.

The scenarios have different schedules for adjusting the rate. In scenario 1, the contribution rate is raised gradually from 2020 to 2029; in scenario 2, it rises from 2030 to 2039; and in scenario 3, it rises from 2040 to 2049. In scenario 1, the contribution rate is raised to 13.8 percent and then fixed; in scenario 2, it increases to 15.0 percent; and in scenario 3, it rises to 17.4 percent. Scenario 1 imposes the lowest burden on future generations while enhancing intergenerational equity. However, because the contribution rate is adjusted earlier, fund assets will increase more. The huge size of the accumulated fund could put operations at greater risk, which could, in turn, affect the larger economy. Thus, scenario 1 is the best option for intergenerational equity and affordability, but scenario 2 is best with regard to optimal fund size.

Another parametric reform option for the national pension is to increase the statutory retirement age. The age was raised from 60 to 65 years in the 1998 reform, but life expectancy in Korea is quickly catching up to that in other OECD countries. Raising the pensionable age further would postpone depletion of the fund. For example, if the pensionable age were increased to 67 years by one year every five years between 2038 and 2048, depletion would be postponed from 2060 to 2064. If it were raised to 68 years from 60 years on a schedule of one year every three years from 2013 to 2034, depletion would be postponed to 2069 (Lee, 2012). Increasing the retirement age seems more attractive than raising the contribution rate for achieving fiscal stability, but it would be difficult to recommend, given the current retirement age and the poor labor market conditions for older people.

Introduction of an automatic adjustment mechanism is another option. But its main purpose would be to systematically reduce the benefit, which seems inappropriate for the national pension, which already has a relatively low average benefit level. Successful reform of the national pension system will require some measures for coverage expansion and adequate benefits, along with measures to ensure financial stability.

Structural reform measures

The most frequently suggested structural reform option is to combine the universal tax-based system (the basic old-age pension with 100 percent coverage of the elderly ages 65 years and older) and the social insurance earnings-related system (the national pension). Table 11.7 shows two scenarios for combining the two systems. In scenario 1, the national pension benefit level is reduced to 30 percent by 2038 and the basic old-age pension is changed to universal coverage with a benefit equal to 10 percent of average earnings of those covered by the national pension. In scenario 2, the combined benefit level is 25 percent of the national pension and 15 percent of the basic old-age pension.

Table 11.7Two Scenarios for Combining the National Pension and the Basic Old-Age Pension
Combination of NP and BOAP (different benefit levels)Pension Expenditure as a Share of GDP (year: percent)NP Benefit Expenditure as a Share of GDP at the Current Benefit Level of 40 Percent of Average Income (percent)
Scenario 1NP 30% + Universal BOAP 10%2030: 4.62030: 2.5
(NP: 40% by 2028, and 30% by 2038 through 1 percentage point benefit reduction every year from 2029 to 2038.2040: 7.02040: 4.0
BOAP: 10% benefit from 2015)2050: 9.92050: 5.7
Scenario 2NP 25% + Universal BOAP 15%2030: 4.8
(NP: 40% by 2028, and 25% by 2038 through 1.5 percentage point benefit reduction every year from 2029 to 2038.2040: 8.5
BOAP: 10% benefit in 2015 until 2028, 15% by 2038 through 0.5 percentage point benefit increase every year from 2029 to 2038)2050: 10.7
Source: Scenarios were devised by author and projected by the National Pension Research Institute using the 2013 National Pension Projection Model and the same assumptions of variables used in the third financial projection.Note: BOAP = basic old-age pension; NP = National Pension. Scenario 1: National pension benefit is reduced by 1 percentage point every year beginning in 2029, until it reaches 30 percent in 2038. In 2015, the basic old-age pension is set at 10 percent of national pension average income and stays at that level. Scenario 2: National pension benefit is reduced by 1.5 percentage points every year beginning in 2029, until it reaches 25 percent in 2038. In 2014, the basic old-age pension is set at 10 percent of national pension average income, stays at that level through 2028, and is increased by 0.5 percentage point every year beginning in 2029 until it reaches 15 percent in 2038.
Source: Scenarios were devised by author and projected by the National Pension Research Institute using the 2013 National Pension Projection Model and the same assumptions of variables used in the third financial projection.Note: BOAP = basic old-age pension; NP = National Pension. Scenario 1: National pension benefit is reduced by 1 percentage point every year beginning in 2029, until it reaches 30 percent in 2038. In 2015, the basic old-age pension is set at 10 percent of national pension average income and stays at that level. Scenario 2: National pension benefit is reduced by 1.5 percentage points every year beginning in 2029, until it reaches 25 percent in 2038. In 2014, the basic old-age pension is set at 10 percent of national pension average income, stays at that level through 2028, and is increased by 0.5 percentage point every year beginning in 2029 until it reaches 15 percent in 2038.

In both scenarios, income security will be greater than in the present public pension system. However, if the old-age pension is universal and its benefit level increases, the cost for income security will also increase. Thus, scenario 1 has a lower cost, but scenario 2 provides a more adequate benefit level. In any event, this reform option has little support among the population. People will strongly resist another benefit reduction in the national pension, and the introduction of a universal pension would also be difficult because of the high cost in an aging society.

Another option would be the introduction of a notional defined-contribution plan with a minimum pension or income guarantee. Table 11.8 shows two scenarios of equivalence between benefit level and contribution rate of the pension plan. In scenario 1, the contribution rate is fixed at 9 percent; in scenario 2, the benefit level is fixed at 40 percent.

Table 11.8National Pension Benefit Level and Contribution Rate Alternatives
Scenario 1: 9 Percent Fixed Contribution RateScenario 2: 40 Percent Fixed Benefit Rate
EarningsBenefit level: 21.8%Contribution rate: 16.5%
Interest RateBenefit level: 23.5%Contribution rate: 15.3%
Source: Scenarios were devised by author and projected by the National Pension Research Institute using the same assumptions of variables used in the third financial projection.Note: These alternatives both assume that contributions are made for 40 years beginning in 2013 and benefits are received for 20 years beginning in 2053. Earnings are escalated according to the wage index, and benefits are adjusted by the price index.
Source: Scenarios were devised by author and projected by the National Pension Research Institute using the same assumptions of variables used in the third financial projection.Note: These alternatives both assume that contributions are made for 40 years beginning in 2013 and benefits are received for 20 years beginning in 2053. Earnings are escalated according to the wage index, and benefits are adjusted by the price index.

In scenario 1, the benefit level provided by a contribution rate of 9 percent would be about 22 to 23 percent, which is too low to be accepted by participants in the national pension. In scenario 2, the contribution rate to support a benefit level of 40 percent would be about 15 to 16 percent, which is too high to be accepted.

The introduction of a minimum pension—for current participants in the national pension who have short contribution histories and elderly people who are not covered by the national pension—seems unrealistic given that it would require an enormous amount of public expenditure. Some have suggested privatizing the national pension, but this idea is unpopular and seems unrealistic.

Conclusion

Korea has experienced rapid growth in its income security system. The introduction of the national pension in 1988 was late compared with other OECD countries, but by 1999 it applied by law to all labor force participants ages 18 to 59 years. With the introduction of the individual pension in 1994 and the retirement pension for private sector employees in 2005, a multipillar income security system was established. Two pension reforms for greater financial sustainability were implemented within 20 years of implementation of the national pension, considerably changing the system’s framework.

Since the introduction of the national pension, the most important considerations have been expanding its coverage and ensuring its long-term financial sustainability. Income security for the current older generation was not addressed until the introduction of the basic old-age pension in 2007. Although this pension has wide coverage, the benefit level is low and its impact on poverty alleviation has been minimal. When the basic old-age pension was introduced, the benefit was set at 5 percent of the average earnings of those insured by the national pension; the plan was to increase the benefit to 10 percent by 2028.

The Geun-hye Park administration, which took office in February 2013, has announced plans to increase the coverage of the basic old-age pension and raise its benefit level to 10 percent of the average earnings of the national pension, thereby advancing the original schedule for increasing benefits. However, debates are expected on the equity and validity of this proposal, and on how it would be financed.

Any change in the basic old-age pension will likely influence the future of the national pension; however, significant change in the near future is unlikely owing to the resistance of the insured. Meanwhile, even without considering the basic old-age pension, the national pension should promote its own development as the main income security system in Korea. Its key tasks are to expand coverage, enhance the adequacy of benefits, and achieve long-term financial stability.

The individual pillars of the Korean income security system need to be developed carefully and in tandem, with each pillar assuming its proper position. Numerous reform options have been considered in the past, and some of them are currently being discussed. Despite the painful and time-consuming process, all participants hope to reach consensus on reform.

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1

National pension benefit formula: 1.2(A+B) (1+0.05n) as of 2028, upon completion of the benefit reduction to 40 percent for the insured with average earnings and 40 qualifying years, where A is average monthly earnings of the total insured, B is each participant’s lifelong average monthly earnings, 1 is for 20 qualifying years, and n is qualifying years in excess of 20 for each participant (40 years for full pension).

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