Abandoned Pension Reform Leaves Young People Anxious

The changes COVID-19 has left on our society are considerable. Contactless industries and the IT sector are leading global markets. Yet discussion of “pension reform,” which is needed to ensure sustainable growth in future society, has been overshadowed by that growth. As industry has become more advanced and society more diverse, human life expectancy has also increased.

However, the problem of low birth rates is worsening by the day due to factors such as “buying a home” and “soaring education costs,” and naturally the burden on future generations to support the elderly is also increasing. To allow people to fully realize their capabilities and lead future society, at the very least the burden of old age must be reduced.

As was the case in Germany, Japan, and Sweden, there is more than sufficient historical justification for discussing pension reform in South Korea, which seeks to move beyond the ranks of advanced countries and lead the world. Now is the time for the political sphere to truly come together in common purpose.

The greatest threat to the National Pension system is, without question, the acceleration of low birth rates and population aging. Article 4 of the National Pension Act stipulates that the National Pension’s fiscal balance be calculated every five years and pension insurance premiums adjusted accordingly.

According to the 2018 announcement by the National Pension Fiscal Projection Committee, the National Pension reserve fund is projected to peak at 1,778 trillion won in 2041, turn into an annual deficit starting in 2042, and be exhausted by 2057. According to the OECD, South Korea’s old-age dependency ratio will approach 79% in 2075.

In other words, because low birth rates and population aging are progressing even more rapidly than in advanced countries, we have arrived at a point where fiscal sustainability can no longer be guaranteed.

Germany and Sweden: Successful Precedents in Pension Reform

When the National Pension was originally designed, it assumed an income replacement rate of 70% and a contribution rate of 3%, but due to much faster aging than expected, the government lowered the income replacement rate twice, in 1999 and 2007, to 60% and 40%, respectively. In particular, in 1999, the pension eligibility age was also lowered to 65.

In December 2018, the Moon Jae-in government announced a National Pension reform proposal containing four options that adjusted the income replacement rate, contribution rate, and basic pension amount. Options 1 and 2 kept the current system unchanged at a 40% income replacement rate and a 9% contribution rate, but Option 1 proposed a basic pension of 300,000 won (the current level), while Option 2 proposed raising the basic pension by 100,000 won to 400,000 won.

The difference between Options 1 and 2 lies in the amount of the basic pension, but in fact the basic pension benefit was designed when the income replacement rate was lowered to 40% in 2007. The basic pension differs in that it is financed from general revenues, but from the perspective that it should be viewed as part of the National Pension anyway, Options 1 and 2 are not significantly different.

The plan most strongly advocated by labor groups and the Moon Jae-in government was Option 3. The claim was that if the income replacement rate were raised by 5 percentage points to 45% and the contribution rate increased by 3 percentage points to 12%, the depletion of pension funds could be delayed by about six years, to 2063.

But even this is merely a temporary stopgap—a case of “covering one’s eyes and pretending all is well”—from the standpoint that the system must move toward long-term balance. In the end, it focused on raising the income replacement rate and delaying the year of depletion by adjusting the contribution rate and the basic pension. Not only is it not a fundamental solution, but it also deserves lasting criticism for being highly irresponsible toward future generations.

Moreover, in order to maintain the current 40% income replacement rate, the contribution rate would have to be sharply raised to around 16%, or after 2060 workers would have to pay more than three times the current premium. That means paying more than three times higher premiums than today for the same benefits.

Even under a pay-as-you-go premium system, given that the total fertility rate was 0.83% in 2020—below 1%—the premium rate is projected to approach 40% by 2080. Ultimately, future generations are expected to face a sharp increase both in the burden of supporting the elderly population and in the burden of paying insurance premiums.

What, then, can be learned from successful pension reform cases abroad? In 2003, Germany incorporated a sustainability factor reflecting demographic structure and other conditions into pension benefit calculations. This is an automatic adjustment mechanism under which pension benefits are automatically reduced when socioeconomic conditions, such as the ratio of contributors to beneficiaries, deteriorate beyond a certain threshold.

This helps improve fiscal sustainability, but it also has the drawback of placing a considerable share of fiscal risk on individuals.

Germany also shifted to a multi-pillar pension system. While pensions are used to cover basic benefit amounts, for benefits above a certain level individuals are expected to use private pensions or insurance products. This both enhances the sustainability of the pension system and gives individuals responsibility and choice regarding old-age security.

In Sweden, of the 18.5% contribution rate, 16% is credited to notional individual accounts, while 2.5% must be paid into pension funds operated by investment companies and banks, thereby leaving a certain portion of pension benefits to individual choice. In this respect, Sweden is similar to the German case discussed above.

Apart from the structure of the pension system itself, Sweden’s pension reform is also highly worthy of emulation procedurally. In 1991, it formed a body for pension reform discussions and established the guiding principles, then in 1992 submitted them to open public discussion involving people from all walks of life. After reaching social consensus, it succeeded in passing legislation through parliament in 1994.

In addition, Sweden built an integrated pension information system through the internet, allowing any citizen to access a vast amount of pension-related information, make independent judgments, and enjoy the freedom to prepare for old age.

There has been much discussion of pension reform in political circles, but no concrete implementation plan has yet been presented. The “closed-door discussions” heavily influenced by labor groups must end, and a transparent and open forum for pension reform must be established.

Like Japan, South Korea must also work to raise the effective income replacement rate with the goal of achieving “fiscal balance over the next 100 years.” It must raise the current effective income replacement rate, which is in the 10% range, and minimize blind spots in the National Pension system in order to secure fiscal sustainability.

Pension reform is a complex issue and cannot be resolved in the short term through short-sighted measures. That is precisely why now is the time to break ground on this discussion for the sake of future generations.

Seoil Jeon, Head of Cheongram

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Original title: 손 놓은 연금개혁, 청년들은 불안

Author: Seo-il Jeon

Date: 2022-07-06

Source: https://www.cfe.org/bbs/bbsDetail.php?cid=press&idx=24831