[Opinion] Urgent Need for Improvement in Retirement Pension System

Jinyoung Shin, President of the Korea Corporate Governance Service and Professor at Yonsei University School of Business

Recently, the Financial Supervisory Service announced the status of retirement pensions by financial sector for the second quarter of 2021. As of the second quarter of this year, the amount of retirement pension reserves under management reached 260.3689 trillion KRW, showing a rapid increase of 16.8% (37.3458 trillion KRW) compared to the same period last year. Notably, the growth rates of Individual Retirement Pensions (IRP) and Defined Contribution (DC) plans are 39.2% and 18%, respectively, surpassing the 11.4% growth rate of Defined Benefit (DB) plans, which currently hold the largest share. In terms of absolute amounts, the DB type decreased by about 2 trillion KRW over six months from 153.9 trillion KRW at the end of last year, clearly reflecting this trend. Among financial sectors, the financial investment industry shows a remarkable growth trend. Although its absolute amount is still the smallest, it saw an additional inflow of 10.4975 trillion KRW compared to the same period last year, reaching 55.6021 trillion KRW, a 23.3% increase. Meanwhile, banks achieved 135.0749 trillion KRW, up 16.6%, and insurance companies reached 69.5428 trillion KRW, up 12.3%.

The rapid increase in IRP and DC types and the inflow of funds into the financial investment sector compared to other sectors is due to differences in returns, highlighting the advancement of the financial investment sector. Looking at the range of returns, financial investment recorded DB type (1.72?6.70%), DC type (4.85?17.62%), and individual IRP (3.68?21.00%). Banks achieved DB type (0.43?1.69%), DC type (1.49?3.92%), and individual IRP (1.44?6.24%), while insurance recorded DB type (1.57?2.89%), DC type (2.12?6.51%), and individual IRP (1.92?10.48%). This is entirely determined by the proportion of risky assets in the management. Non-life and life insurance companies invest 99% and 94%, respectively, in principal-guaranteed products such as deposits and savings, and banks also manage 89% in principal-guaranteed products. The financial investment sector, which has the highest returns, holds only 76% in risky assets compared to other sectors. As a result, the financial investment sector has linked the stock market boom continuing since last year to improved returns by expanding the investment proportion in risky assets. Some securities firms’ DC plans achieved returns exceeding 20%.

The growth rate of the elderly population aged 65 and over in Korea is 4.4% annually, significantly higher than the OECD average of 2.6%, marking the fastest pace among OECD member countries. However, the elderly poverty rate stood at 43.4% as of the end of 2018, three times the OECD average of 14.8%. This disparity is primarily due to the markedly insufficient pensions after retirement compared to advanced countries. As of 2018, Korea’s public and private pension income replacement rate was only 43.4%, whereas the OECD average was 62.9%, leading to a significant difference in post-retirement living standards.

To stabilize the elderly’s livelihood, improving the retirement pension system is urgently needed, and the current period of overall capital market activation appears to be an opportune time for such improvements. Discussions on improving the retirement pension system have been ongoing but have seen little progress. First, the National Assembly should prioritize the introduction of a default option. The default option is a system where the retirement pension management company operates funds according to a predetermined method without the DC plan subscriber having to instruct how to manage the funds. This system is already widely used in advanced countries’ retirement pension systems. Two years ago, the author joined a DC plan and was very confused about which products to invest in. Even as a financial expert, it was difficult to understand and decide, let alone for ordinary subscribers.

As a solution to this problem, the default option has been used for a long time in advanced countries and has achieved its intended results. The UK case, which introduced behavioral economics theories by Professor Richard Thaler, a Nobel laureate well known for "Nudge," into its pension system, proves that the default option contributes to pension subscription, retention, and stable retirement life. Concerns about the introduction of the default option include the argument that pensions prioritize stability, and a high proportion of risky assets could undermine this stability. However, generally, the default option is applied only when appropriate diversification and systematic management are implemented, making medium-risk, medium-return outcomes possible in the long term, as experienced by advanced countries. The National Pension Service, which has diversified investments in various risky assets for several years, secures a stable return of over 5%, and there is no reason not to apply such management to retirement pensions. Ensuring the public’s stable retirement life is a crucial immediate task. We look forward to improvements in the retirement pension system that can lead to systematic and stable retirement preparation.