KDI "Transition to Fully Funded New Pension System for National Pension Needed"

Announcement of the 'National Pension Structural Reform Plan'

A national policy research institute has suggested that to avoid demanding sacrifices from future generations, the pension system should be promptly transitioned to a fully funded new pension scheme. KDI emphasized that even in the context of an extremely low birth rate, pension reform toward a fully funded system is necessary to ensure that future generations can receive at least the amount equivalent to the insurance premiums they paid plus the expected investment returns of the accumulated fund.

On the 21st, KDI researchers Lee Kang-gu and Shin Seung-ryong released a KDI Focus report titled “National Pension Structural Reform Measures” containing these findings. The two researchers argued that to effectively resolve the financial depletion issue of the National Pension, the introduction of a fully funded new pension with an expected return ratio of 1 is necessary.

The fully funded system builds a fund from the principal and interest of insurance premiums imposed on the working generation to cover pension benefits. By definition, it always satisfies an expected return ratio of 1. In contrast, the pay-as-you-go system covers pension benefits annually from insurance premium income without an accumulated fund. Currently, South Korea’s National Pension is considered partially funded because the fund is accumulated but switches to a pay-as-you-go method once the fund is depleted.

The two researchers diagnosed that the intergenerational equity issue in South Korea’s National Pension system stems from the fact that the “expected return ratio” of the previous generation is greater than 1. This is because the sum of the insurance premiums paid by contributors and the expected investment returns of the accumulated fund is much larger than the total promised pension benefits to be received until death. If the excess pension benefits of the previous generation continue to be covered by the accumulated fund and expected investment returns of the subsequent generation as is currently done, it is uncertain whether the expected return ratio scheduled for the later generation can be guaranteed.

Therefore, the two researchers emphasized, “To guarantee an expected return ratio of 1 even under an extremely low total fertility rate, the introduction of a fully funded new pension is necessary.” From the reform point onward, all insurance premiums paid should be accumulated into the new pension fund, and accordingly, pension benefits with an expected return ratio of 1 should be paid in the future. Conversely, insurance premiums paid before the reform point should be separated into an old pension account, and pensions for the old pension should be paid according to the benefit formula with an expected return ratio above 1 before the reform.

However, in this case, pensions will be paid according to the benefit formula with an expected return ratio above 1 before the reform. The accumulated fund of the old pension will not be able to cover the total future pension benefits, resulting in a financial shortfall. The researchers suggested that this financial shortfall should be covered separately from the new pension by general government finances. The scale of this coverage was estimated to be around 609 trillion won as of 2024, assuming immediate reform of the National Pension.

Regarding the claim that the new pension guaranteeing only an expected return ratio of 1 is no different from private insurance, the researchers responded, “However, in most countries, pensions are operated as mandatory savings rather than voluntary individual choices.” One researcher stated, “There is a global need for public pensions to provide the minimum necessary retirement income to ensure overall social stability,” and added, “It is also necessary to consider that the operating returns of large-scale funds like public pensions are higher than those of other private insurances.”