"National Pension Reform, 'No Solution' Without Government Financial Input" [Issue Interview]

Professor Kim Woochang, Department of Industrial and Systems Engineering, KAIST
Former Member of the National Pension Financial Estimation Committee
Co-author of 'There Is No National Pension for the People'

"No matter how you calculate it, the only way for the National Pension Service to achieve financial stability is through government funding. There are limits to increasing the fund's investment returns, and raising insurance premiums beyond a certain level can foster intergenerational resentment. The later the government injects funds, the harder it becomes to fix the problem, turning a small issue into an unmanageable one."

Professor Kim Woo-chang of the Department of Industrial and Systems Engineering at KAIST made these remarks during an interview with Asia Economy on the 13th at KAIST in Yuseong-gu, Daejeon. Professor Kim emphasized, "The issue is whether to contribute 1% of the Gross Domestic Product (GDP) annually to the pension despite the discomfort or to ignore it and pass the burden onto future generations. If left as is, Koreans are destined to hate the older generation when young and be hated by the younger generation when old."

Professor Kim is a pension expert who participated in both the 4th and 5th National Pension Financial Projection Committees (2017?2023). Since serving as an external expert during the 2014 public servant pension reform, he has been involved in pension reform discussions. In February, he published a clear analysis titled No National Pension for the People.

Professor Kim Woo-chang of the Department of Industrial and Systems Engineering at KAIST is being interviewed by Asia Economy on the 13th at KAIST in Yuseong-gu, Daejeon.

-There are even calls for abolishing the National Pension, especially among the MZ generation (Millennials + Generation Z).

▲From the perspective of people in their 20s, the National Pension system may seem unfair and better off abolished. Given the current situation, this is a natural thought. However, everyone born in this country loses economic power as they age. If the collective old-age income security system, the National Pension, disappears, uncertainty about old-age income security will greatly increase. Individuals cannot predict how much retirement funds they will need at any point or how long they will live. Managing this uncertainty at the national level is far more efficient than individually.

-In what way is it efficient?

▲Imagine what would happen if the National Pension were liquidated and everyone managed their own retirement funds. If all investment options are broadly divided into safe and risky assets, people in their 20s and 30s tend to invest aggressively in risky assets. However, about ten years before retirement, they start considering liquidity, making risky assets burdensome. They gradually reduce risk and by their 60s, they go 'all-in' on safe assets. Because of the low risk, returns inevitably decrease. It's 'low risk, low return.' Mathematically, the difference in returns is about 1.5 times.

-You also mentioned it can address 'longevity risk.'

▲With the average Korean lifespan now at 83 years, retirement preparation should cover up to around 90 years. Since these retirement funds must last about 30 years, consumption is minimized. This reduces the quality of life for the elderly, causing suffering, but it is also a loss for the country. The elderly need to circulate money by dining out, traveling to provinces, or giving pocket money to grandchildren. With the National Pension system, recipients know the monthly amount they will receive and can plan their lives accordingly.

-Given these advantages, why are there calls to abolish the National Pension?

▲The situation is urgent. The total fertility rate (the expected number of children a woman will have in her lifetime) has dropped to the 0 range, opening a completely different era from the past. It has become impossible to support the current generation's retirement with the economic power of the next generation. The biggest issue is the sustainability of the finances. Trust in the National Pension is at rock bottom. During the 2015 public servant pension reform, when the fund was insufficient, pension payments were effectively cut. Since then, the perception that promised payments cannot be guaranteed if the fund is lacking has grown.

-You proposed the '3115' pension reform plan in your book.

▲It aims to strengthen pension finances by properly coordinating the roles of insurance premiums, government funding, and fund management. The plan suggests raising the insurance premium rate from the current 9% to 12% (a 3 percentage point increase) and injecting government funds equivalent to 1% of GDP into the pension. Many overlook that fund returns are also a variable to utilize. The proposal is to improve the expected average annual fund return from 4.5% to 6% (a 1.5 percentage point increase).

-Is a 6% fund return realistically achievable?

▲The 4.5% average annual fund return from the 5th National Pension financial projection does not accurately reflect reality. The method used was to multiply the asset allocation ratios?domestic stocks, domestic bonds, foreign stocks, foreign bonds, alternative investments?by the expected returns of each asset. The problem lies in domestic stocks and bonds, which make up about 45% of the total. Since Korea's economic growth rate is expected to decline long-term, domestic asset returns are low, resulting in a target return of only 4.5%.

But will the current asset allocation remain the same until 2090? Knowing that the expected returns of certain asset classes will plummet, the allocation will not remain unchanged. Recently, the Fund Management Committee decided to reduce domestic stock investments. Considering changes in asset allocation, a 5.5% return is a reasonable forecast.

-Still, you suggest raising it by another 0.5 percentage points.

▲What if we increase the proportion of risky assets like stocks and alternative investments? With the current risk level borne by the National Pension, it is difficult to raise returns by 0.5 percentage points. The Fund Management Committee announced plans to expand risky asset allocation to 65%, but it could be increased further to 70?75%. In financial engineering, a 7 (risky assets):3 (safe assets) ratio is considered a textbook portfolio and is the industry standard recognized by Nobel laureates. The current 6:4 ratio is a stable portfolio for individual investors.

-Wouldn't taking on more risk increase losses?

▲Returns are not free. If the financial market performs poorly, losses naturally increase. In 2022, when the market worsened, the National Pension's return was -8%; with a 7:3 ratio, it would have dropped to -12%. However, good markets do come. When stocks and bonds both perform strongly, as last year, losses can be recovered and higher returns achieved. Last year's fund return was a record high of about 14%. If risky assets exceeded 70%, returns in the 20% range would have been possible. If fear of losses leads to increasing safe asset allocation like bonds, the only option left is to raise insurance premiums.

-What is the asset allocation of Canada, the top-performing overseas pension fund?

▲100% risky assets. The Canada Pension Plan Investment Board (CPPI) website states, "We accept risk for higher returns." CPPI suffered losses of about -20% in bad market years like 2008 and 2022 but achieved an average annual return of 10% over the past decade. If we invested like Canada with a 10:0 ratio, we could achieve a 6.5% return. Then, the insurance premium rate could be lowered below 12%. However, whether 100% risky assets are socially acceptable risk levels remains a matter of persuasion.

-If the fund return is 6%, is financial stability achievable by raising the insurance premium rate to 12%? Compared to major countries, Koreans still receive more than they pay.

▲Calculations with a 40% income replacement rate and 6% fund return show the break-even point between pension contributions and payouts is exactly at a 12% insurance premium rate. This is a balanced figure without concerns about pension depletion. The reason it seems like a pension system where people pay less and receive more than other countries is due to the reserve fund of about 1,000 trillion won. Major countries like Canada and European nations reformed their pensions after exhausting their funds. Korea still has about 1,000 trillion won, so the pain of reform is relatively less.

-Wouldn't raising the insurance premium rate above 12% make pension finances more stable?

▲That would shift the debt of previous generations onto future generations. The pension system started in 1988 with a groundbreaking 3% insurance premium rate and 70% income replacement rate, but premiums have gradually increased and payouts lowered, yet deficits continue to accumulate. This accumulated shortfall of about 1,700 trillion won is called implicit debt. Raising the insurance premium rate above 12% to make younger generations repay this debt raises concerns about intergenerational resentment.

We must also consider whether small and medium-sized enterprises and self-employed individuals can bear insurance premiums beyond a certain level. Companies pay half of the employee's premium, while the self-employed pay 100%. If monthly contribution burdens increase excessively, pension reform itself may fail.

-How should the implicit debt exceeding 1,700 trillion won be resolved?

▲No matter how you calculate it, the only way to resolve implicit debt is through government funding. Government funds equivalent to 1% of GDP must be injected annually into the pension. I am also someone who dislikes paying high taxes. However, my research two years ago concluded that without government funding, it is infeasible for the National Pension to achieve financial stability. Government funding is no longer an option; it is now an obligation.

-The later the government funding is delayed, the greater the burden of implicit debt.

▲What could have been stopped with a hoe will become impossible to stop even with a rake. If pension reform had been achieved five years ago, a temporary injection of 1% of GDP could have solved the problem. Now, it requires a permanent 1% of GDP injection, and in five more years, it will increase to 1.5%. After pension depletion, the government will have to inject 6?8% of GDP. The issue is whether to quickly inject 1% annually despite discomfort or to ignore it and pass the burden to future generations.

Book Concert Materials. Professor Kim Woo-chang of KAIST Department of Industrial and Systems Engineering explains that the financial sustainability can be achieved even with the bipartisan compromise plan (insurance premium rate 13% · income replacement rate 44%).

-What do you think of the reform plan proposed by the National Assembly?

▲Even if the insurance premium rate and income replacement rate are raised to 13% and 44%, respectively, as the bipartisan compromise suggests, financial sustainability can be maintained?assuming government funding and fund returns remain fixed. Whether raising the income replacement rate is right or wrong is not the main point. If society can bear the cost of increasing the income replacement rate, it can be raised as much as desired. In other words, if there is capacity to pay 13% insurance premiums instead of 12%, a 44% income replacement rate is feasible.

-Is there a way to increase 'payouts' other than raising the income replacement rate?

▲The pension system is not limited to the National Pension. Koreans bear a significant amount for old-age income security. Besides the National Pension's 9%, there is an 8.3% retirement pension and an individual pension tax deduction limit of about 9 million won annually. This means contributing 20?25% of pre-tax income during economic activity for retirement funds. We need to consider how to share roles among many existing systems to guarantee old-age income.

-Any final thoughts?

▲It is time for the government to present a plan. Pension reform discussions have come this far, and missing this opportunity would be very disappointing as a citizen. If the National Pension is left as is, Koreans are destined to hate the older generation when young and be hated by the younger generation when old. The state should not create a system where young people inevitably hate the elderly. This is the last chance to fix the pension system, so the government should propose a plan and end this chaos. Time is running out.

About Professor Kim Woo-chang of KAIST Department of Industrial and Systems Engineering...

Born in 1977, he graduated from Seoul National University’s Department of Industrial Engineering in 1999 and earned a Ph.D. in Operations Research and Financial Engineering from Princeton University in 2009. He has served as a member of the National Pension Voting Rights Exercise Committee, the Fiduciary Responsibility Committee, and the National Assembly Pension Reform Special Committee’s Private Advisory Committee. He participated in the 4th and 5th National Pension Financial Calculation Fund Management Development Committees. He is currently a professor in the Department of Industrial and Systems Engineering at KAIST.