A generational bond? No way

An invisible generational bond cuts through the national pension scheme. The underlying creed is that the younger generation will take care of the older generation. The Korean pension system runs on a defined contribution plan. Instead of piling up the fund, premiums are deducted from working people’s wages to pay benefits to retirees. Younger people set aside part of their earnings to support their parents.

Most countries run pensions under an unfunded or hybrid method. The trouble is that the pay-as-you-go formula doesn’t work well in the current demographic structure of low birth rates and a rapidly aging population, with more and more pensioners and fewer and fewer workers.

There is only one way to solve this problem under the current model: The payers must pay more. Workers will have to surrender more than 20 percent of their monthly income to support the retired population. The problem is shared in all advanced societies, including the United States, Germany and Canada.

A pension system also can be run using a pre-funded plan. Contributions are pooled and paid out under a prearranged formula. Korea’s national pension system is a hybrid that is partially funded. Part of the monthly contribution goes toward payouts for pensioners and the rest into a reserve fund run by a state manager to make a profit. But if investment returns are small and pensioners increase, the reserves would eventually be depleted.

Korea is headed down that path. The pension is designed for pensioners to receive 40 percent of their average pay during their working years. The pension system takes 9 percent from their monthly pay. Under the current arrangement, the fund will run dry in 2060. Experts say the pension system would eventually have to run on a pay-as-you-go system.

In short, pensions would have to be paid entirely by contributions from the current work force.

The logic is correct, but circumstantially unfair. Korea is the fastest aging society among the member countries of the Organization for Economic Cooperation and Development (OECD). According to the statistics office, 12.7 percent of the population last year was made up of people 65 and older, but that will shoot up to 40.1 percent by 2060. At the same time, people aged 15 to 64 will plunge from 73.1 percent of the population to just 49.7 percent.

This means that by 2060, the number of people receiving pensions will be around the same as those paying the premiums. Under a pay-as-you-go system, the working population would lose about 30 percent of monthly pay to support pensioners who paid less than 10 percent of their wages. The older generation would receive benefits for which they had not paid. Under such circumstances, a bond between the generations would be wishful thinking.

Advanced countries that have been through this problem already are setting aside reserves again. The United States changed its Social Security system to a partially funded model when payouts exceeded premium revenue in 1983. Canada also revised its proportional pension system to be partially funded in 1997.

We already have a partially funded system. What we have to do is try to delay the point of depletion. To keep the fund alive, we have to pay more and collect less. A year’s subscription rate guarantees a 1 percent coverage rate. To receive a full 40 percent of working income, one must contribute for 40 years. A Korean salary-earner on average works 25 years. So the pension covers about 25 percent of what one has earned. In short, the amount can hardly cover living expenses. The coverage ratio cannot be reduced, so the only option is to raise premium rates.

In order to maintain a sustainable pension system, we should talk frankly about raising the premium rates.

Yet, politicians suddenly came up with the idea of raising the coverage ratio to 50 percent while discussing separate reforms for the pension plan for government employees, eyeing votes in the next election.

Pensions aren’t free. To get more, you must pay more. At birth in 1988, the national pension policy was structured to cover 70 percent of monthly salaries made in a lifetime with a 3 percent premium rate. Such a design was necessary in the beginning to attract as many as people as possible. But at the same time, the rate was set to go up 3 percentage points every five years to a maximum of 15 percent.

The rates went up according to the timetable until 1998. No one complained: They understood the burden was necessary for the stable management of their future pensions. Politicians didn’t think to abuse the system for political purposes. But then they got greedy. The rate increases stopped. Instead, they pushed back the benefit age to 65 from 60 and lowered the payout ratio.

There’s no reason why we should stick to a 9 percent threshold on premium rates. It has been capped so as not to increase the financial burden on workers. But to increase social benefits, contributions also must increase. Premium rates should go up to ensure a minimal, but comfortable, standard of living in old age without relying entirely on future generations. Hanging our hopes on the benevolence of our young people is both naive and irresponsible.

JoongAng Ilbo, May 27, Page 32

*The author is the editor of business and industry news at the JoongAng Sunday.

by Kim Jong-yoon