S. Korea NPS depletion forecast bolsters calls for reform

South Korea's pension system is in need of reform amid low birth rates, an aging population and slowing economic growth, experts said.

As well as a need for increased contributions, investment rules need to change. A strict target portfolio with a domestic bias, which is imposed on public pension funds including the National Pension Service, Jeonju, also hurts plans' long-term sustainability, experts said.

On Jan. 27, a government panel said the NPS, one of the world's largest pension funds with 920 trillion won ($692.5 billion) in assets as of Nov. 30, will be depleted by 2055 — two years before the previous forecast.

The panel conducts a review and publishes estimates on the NPS every five years. In 2018, it said the year of depletion would be 2057, and the year the NPS would be in deficit would be 2042. In the recent announcement, it said the year of deficit is now 2041.

"As the total fertility rate declines and life expectancy increases, it is expected that the number of people enrolled in the national pension will decrease and the number of recipients will increase, resulting in a decrease in income from insurance premiums and an increase in expenditure on benefits," the report said.

South Korea's fertility rate fell to the lowest in the world in 2020 for the first time, and it has continued to fall. Women in South Korea are now expected to give birth to an average of 0.73-1.21 babies in their lifetime over the period of 2023-2070 — a decline from the 2018 review of 1.27-1.38 births.

The proportion of people aged 65 and above is expected to come in at 17.5% of the population when the final count is released for 2022, and reach 34.4% by 2040.

The Organization for Economic Cooperation and Development forecasts South Korea's real GDP growth rate to be 2.7% for 2022, 1.8% for 2023 and 1.9% for 2024.

Pension reform has been in discussion in the country for years, and the current government — which came into power in May — has said pensions reform will be at the top of its agenda.

Final details of the reform will only be submitted to the National Assembly, the legislative branch of government, in April.

But the committee commissioned to work on the reform said it planned to propose the starting age for benefit payments be delayed to age 70 from 65; increase the contribution rate gradually to 15% from 9%; and require individuals to contribute to their pensions until age 64, up from 59, a senior consultant specializing in South Korean pension funds said, speaking on condition of anonymity.

The current contribution of 9% is split evenly between the employer and employee.

Historically, attempts at pension reform in South Korea have not been successful.

"There has to be political consensus," said Andrew Reilly, pension analyst in the social policy division of the OECD. "The last major reform proposed in 2015 had the support of the two main political parties in terms of outcome — i.e. they proposed to increase the benefit level from 40% to 50% after a 40-year career. However, there was no consensus on how the increased cost should be financed and so the process collapsed."

"One proposal was to have the increase financed by an additional employer contribution but unions were strongly against this," he said.

The senior consultant agreed, saying that dynamics between the right wing and left wing on the political spectrum have caused stalemates, and stakeholders who view the reform as unfavorable — for instance workers who would receive retirement benefits later — have led to delays in the pension reform.

The current government is already facing challenges on increasing the contribution ratio to address the aging population and declining birth rate, the consultant said.

Pension systems in nations with aging populations around the world have been grappling with similar issues, said Andrew Hendry, Singapore-based head of distribution for Asia ex-Japan at Janus Henderson Investors, which had $275 billion in assets under management as of Sept. 30.

"In France, the whole of Europe knows the retirement system is going to run out of money. They're trying to do as much as possible short of raising taxes and contributions to try to fix it. But it's politically sensitive," he said.

This year, more than 1 million people in France participated in strikes and protests in response to government plans to raise the age of retirement to age 64 from 62.

The number of people aged over 60 in France is expected to reach 24 million by 2060, up from 15 million in 2012, according to the United Nations.

Other nations in Asia have faced similar issues. On Jan. 17, China's National Bureau of Statistics reported that the country's population declined for the first time in six decades, raising concerns about how the elderly will be cared for.

One country that has done well with its retirement system is Australia, Mr. Hendry said.

"Australia was very sensible. They built in all of these contribution increases so people don't think twice about them. Whereas anywhere else, this would be a political landmine," he said, in reference to the country's superannuation system.

Investment caps with a domestic bias also present a disadvantage to pension funds such as NPS.

NPS' target portfolio for 2022 is set at 16.3% in domestic equity, 27.8% in overseas equity, 34.5% in domestic fixed income, 8% in overseas fixed income and 13.4% in alternatives.

Returns for the fund between January and November, the latest month available on the NPS website, stood at -4.9% overall, with domestic equity, global equity, and domestic bonds returning -14.9%, -6.3% and -6.3%, respectively. Alternatives recorded a positive return, at 10.7%.

Overseas fixed income, the smallest asset class in NPS' portfolio, posted a positive 0.6% return.

"The fixed-income portfolio is where you have the biggest impact of currency. Because typically, returns are much more muted. But there's political reasons why you have to support the domestic fixed-income market. And that's the complexities of being a government entity," Mr. Hendry said.

"Pensions like NPS can help to solve the problem of running out of money by 2055 by increasing the incline of their annualized return, which means investing outside of Korea," he added.

Elevated returns are the principal reason for investing overseas, he said. "If you have a weak currency like the won did last year, and you bought U.S. dollar assets, you would have made a lot of money if you converted it back now."

Still, Mr. Hendry admitted that even with the most optimized portfolio, a pension fund that is distributing more benefits than contributions will eventually run dry and the reality is that pension plans must consider issues such as raising contribution rates and retirement ages.

"There are no concrete plans in place currently, but it is recognized that reform is necessary," said Mr. Reilly of the OECD, which recommends increasing the NPS contribution rates, ensuring active participation from all eligible individuals and financing some pension redistributive components from the state budget as part of the pension reform.