April 2010

By Dr Kim Ki Ryung, Representative Director, Aon Consulting Korea, Inc.

South Korea's rapidly aging population will present workforce challenges that need immediate recourse if the country is to avoid facing the twin risks of a major workforce gap as well as retirement-funding shortfall in the future.

As part of a dynamic economy that plays a pivotal role in powering Asia's engine of growth, South Korea has for many years led industrial innovation based on the availability of a young and talented workforce. The writing is however on the wall – South Korea will be faced with a talent shortfall as its population turns grey and the country's low birth rate do little to fill the impending workforce decline.

The trend of low birthrate, an aging population and workers opting to retire younger present South Korean regulators with the real prospects of a nation deplete of precious human resource to power its economic engines. Meeting retirement funding target is also fast becoming the national treasurer's nightmare.

The state-run National Pension System (NPS) was set up in 1988 and includes public pension, social health insurance, unemployment compensation, and industrial accident insurance. Private companies have since the 1960s been providing a severance pay system for their staff which functions as a de facto pension payment. In 2005, the government laid the groundwork to move the severance pay system into a corporate pension system.

The complex task of managing the National Pension Scheme has become increasingly fraught with perils as payouts are looking unsustainable. Under Korea's NPS system, premiums are collected as contributions, but they are in fact formulated as payroll taxes in the case of corporate employees, and as earmarked taxes in cases of local area residents and the self-employed.¹ 

According to the Korean Development Institute (KDI), the national pension fund will begin to see losses in 2031, with the possibility of facing bankruptcy by 2042.² 

Impact of an aging population on the workforce

Official statistics show that by 2026, over 20% of Korea's population will be grey. This compares with 7.2% of Koreans being over the age of 65 in 2000, progressively growing to 14.3% by 2018. The prognosis is not bright – South Korea is becoming a super aged society at one of the world's fastest rate. Match that with a low birthrate of 1.08 (as at 2006) and Korea's is the slowest to produce newborns among OECD countries. Korea will be faced with a talent shortfall unless this trend reverses.

Cracks are appearing in the equilibrium of the workforce that threatens to throw workforce supply-demand balance off the chart that will have negative impact on the nation's long-term productivity and national product growth.

Employees are retiring earlier, and they are living longer. According to a survey by the Ministry of Labor, the average length of employment  for South Korean workers is merely 5.9 years while employees are also retiring at a younger age of between 45.5 and 55 years old. Due to advances in medical care, national life expectancy rate is around 80 years old.

Korea's baby boomer generation is expected to total 7.12 million by 2010. A big portion of this baby boomer generation will retire early and live longer, sucking out a vital labor force from the nation. According to Hyundai Research Institute (HRI), total labor force participation rate during the 2010 to 2018 period is estimated to be 72-73% but will drop to 57.8-62.6% if the 55-64 year age group is taken out of the workforce pool.

This shrinking labor force will put undue stress on the South Korean economy. The implications are that future industries will be left without labor to run, affecting national productivity. According to a forecast by KDI, South Korea's average potential economic growth rate is forecast to drop to 2.3% in the 2020-2030 period, and to 1.6% in the 2030-2040 period from its current average growth rate of about 4% per annum due to a loss in national productivity.

The onslaught of baby boomers retiring is also likely to dampen national property prices as the retirees make plan to cash out from their holdings of properties prior to retirement, according to LG Economic Research Institute (LGEI). 

The government is likely to be under huge financial pressure as a result of a shrinking labor force and a growing pool of early retirees putting financial burden for pension scheme withdrawals. Household income tax burden is also likely to increase should the government turn to private households to keep the pension in the black.

Based on HRI’s assumption of 712 million baby boomers retiring in the next nine years (2010-2018), some 7.72 trillion Won will be needed to fund Korean baby boomers' retirement. Korean employees are not looking forward to the prospects of the national government raising additional income tax to fund the pension expenditure.

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Tip of the iceberg: Coping with the pension dilemma

To cope with the country's pension dilemma, the government introduced the Employee Retirement Income Security Act in 2005 which allows companies to introduce corporate pension plans to create a steady stream of retirement income for employees. As part of the legislation, employers have the option of introducing a retirement pension plan either as a defined benefit or defined contribution plan; or continue with the Severance Pay Plan, by Dec. 31, 2010.

There are currently three options for pension plans: Defined Benefit (DB), Defined Contribution (DC) and Individual Retirement Account (IRA).

• Defined Benefit: Employers put in a variable amount towards employee's pre-determined benefits each year.
• Defined Contribution: Employers contribute a fixed ratio based on employee's salary.
• Individual Retirement Account (IRA): The employee makes the retirement contribution into this account, regardless of the company he/she is working for.

The current severance pay system has been around since 1961 and has many management issues. Employees are also afraid that they will have insufficient retirement savings to fall back when they are at retirement age.

As a way of dealing with the limitations of the different retirement plans in place, retirement insurance and trust were introduced in 1998 and 2000 respectively. Employees' retirement funds are deposited with financial institutions with guarantees provided for the return of the savings.

However, retirement insurance plans have their limits:

• There was no minimum saving amount. 
• There was no mechanism to settle the retirement fund when employees switch jobs.
• The savings plan is focused on capital preservation hence may not meet the customers' various investment aspirations. 

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Loopholes in the management of retirement savings

Although in theory, the severance pay schemes have been put in place to ensure employees' retirement funds are held in reserve until they reach pensionable age, in practice, there is nothing to prevent employers from using the fund for their daily operations rather than holding the funds in reserve. If a company meets bankruptcy, employees are not able to get a full or partial payout from their employers.

The way the retirement funds are managed, employees have the option to cash out their retirement savings prematurely, resulting in some of these employees draining their entire retirement funds way before they even retire.

Further, companies have been releasing employees' retirement savings periodically, enabling employees to access what is meant for retirement early. As a result, employees get less than what they anticipate by the time they actually retire.

There have also been issues related to the management of the retirement fund which is often de-linked from an organization's HR system. This raises the issue of how salary payout – which is tied to performance – can be applied to an employees' retirement plan. 

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Getting serious about corporate pension plans

As the deadline draws close to the compulsory adoption of corporate-run pension plans by the end of 2010, corporations with more than five employees will be forced to deal with the task of setting in place retirement scheme for employees, or revisit legacy systems that are no longer practical from a financial or management point of view.

The following table lists out the options and the benefits from the employees' and employers' perspective.

Table 1: Advantages of a corporate-run retirement pension scheme  

Table 2: Types of  Retirement Pension   
 

Graph 1: 5 years of retirement pension overdue
 

Source: Ministry of Labor 

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It is all about the communication

With effect from this year, existing retirement insurance and trust plans will be abolished. Hence, retirement pension schemes will take on added importance. Currently, the retirement pension scheme market has around 50 pension providers competing for business. Even non-pension companies are actively reviewing their pension schemes for their employees. The market will be slushed with many conflicting options and information about types of plans of various complexities.

Offering a well-thought out and sustainable pension plan will help raise employer-employee relationship as well as contribute to the employer's brand. Employers intending to map out a plan will have to ensure the plan can be sustained by the company’s current and future financial health. The success of the pension scheme is dependent on how the scheme is being explained and communicated to the employers. Even the best of plans will gain little acceptance or commendation should employees fail to recognize the benefit the organization is providing. 

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Contact

Please contact Dr. Kim at charlie_kim@aon-asia.com for more information about how Aon Consulting can assist you in Korea addressing these issues within the specific context of your business. 

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Notes: