Introduction

The speed of demographic structural changes in the Republic of Korea (hereafter Korea) is almost threatening. The lengthening of the average lifespan and retirement of baby boomers are expected to quadruple the number of those over 65 years old from 9.1% in 2005 to 38.2% in 2050 (Korea National Statistical Office [KNSO] 2006). But, due to an unprecedented phenomenon of low birth rate, the ratio of the economically active population (aged 15–64) is forecasted to decrease by more than one-fourth from 71.7% to 53.0% for the same period. This means that the old dependency ratio is expected to rise by almost six times from 12.6% in 2005 to 72% in 2050 (Figure 1 [ PDF 16.3KB | 1 page ]).

A rapidly aging population will make old age income security more important, while at the same time, significantly affecting public pension finance. In this regard, Korea now faces two major policy challenges—that of improving the old age income security system as soon as possible and, at the same time, improving the financial sustainability of the public pension system. These two policies, however, could potentially clash. For example, in the case of overemphasizing the function of public pension social insurance, a rapidly aging population could undermine the system's sustainability. On the other hand, if Korea focused mainly on stabilizing pension finance, its function for old age income security could weaken.

To accomplish these two policy goals, it would not be appropriate to depend on a single method, and efforts to develop various income sources for the elderly are needed. In other words, a more advanced old age income security system should be established by harmoniously developing various methods, such as national public pension, retirement pension at the corporate level, private pensions at the individual level, and savings for after retirement. It is also necessary to streamline the function of public pension adequately through the establishment of complementing systems and operating the system in a financially stable manner.

The National Pension Scheme, which serves as the backbone of Korea's public pension system, was first implemented in 1988. The scheme started to be extensively applied in 1999 to include self-employed people in urban areas, establishing a framework for the fullscale National Pension Scheme. Despite this external growth, however, the National Pension Scheme had a serious structural problem, specifically, on the imbalance between generous benefits and low contribution rates since its introduction.

To resolve this “low contribution-high benefit” discrepancy, the first amendment to the National Pension Act was done in 1998. At that time, the original revised bill included a decrease in the average income replacement rate for insured people with 40 years of coverage from 70% to 55%, extension of the age entitled to receive the first pension benefits to 65, and adoption of the actuarial valuation (conducted every five years, starting in 2003), while maintaining the basic framework of the previous unified pension scheme. However, as the bill went through a political decision process at the National Assembly, the proposed income replacement rate was adjusted to 60% from 55% and the overall contents failed to meet the original goal of the amendment.

As a result, according to the actuarial valuation conducted in 2003, which was done less than five years after the first revision, a pension deficit would occur by 2036, and the pension fund would completely be exhausted by 2047 (National Pension Development Committee [NPDC] 2003). Accordingly, the long-term financial instability of the National Pension Scheme became a serious issue again, damaging the confidence of pensioners on the government's pension plan. To respond to the situation, the government submitted a second revised bill for the National Pension Scheme in 2003 containing measures to strengthen the financial stability of the fund and to ensure the substantiality of various systems, including the permanent establishment of a fund management committee. This bill, however, was not passed until July 2007, some four years after it had been presented to the National Assembly, with a somewhat reduced scale of changes from what had been originally submitted.

In this study, the expected effects and limitations of the second amendment to the National Pension Act are assessed and the political implications reviewed. To this end, various simulation methods have been used to quantitatively analyze the impact of the second amendment on the financial sustainability of the National Pension Scheme, intergenerational and intragenerational equity, and the scheme's adequacy as an old age income source. Based on the results of my analyses, additional tasks for the sustainable and efficient development of the National Pension Scheme are suggested.

The contents of this study are as follows: Section 2 briefly summarizes the major contents of the amendment to the National Pension Act. Section 3 outlines the quantitative assessment of the effect of the revision through various simulation analyses. Based on the assessment results, Section 4 presents policy tasks that should be focused on for the improvement of the National Pension Scheme in the future. Finally, Section 5 concludes with a summary of major analysis results and policy implications.

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