[Tax Story] Rational Reform Needed for National Pension Fund Management System

On the 9th, the National Pension Fund Management Committee made an unprecedented decision to expand the domestic stock holding limit. Since the end of last year, the National Pension Service (NPS) has been selling off 17 trillion won worth of domestic stocks, raising the upper limit of domestic stock holdings from 18.8% to 19.8%. The planned sell-off volume of 11 trillion won is expected to be reduced to 2.5 trillion won. This move contradicts the NPS’s portfolio adjustment direction to reduce the investment proportion in domestic stocks, drawing criticism that it sacrificed the stability of the entire nation’s retirement funds for the sake of the “Donghak Ants” investors’ returns. Following the Board of Audit and Inspection’s recent criticism that the NPS exercised its voting rights guidelines (a voluntary guideline that allows institutional investors such as pension funds to participate in corporate decision-making as stewards managing the owners’ assets) without principles, distrust in the NPS’s fund management methods has resurfaced.

South Korea’s National Pension Service was first implemented in 1988 targeting workplaces with 10 or more regular employees after the National Pension Act was promulgated in 1987. Subsequently, the coverage expanded to workplaces with 5 or more regular employees in 1992, rural subscribers in 1995, and urban subscribers in 1999, marking the beginning of a nationwide National Pension era. The National Pension Service, under the Ministry of Health and Welfare as a quasi-governmental agency established in 1987, is responsible for collecting pension premiums, paying pension benefits, and managing the fund. As of the end of December 2020, there were approximately 5.38 million beneficiaries, about 22.1 million subscribers, and the fund size exceeded 833 trillion won. The NPS ranks as the world’s third-largest pension fund after Japan and Norway and is approaching the era of a 1,000 trillion won fund. The NPS is fundamentally a savings system where contributors receive back what they paid based on national consensus on policy variables such as pension premiums, income replacement rates, and benefit commencement age. However, it also has the characteristics of a social security system with a low contribution and high benefit structure, where benefit payments exceed contributions.

Pension premiums are calculated by multiplying the “standard monthly income ceiling of 5.24 million won and floor of 330,000 won” by a “9% pension premium rate.” For workplace subscribers, the premium is split equally between employer and employee, while regional subscribers bear the full amount themselves. Pension benefits are divided into old-age pension, disability pension, survivor’s pension, lump-sum refund, and death lump-sum. Among these, the core benefit of the NPS is the old-age pension paid to subscribers aged 65 or older who have contributed for at least 10 years (as of 2021, the benefit commencement age is 62 and is gradually increasing). The old-age pension is calculated by applying the “income replacement rate of 40%” to the amount derived from multiplying the “average monthly income of all NPS subscribers over three years, approximately 2.54 million won,” plus the “average standard monthly income of the recipient during the subscription period,” by the “payment rate (50% for 10 years of subscription, with an additional 5% for each extra year).” If the pension recipient has income, a reduction rate by income bracket is applied for five years from the benefit commencement age. Upon the subscriber’s death, a survivor’s pension is paid to the spouse or children under 25, which includes a portion of the basic pension plus a dependent family pension. Contributions to the pension are fully deductible from income, and pension benefits received are taxed as pension income.

The NPS goes through three stages: contribution, management, and payment, with management being the most critical process. Especially with low birth rates and an aging population, the NPS is projected to run deficits starting in 2042 and be depleted by 2057, making the need to improve fund management returns urgent. Although the NPS has a separate governing body, the fund management and operation are overseen by the Fund Management Committee chaired by the government minister, making it the world’s only pension fund where the government bears responsibility for management and operation. The Fund Management Committee, the highest decision-making body of the NPS, consists of 20 members including the chairperson?the Minister of Health and Welfare?the NPS president, four vice ministers from various ministries, and 14 private members. Under the Fund Management Committee is the Practical Evaluation Committee chaired by the Vice Minister of Health and Welfare, which oversees the Investment Policy Committee, the Stewardship Responsibility Committee, and the Risk Management and Performance Compensation Committee. The NPS Fund Management Headquarters is responsible for fund management, executing the investment policies decided by the Fund Management Committee. Fund management is divided into “direct management (about 57.3%)” conducted by the Fund Management Headquarters and “entrusted management (about 42.7%)” handled by external investment institutions. Although the NPS’s scale has grown more than 30 times since the Asian financial crisis, the fund management method adopted then has remained largely unchanged for half a century.

Concerns about the NPS fund management have been raised across various sectors regarding lack of independence, accountability, and expertise. First, the NPS is uniquely structured with the government holding voting rights over fund management, making it difficult to escape criticisms of government control and pension socialism. Particularly, the recently introduced Stewardship Code on fiduciary responsibility has been criticized as a channel for the NPS?dubbed the “Lilliputian Gulliver” due to its high domestic stock investment ratio?to interfere in corporate management. Moreover, most members of the Fund Management Committee are government appointees or regional representatives, leading to justified claims of insufficient expertise.

At this critical juncture, with the NPS approaching the 1,000 trillion won era and responsible for the nation’s retirement security, it is urgent to devise strategies that secure professionalism and independence while prioritizing profitability and stability according to mid- to long-term fund management principles. First, to improve the governance structure of the government-dependent NPS, there is a need to consider establishing a provisional “National Pension Committee” within the Ministry of Health and Welfare to perform supervisory functions only, with the Fund Management Committee placed under it and composed solely of fund management experts similar to the Monetary Policy Committee. Furthermore, to strengthen independence and expertise in fund management, the establishment of a separate fund management corporation is a plausible proposal. Additionally, the National Assembly Research Service’s suggestion to divide the NPS into funds of 100 to 200 trillion won each to induce competition among funds and have independent organizations invest from diverse perspectives, thereby dispersing overall fund risk, is worth considering. The Stewardship Code, which enables unchecked corporate pressure, should also be substantially revised, and the government’s appointment of members to the Stewardship Responsibility Committee should be abolished. It is also desirable to secure excellent professional fund managers through appropriate compensation and reduce restrictions on fund management to contribute to national wealth. Rational reform of the NPS fund management system is the wisest shortcut to prepare for the visible deficits and depletion of the NPS, reduce the excessive burden on younger generations, and ensure income stability for the elderly.

Baek Jeheum, Lawyer at Kim & Chang

This content was produced with the assistance of AI translation services.