|
Korea's Evolving
Pension Programs
By Tom Coyner
Korea Times
March 7, 2007
More than ever, Korea's employers are facing a wider variety of
opportunities -- and challenges -- when it comes to creating retirement
schemes to attract, retain and reward their employees.
Traditionally, employers were legally obliged to provide a lump-sum
severance scheme that paid out at least one month average salary (averaged
over the last three months) regardless if the terminating employee – whether
the termination occurred voluntarily or involuntarily - had worked one year
or thirty plus years. Though this scheme was supposed to be funded, in
actuality it was often simply carried on the books. The fragility of this
deferred income benefit became too apparent during the "IMF crisis" when
many employers went bankrupt leaving particularly their older employees
without any funds for their retirement.
Given this background, the British Chamber of Commerce's well regarded
Business Breakfast group, headed up by Joe Day, took on this topic with
Edward Eun, actuary and head of retirement benefits consulting practice for
Watson Wyatt Korea who led an energetic roundtable discussion.
Mr. Eun pointed out that in December 2005 Korea's first corporate pension
law, the Employee Retirement Benefit Security Act or ERBSA, took effect as a
means to ease out of existence the above-described, 45-year-old severance
system. Related tax laws provides rewards of tax credits for defined benefit
and defined contribution schemes and in time will diminish the tax benefits
to employers who continue with the current severance payment schemes.
The change over to these new schemes requires majority consent of employees
or if the majority of the employees are unionized, the agreement from the
union, and as such there has been a good deal of resistance from the unions,
especially when offered a defined contribution alternative. Currently the
larger corporations are taking their time within the legislated 3~4 years,
until 2010, to make the transition while the small- & medium-sized companies
are moving faster upon analyzing the risks and benefits of these new
alternatives. The year 2010 is significant since after 2010, the external
funding vehicles of the current severance pay schemes will lose their tax
benefits.
Regardless, Mr. Eun forecasted there will be a major shift among several
companies away from the severance schemes about the end of this year. Many
employees like the idea of external investing of money, coming to at least
one month of their annual salary, to a third party investments.
As such, today many pension providers (insurance companies and banks) are
inundating HR managers with a mind boggling array of schemes and marketing
materials. But Mr. Eun warned that many of these new Korean pension
providers will merge or simply disappear in the next few years.
Employees and employers are now looking at three major types of retirement
funding – each with their own advantages and disadvantages. The employer can
continue to operate the traditional severance program, albeit with
decreasing tax benefits. This option is easy for both employee and employer
to calculate and to administer. But the employer must properly handle its
responsibility so that the program is not compromised by future liquidity
requirements. Yet even today this is often not the case. Still, most
employees wish to stay with the current scheme so long as they have faith in
the overall welfare of their company. At the same time, however, older
employees with their accruing huge severance liabilities become increasingly
less attractive for employers to retain.
The employer-funded defined benefit schemes are more complicated for the
employer to administer, but like the severance program, is easy for the
employee to appreciate or calculate future benefits. They are also much
safer for the employee should anything happen to the employer -- albeit, the
employee has to trust the third party will act responsibly.
The defined contribution schemes may be most attractive to younger employees
who may want to have some say as to how the pension money is being invested.
Employees can invest additional funds to these schemes beyond employer
contributions and can even receive tax deduction up to W3 million. Also,
unlike defined benefit plans, defined contribution schemes are transferable
as employees move among employers. But one must remember that defined
contribution schemes are quite new to Korea and as such require a great deal
of employee education. All countries go through this kind of learning curve,
and based on past experience, while this kind of scheme is currently not so
attractive, we can expect its popularity to skyrocket once younger employees
catch on to its benefits.
Nonetheless, with salaries inflating roughly 6~7% per year, albeit slowly
lessening in percentile increases year by year, the rate of growth of
pension program benefit remains higher with the severance payment schemes
and defined benefits than defined contribution offerings. In time, this is
likely to change as the Korean economy matures and average income increases
come in line with most modern economies.
Given all of this, changes are taking place. In the past when employees
terminate, very few use the lump sum from the severance program to purchase
an annuity program. Much to the Government's concern, many former employees
basically blow their sudden, temporary wealth on real estate, vacations,
cars or small businesses – only to find themselves in great financial
difficulty a few years later. To off set this, there are now special tax
advantages to encourage the purchase of annuity programs.
Within this context, the Government has a scheduled in tax benefits and
penalties to move employers away from the severance payments on to these
safer pension programs. Amazing enough, there are no formal pension trustees
in Korea who carry the liabilities of fiduciary responsibility. The closest
to such are designated pension program custodians, such as banks and
insurance companies, who act on the employers' instructions. The reason for
this is the new pension options are based on the Japanese model, and in
Japan there are no pension trusts. Also, during the new law's formation, the
big pension providers lobbied heavily against the establishments of
trusteeships so as to maintain greater control of these funds.
The British Chamber's Business Breakfast participants' overall consensus was
that while the Government is pulling the market in the right direction, the
tax incentives to wean employers and employees from the traditional
severance program are inadequate. At the same time, the pension programs
need to better address the current investment mentality of most Koreans that
tends to address investment opportunities within the 3~5-year horizon rather
than the say 35-year timeframe of a full career ahead of a young employee.
Nonetheless, most Koreans will in time become savvier in spreading out their
long-term, personal investments into more diverse instruments. It's all a
matter of Korea eventually moving on up to the next level of advanced market
sophistication.
Tom Coyner, a long-term resident in Korea, runs consulting
firm, Soft Landing Korea.
Coyner can be reached on softlandingkorea.com.
|
