extending coverage of the formal sector scheme in korea extending the coverage of the formal sector...

Extending Coverage of the formal Sector Scheme in Korea

Extending Extending the Cthe Coverage of overage of the the FFormal ormal SSector ector SSchemecheme

in Koreain Korea

Wonshik Kim wonshik@kku,ac.kr

December 1, 2006

National Pension in Korea 2


ContentsI. IntroductionII. The System of National Pension

in KoreaIII. What Korea Does for the Future of

National Pension IV. Policy Directions for

Workplace Based PensionV. Conclusion: Experiences of Korea

3Extending Coverage of the formal Sector Scheme in Korea

I. Introduction


Introduction

Accelerated Population Aging in Korea Very low fertility rate: 1.15% in 2004 Higher longevity: 74.3 for men, 81.2 for women

Strong Demand for Safety net: Major environmental changes in social insurances since the 1960s Workers’ compensation since 1963 Health insurance since 1980 National pension since 1988 Employment Insurance since 1994 Now, the above four social insurances cover all population Long-term care are expected to be launched in 2007.

I. Introduction


Step-by-Step expansion of National Pension Coverage Implementation of National Pension to workplaces with

more than 10 full-time employees in 1988 Expansion of the coverage to workplaces with more than 5

full-time employees in 1992 Expansion of the coverage to the farmers, fishermen and all

residences in rural area in 1995 Expansion of the coverage to urban self-employed in 1999

Workplace-based scheme: full time workers in a firm with more than or equal to 5 full-time employees

Individual-based scheme: the remaining workers of the firms with less than 5 and more than one full-time employee and their employers Rural insurants: farmers and fishermen Urban insurants

I. Introduction

Introduction-continued


Lower participation leads insufficient benefits for retirement and more government assistances to fill up the pension gap (= minimum living cost of aged – pension received)

Sustainability: Trade-off in policy goals under incomplete information High enforcement and underreport of income True income revelation and voluntary participation Higher enforcement lead distortions of informal labor

market behavior Avoidance of paying contributions of social insurances,

overall The financial instability of National Pension The break-even of cash follow is expected in 2036

150 billion Dollars is accumulated as a pension fund. 800 billion Dollars as a present value is expected in

2036.


I. Introduction


The depletion of pension fund is expected in 2047 Low contribution high benefit structure ROR on pension fund was 12-3% in 1990s. Average lifetime of Korean was about 67 years in the

late 1980s. i.e. financial market risk and longevity risk would

contribute the future deficit of national pension.


I. Introduction


II. The System of National Pension in Korea


Basics for Evaluation

High compliance of workplace based scheme and Low compliance of individual based scheme until 2003 High administration cost of individual based scheme for

small sized workplaces (formal sector) Unclear income records for their employees Informal labor contracts of formal sector Frequent move of their offices Frequent in and out of business

Less than five full-time employee workplaces are excluded Exclusion of irregular employees in the formal sector for

various fringe benefits, such as safety nets. Unintended discrimination against irregular employees Poor irregular employees have no interest on national

pension because of their burden on contributions



Large share of informal sector in Korean labor market 50% of employees are irregular workers 40% of labor force on their own business

Strict business accounting is not required for small firms. Contribution deals between employees and employers ar

e possible. Outside auditing system is not enforced for midium and s

mall firms. Two different aspects in extending formal sector scheme’s c

overage Irregular employees of medium and large workplaces

Expandable by various enforcement measures Employees of small workplaces

Expandable by incentives

Basics for Evaluation-continued



Policy Alternatives – for the poor – causing confusion: Participate? Contribute?

Aged Allowance for the aged over 65 Basic Living Cost Guarantee Act (2000) Basic pension financed by government revenue (discussion

on reforming National Pension in progress by politicians) It is an assistance, not pension.

EITC (discussion in progress by government) Corporate pension transformed from mandatory severance

Pay in 2005 i.e. negative signals in decision on participation of National

Pension for poor working groups

Basics for Evaluation-continued



Major Contents of Workplace Based Scheme

Coverage All employers and employees at (formal / informal)

workplaces with more than one full-time employee Those not included in full-time workers:

Daily workers / workers with a contract that lasts less than a month

Workers who are not employed for continuous purposes, such as part time workers with less than 80 hours per month.

Under 18 years old and more than 60 years old



Contribution is equally shared between employers and employees: 4.5% each

No income record for small workplaces Very poor accounting system, even in

some professional offices such as lawyer and physician’s office

Negotiation on contribution between them are liable.

Major Contents of Workplace Based Scheme-continued



Major Contents of Individual Based Scheme-continued

Coverage: those who are neither in workplace based scheme nor voluntary insured, for example: the self-insured Irregular (temporary and daily) workers and part-time

workers in a workplace with more than one full-time employees

Non-income earners

Contribution of 9% of their income is fully burdened by the individual based insurants

Voluntary report system of income for contribution



The Benefit Schedule for both

Pension Benefit= 1.8* (A+B) * (1+0.05N) A: The average monthly income of the all workers B: The average monthly income of the insured

workers N: The number of insured years in excess of 20 years

A is the redistributive componentB is the proportional component to individual

worker’s income



<Table> The Trends of Insurants by Scheme

Total

Insured

Workplace based Individual Based(B) (A) A+BWork-places

Insured (A)

Urban Rural

’88. 12 4,432,695 58,583 4,431,039 - - 100.0

’95. 12 7,496,623 152,463 5,541,966 - 1,890,187 74.6

’99. 12 16,261,889 186,106 5,238,149 8,739,152 2,083,150 32.6

’01. 12 16,277,826 250,729 5,951,918 8,132,036 2,048,075 36.9

’02. 12 16,498,932 287,092 6,288,014 7,997,593 2,007,196 38.6

‘03. 12 17,181,778 423,032 6,958,794 7,902,223 2,062,011 41.1

‘04. 12 17,070,217 573,727 7,580,649 7,403,424 2,009,142 44.6

‘05. 02 16,903,872 587,466 7,610,043 7,250,514 1,972,256 45.2



The Three Steps for Expansion from 2003

Three steps to expand the coverage of the workplace based pension from 2003 First, irregular employees of workplaces, with more

than one employee, that were corporations and professional offices in 2003

Second, workplaces applied by national health insurance and employment insurance, that did not belong to the first step in 2004

National health insurance and employment insurance have higher participation.

Their risks (Health risk and unemployment risk) are more urgent than that of pension

Third, the rest of the workplaces in 2006



57.8% of the newly insured were exempt from contribution in the first step of workplace based scheme expansionThe reasons for exemptions from expanding of workplace coverage: Close-out or out of business (31%) Unknown address (28%) No employees (22%)

The average reported income of the newly insured was lower than average income of the existing workplace based insurants by ~15%

The Three Steps for Expansion from 2003-continued



Why did Korean government expand the coverage of the workplace based scheme excessively? Lower management cost was expected

Employers (not employees) obliged to pay contribution

Half the burden of the insurants compared to that of individual based scheme

Deep worries for the rapidly aging population Recent social demand for policies favoring

irregular workers and their organized strong voices




What is the problem of the excessive expansion of Workplace based scheme? Frequent mobility in workplaces and employees

for the targeted groupsDifficulties in tracing insurants

Avoidance of employers to pay contribution of their employees

Changes in employees' actual statusChanges in employees’ status into fictitious one

Pay with cash without payroll recordsIgnorance of their duties to pay contribution




Lower pension benefits of existing workplace based insurants - lowering average income of all insured in benefit formula

complaints of the existing workplace insurants




<Table> The Result of the First Step Workplace Expansion

(Dec. 2003)Targeted Insured Exempt Missing Participa-

tion rate

New workplace

Total Workplace 107,707 107,661 87,093 20,568 80.8

Workers 232,845 232,845 187,800 45,046 72.2

Corporation Workplace 57,212 57,212 41,288 15,924 72.0

Workers 129,098 114,166 82,835 31,331 64.2

Professionals Workplace 50,449 50,449 45,805 4,644 90.8

Workers 118,679 118,679 104,965 13,714 80.2

Existing workplace (irregular workers over 5 full time employee firms)

Workplace - 50,449 12,477 - -

Workers 215,962 215,952 44,009 171,943 20.3



<Table> The Average Reported Income of the First Step Workplace Expansion

unit: thousand WonTotal The Expansion of Workplace Expansion of EmployeesTotal Corporation Professional

1,517 1,637 1,387 1,833 1,006

Why are they lower their reported income? No incentive to save money in national pension for

retirement: out of their pocket No measure to monitor the reported income The lower reported income, the higher rate of return on the

contribution



<Table> The Mobility of the Insured to Workplace Based

Scheme

Classification Total Pre-expansion of workplace based scheme Others(missed)

Sum Incomereported

Exemption

1st Step Insured 231,809 167,830 153,900 13,950 63,979

% 100.0 72.4 66.4 6.0 27.6

2nd Step Insured 221,404 180,190 174,250 5,940 41,214

% 100.0 81.4 78.7 2.7 18.6

Unit: person



<Table> The Difference of the Reported Income under

Different Schemes Unit:

Thousand WonUnder Individualbased Scheme (A)

Under Workplacebased Scheme

(B)

Difference(=(B)-(A))

1st Step Total 1,705 1,674 -31

Professional 3,256 3,105 -151

Others 1,253 1,295 42

2nd Step Total 1,551 1,432 -119

Employers 2,051 1,819 -232

Employees 1,158 1,127 -31



<Table> The Result of the Third Step Workplace Expansion

(June 2006)

Targeted Insured Exempt Undecided

Workplaces Number 173,814 57,942 115,389 483

Ratio 100.0 33.3 66.4 0.3

Workers Workers 271,305 103,099 164,713 3,493

Ratio 100.0 38.0 60.7 1.3

<New Insurants>

Total Employers Employees

Reported Income 1,367 1,668 1,088

<Average reported Income of New Insurants>Unit: thousand Won



III. What Does Korea Do for the Future of National

Pension?


Basic Pension: Suggested by the minority party Guarantee basic cost of retirement: 20%

replacement ratio is demanded by the largest minority party

Not contributory and Tax financed: government burden too heavy

It can be a policy for the low income workplace employees and exempted participants of individual based insurance

III. What does do Korea for the future

What Does Korea Do for the Future of National Pension?


Old aged allowance Over 65 aged income tested allowance Government is expected to increase beneficiaries

to about 60% of the aged over 65 – as a complimentary of pension reform

Individual based insurants can expect to be benefited

Earned income tax credit Expected to be introduced in 2008 Maximum amount to be 800 thousand Won (about

800 U.S. dollars). Income records are available for self-employed or

irregular workers


- continued



Integration of the collections of the four social insurances and the Collection Agency under IRA Pro

It may raise efficiency in the process of collection / decrease administration cost

More income record and insurants’ information are available

Reduce labor force required in social insurance agencies


- continued



ConOther agencies without the certainty of

efficiency enhancementThe income records of self-employed and

irregular workers do not exist in the real worldSeparation of the revenue and expenditure does

not lead to efficiency in managing risk: check and balance is not possible within a system

The borderline of the functions between IRA and Collection Agency is not clear: competition between growth and redistribution in government financing


- continued



IV. Policy Directions for Workplace Based Pension

Scheme


Policy Directions for Workplace Based Pension

Mandatory expansion should be reconsidered Low compliance ratio Hard to monitor reported income Other safety-nets are not sufficient

Housing Health care Workplace safety Long-term care i.e. the priority of retirement is still low.

Strong enforcement raises administration cost Job mobility eventually equalizes their contributions in the

long run.

IV. Policy Directions for Workplace Based Scheme


Flat rate contribution can be considered for small workplaces Actual income record is not available Unequal treatment on income sources between workplace

based and individual based scheme Workplace insurants: contribution on labor income Individual insurants/self-employed: contribution on

labor income and their capital income from their workplace

Keep pace of expansion with the development of labor market High share of informal sector in the labor market

Policy Directions for Workplace Based Pension -

continued



To give credit for the firms which allow qualification of their irregular employees for workplace based pension. In accounting, lump-sum labor cost for irregular

workers with ID can be induced to be reported. Fixed contribution for the reported irregular

workers.

To adopt employee friendly policies: mini loans, micro financing, etc


continued



To separate budgeting system between workplace based and Individual based schemes or financing methods of “A” based benefit and “B” based benefit Now

Cross income subsidy between the two. The existing low income workers suffer from loss of ben

efit The moral hazard of individual based insurants

Government finances the deficit of one of the schemes, for example, individual based scheme, “A” based beneift, or flat contribution scheme.

Income test based government subsidy for individual based insurantsReorganization of labor market in the long-run


continued




continuedWhat should we do with National Pension in case of Korean Unification? Flat contribution pension scheme should be

designed before Unification.



V. Conclusions: Experiences of Korea


Conclusions: Experiences of Korea

Misunderstandings on the National Pension A policy for the poor?

Excessively income-redistributive benefit schedule

A first generation’s problem should be granted? Excessive requests from the aged

Increasing aged allowance Expansion of the aged allowance coverage

Should the giant national pension fund be separated from the insurants? No actual relations between national pension

fund and insurants

V. Conclusion: Experiences of Korea


All monthly payments system for the aged is pension? Pension should be based on contribution.

Conclusions: Experiences of Korea-continued



National Pension is a financial product to be sold Incentives for the poor employees of small

workplacesIncome redistributionFlexible contributionCredits for the workplaces qualifying their

employees to the workplace base schemeConceptual separation of contribution and tax

Otherwise, aged allowance financed by tax




Income data system should be linked with those of other social insurances and matched with IRA income record

The payroll of the workplace workers should be kept in detail. Incentives for employers to participate in

qualifying their employees

Administration of the workplace based pension should be more flexible in complying the system: contribution is not a tax. Flat rate contribution may be allowed.




Optimal expansion of informal sector scheme exists! Administration cost Regulations as an incentive for employers

Conclusions: Experiences of Korea - continued


National Pension in Korea 44


Thank you!

extending coverage of the formal sector scheme in korea extending the coverage of the formal sector...

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