Tips on how to establish qualitative life plan

It has been six and a half years since the Employee Retirement Benefit Security Act (the ERBSA) was first implemented in Korea. The ERBSA allows employers to set up an externally funded and managed employer-sponsored retirement plan as an alternative to the more traditional mandatory severance pay system.

Changing corporate tax rules has encouraged many employers to make the switch to a corporate retirement plan. Statistics from the Ministry of Employment and Labor show that as of April 2012, over 150,000 employers covering over 3,600,000 employees had introduced a new plan, with assets under management of over 50 trillion won.

To date, companies in Korea have coped well with the initial transition to corporate retirement plans, whether they are defined benefit or defined contribution arrangements. The focus now switches to how best to manage the plans that have been established.

Towers Watson recently released the results of its 2012 Pension Governance and Monitoring Survey which provides an insight into how companies in Korea view the process of managing their retirement plans.

The Survey, which included a mixture of local-based and overseas headquartered companies, shows that companies appear to be reasonably satisfied with the service offered by pension providers, particularly in terms of HR support, employee education and the principal and interest guaranteed investment options offered by the providers. Indeed, only 6 percent of respondents said that they are not satisfied with the overall service they are receiving.

However, the results also show that as yet many companies in Korea do not have an effective structure in place for managing and monitoring their retirement plans. For example, only around a quarter of the Survey respondents have set up a governance committee to oversee the operation of the retirement plan. This is much lower than can be seen in other developed countries such as the United Kingdom or the United States where over 80percent of companies have a governance structure in place.

Similarly, the Survey shows that even where a governance process has been set up, Korean companies appear to be taking a light touch approach. For example, in Korea it is most common for a retirement scheme governance committee to meet annually. In comparison, in the United States, quarterly meetings are the norm with far greater participation from senior executives. (To insert figures)

Another telling statistic from the Towers Watson Survey is that more than 90 percent of participants in Korea utilize their retirement plan provider as their main source of pension related information. Whilst the retirement plan providers can be an excellent source of information, they are not able to provide independence when it comes to monitoring plan performance.

In part, the lower level of retirement plan governance that we see in Korea reflects differences in the legal and regulatory framework. For example, in the United States, choosing a retirement service provider is viewed as a fiduciary duty, placing various obligations on employers including the need to establish and follow a regular review process. There have also been a string of lawsuits in the United States against fiduciaries, including employer sponsors resulting in several multi-million dollar payouts.

The ERBSA in Korea also includes measures designed to promote good plan management, such as the requirement to provide education to employees at least once a year. However, to date many of these actions have been delegated by employers to the retirement plan providers.

With or without a legal obligation, there are significant benefits to employers from implementing a retirement plan governance strategy. Poor governance introduces a risk of the plan being seen as poor quality with the accompanying reputational, recruitment and retention risks. On the flipside, improving member understanding of, and confidence in, the retirement plan, can significantly increase appreciation of the value of the employer's contribution.

In terms of direct impact, a good governance process can be very effective in identifying and preventing problems around operational issues such as the administration service, the payment of contributions and benefits and compliance with the legislative and regulatory requirements.

However, the benefits of a good governance process go well beyond operational matters. Qualitative governance, which considers whether the plan is operating in the interest of employees, and looking for ways to improve the “employee experience” is also important.

For example, in countries with a longer history of defined contribution schemes than Korea, it is very common for a governance committee to monitor whether the investment fund range is appropriate, the investment managers are performing adequately and members are being communicated to effectively.

Whilst not all of the overseas trends are applicable to Korea, there is much that can be learned from overseas governance practices, particularly in terms of how companies identify and manage potential risks. In particular, Towers Watson believes that every company should have a documented retirement governance process and be able to answer the following questions:

1. Do we have clear objectives for our plan?

2. How should we measure and monitor the performance of our plan?

3. Do we understand our membership circumstances and needs?

4. Have we identified and mitigated the various risks in operating the plan?

5. Are we prepared for future changes?

This article was contributed by Towers Watson Korea.

Defined benefit schemes versus defined contribution schemes

Under ERBSA, two types of benefits are permitted, defined benefit or defined contribution. In a defined benefit plan, the benefit an employee receives is linked to his or her salary at retirement and the length of service with the employer. This is very similar to the traditional severance style of benefit.

In contrast, in a defined contribution plan, the employer makes regular contributions to an individual investment account in the name of the employee which is invested based on choices made by the employee. The benefit the employee receives then depends on the investment returns earned on those contributions. This shifts the investment risk, both on the upside and downside, to the employee. As a result of this transfer of risk away from the employer, in many developed economies such as the United States and the United Kingdom, defined contribution schemes are now the norm, particularly for new hires in the private sector.

In Korea, the shift to defined contribution has not progressed as far. In part, this is because companies in Korea need to get the agreement of the majority of employees or their union, as appropriate, before a new retirement scheme can be introduced. Nevertheless, there are already over a million defined contribution scheme members in Korea and the numbers are growing rapidly.

This article was provided by Towers Watson Korea.