Being ready for retirement
Changes everyone should be aware of about pension system
By Towers Watson
It is now just over six years since Korea enacted the Employee Retirement Benefit Security Act (ERBSA) that introduced defined benefit (DB), defined contribution (DC) and independent retirement account (IRA) plans. Since then, over 3.3 million individuals have become members of retirement pension plan and the total pension assets stand at around 50 trillion won at the end of 2011.
Pension market in Korea continues to grow rapidly and competition is fierce among its 57 registered service providers. As assets grow, so do the fees that corporate sponsors must pay their service providers, and demand for greater value-add is slowly emerging, as service providers seek ways to more effectively appeal to both corporate sponsors and plan members.
The fiduciary role of the sponsor remains challenging, as both the size of assets they must administer increases ― which raises the stakes, and the number of service providers and products grows ― which makes it difficult to compare them effectively.
Over the last few years, the retirement pension market has been extremely active with intense competition among the larger service providers. While growth in pension markets has been reasonable, this has lagged behind general expectations.
The government has recently introduced changes to the existing regulations based on feedback from market participants on how to promote growth in the pension market and prevent over-competition amongst the service providers.
During 2011, several revisions ― submitted in 2008 by the Government ― to ERBSA were passed resulting in a number of significant regulatory changes. A number of regulations will be effective starting from July 2012.
Most of the revisions are part of the government’s efforts to ensure old age income security. Furthermore, the revisions address some of the key issues with ERBSA which was originally introduced in 2005. These include, but are not limited to, inflexibility of corporate pension design, membership opportunities limited to company employees, insufficient protection of DB members’ pensionable rights, and early withdrawal of benefits leading to insufficient retirement income, as well as unclear responsibilities and lack of guidelines in terms of sales practices. It is our belief that these regulatory changes will have significant positive effects on the pension industry.
Changes impact on service providers
Service providers have been offering high interest rates on their principal- guaranteed products in order to attract new clients. In addition, service providers have been selectively declaring different rates for different clients. This has resulted in the Government issuing administrative guidance on the rates that service providers can offer on their products, resulting in a cooling-down in the hyper-competitive markets to date.
The regulations were amended in June 2011 and a new one-year administrative guidance on interest rate was introduced. Service providers of principal guaranteed products are required to assess the risks taken in their investments backing the product and establish an interest rate which commiserates with the risk being taken. This is termed the “screened” rate. In the case where the interest rate declared is higher than the “screened” rate, the service providers must submit to the Financial Supervisory Service (FSS) the risk committee's resolution and evaluation report.
There is currently an unhealthy tendency for service providers ― banks, insurance companies and security firms ― to offer their own "principal-guaranteed" products and the investment weighting to these products are generally high. These in-house products usually help the service providers generate revenue for their non-retirement businesses. Service providers may not be looking after the sponsors’ best interest when placing their retirement plans in these products.
Principal-guaranteed products established under insurance arrangements are treated differently. The underlying investments are generally GICs and these are managed in a separate account independent from the assets of the provider. Hence, even if the service provider faces financial difficulties, given the assets of the GICs are separate from the provider’s own assets, these are earmarked for the principal-guaranteed product, therefore mitigating financial losses faced by Sponsors and Members. Furthermore, GICs are also protected by the Depositor's Protection Act.
As such, a cap of 70 percent was introduced, limiting investment in the service provider’s in-house principal-guaranteed products established under trust agreement. This rule will only apply to new contracts and excludes smaller accounts. (1 billion won for DB plans; 50 million won for DC and IRA plans within the limits set by the Depositor's Protection Act)
The current method of disclosing the annual average return on total pension reserves does not allow meaningful comparison of returns by product type. The new requirements will seek monthly reporting of investment returns and split the component of returns into two categories - principal-guaranteed and return-seeking products. In addition, the maximum and minimum declared returns on DB plans will be disclosed. The periods for disclosure will be reduced to quarterly / monthly from annual so that any distortion of return on reserves can be prevented. This monthly reporting should increase the quality and transparency of information available to Sponsors and Members.
To date, there have been no rules regulating sales activity, and providers used their existing sales staff. The new revisions to ERBSA place restrictions on the service provider's sphere of sales activities and dictate the qualification of external sales representatives and their work requirements which are to be established via Presidential decree. This change should raise the overall quality profile of the retirement pension market.
Changes impacting sponsors and members
Due to complexity and costs, the majority of retirement pension plans have been set up by large corporate. As of Dec 2011, large companies with 500+ employees had adoption rates of 84.6 percent in contrast to small companies with less than 100 which had adoption rates of 9.1percent. In order encourage smaller firms to adopt retirement pension plan, service providers will be able to establish “pooled” DC plans which allow several companies to jointly participate, thereby reducing the burden of adopting a new scheme. However, close monitoring of the actual fees charged and ability for the pooled arrangement to reduce Sponsor’s administration costs will be required.
To date, each employer has been able to simultaneously operate both DB and DC retirement plans but individual employees were only allowed to be members of one plan (i.e. they had to choose). New regulations have been passed that allow Employers to set up joint plans with a fixed ratio of asset weights to both DB and DC (e.g. 60 percent DB and 40 percent DC), allowing Employees to be entitled to both DB and DC benefits. Employees do not have freedom to determine the weights between DB and DC. The Employer sets up only one joint plan and allows Employees to choose to enroll in the joint plan or the existing DB or DC plan. This is expected to provide more flexibility to Employers in structuring their retirement benefit program.
DB plans must meet minimum funding requirements ― currently set at 60 percent and expected to increase going forward per Presidential Decree. However, the previous pension legislation did not require service providers to inform Sponsors of their account balances and pension funding ratios. Under the new regulations, service providers must inform Sponsors of their funding balances and whether they meet minimum requirements in a timely manner. Notification is required within 6 months after the end of fiscal year.
Retirement savings via Severance schemes lacked continuity because of Employee tendency to withdraw savings prematurely. To resolve this issue, the government has capped early withdrawal (i.e. withdrawal before reaching retirement age) to within 50 percent of savings as dictated by Presidential Decree. Similarly, secured loans are capped at 50 percent of savings under DC, IRA, or IRP. Both early withdrawal and secured loans are restricted to three specific cases. 1) Home purchase for those currently does not own a property, 2) Long-term (6 months) illness of the Member of his or her immediate family members, 3) Certain conditions as dictated under the Act of Ministry of Employment and Labor (i.e. natural disaster or incident).
Introduction of a collective retirement account: IRP (Individual Retirement Plan)
IRP is a broader definition of IRA and will eventually replace IRAs. It is more flexible in that unlike IRA, it allows portability for previous DB and DC members. Upon changing jobs, an employee’s retirement savings will be transferred to the IRP. Given tight restrictions allowing withdrawal, the IRP functions as a retirement account which aims to pool all previous retirement benefits together and manage funds for financial security in old age. From 2017 and onwards, independent workers and contractors will be allowed to set up their own IRPs. However, both IRP and IRA plans may be "cancelled" prior to retirement with minor penalties.
Mandatory adoption of retirement pension for newly established firms
In general, awareness of retirement issues is low. Retirement pension plan as introduced in 2005 was cumbersome in that it required a labor-management agreement prior to adoption, resulting in lower-than-desired adoption rates, especially for small and medium sized companies. Retirement pension plan has now been revised to require newly established companies to set up their retirement pension plans within a year from the date the business was incorporated. The opinion of the representative of employees can be reflected in introducing pension plans.
As our report suggests, there have been a number of important changes to ERBSA and other regulations in 2011 that not only service providers but also companies and employees must be aware of. These are expected to resolve some of the issues in the existing system and thus we expect this to have a positive impact on pension markets.
This article was provided by Towers Watson.