The South Korean National Pension Service (NPS) is the third-largest national pension fund in the world with US$560 billion in assets. It was founded in 1988 to ensure that all South Koreans after retirement would have a stable source of income. Currently, a certain amount of money is automatically deducted from the salaries of employees and employers as a contribution to the NPS by law.

However, many Koreans worry that the NPS will run out of funds in the near future, which means the current older generations would benefit at the expense of younger Koreans in their 20s and 30s. There have been numerous research papers analyzing at which year the NPS is expected to run out of funds.

For example, an article in The Korea Herald predicted that NPS fund would be depleted by 2057 under the current system as it is expected to post shortfalls starting in 2042 due to the low birth rate coupled with sluggish economic growth. Such alarming reports, combined with a recent announcement that the NPS was considering increasing obligatory contributions from employees and employers, have sparked controversy to the extent that some people say that pension contributions should be optional, not mandatory.

Are there ways to overhaul the seemingly precarious NPS and improve its profitability in the long run? Several suggestions have been made.

Move HQ back to Seoul

The NPS moved its headquarters from Seoul to Jeonju, North Jeolla province, in February 2017 as a part of the government’s broad scheme for decentralization. As Seoul takes up a disproportionate amount of the country’s economic, political and cultural activities, many government agencies started moving into other regions in the 2000s.

While the government’s intention was noble in nature, its decision to force financial organizations to move away from Seoul overlooked an important aspect of the finance industry: Seoul had an established network of financial institutions, and moving away would mean isolation for finance professionals. In fact, financial institutions and services cannot be separated from the larger, broader economic activity of the entire country because the finance industry supports the real economy by channeling funds and providing necessary financial services for business.

On top of this, finance professionals need networks whereby they can effectively trade their products and services, exchange ideas and information, look for jobs in other companies and connect with other professionals working in the finance industry. In short, moving to Jeonju meant that any professionals working for the NPS would be cut off from their established network in Seoul.

As a matter of fact, The Korea Times reported, “NPS had 30 fund managers quit in 2016, following the plan to move its office to Jeonju, which compares with 2014 when only nine people quit.” It also had 27 fund managers leave in 2017. Many of senior positions are now empty, and, according to the website Pensions & Investments, “South Korea’s National Pension Service could be poised to lose two more senior investment professionals even as the pension fund announced a drive to fill 34 positions on its investment team.”

There are many other reasons these professionals have decided to quit, such as low compensation, but moving to Jeonju was definitely another nail in the coffin.

Pay asset managers more

Some professionals say that what draws them to work for the NPS is a sense of national service, as some say they are “proud to manage the assets of the Korean people.” However, in the end, what motivates professionals to work hard and feel their worth is their salary. In fact, NPS fund managers earn about 70% of the pay of their private-sector counterparts. That’s largely due to the constraints of being funded by taxpayer money and having the budget overseen by the Finance Ministry.

However, it really does not make sense that managers one of the largest funds in the world are only paid 70% of their private-sector counterparts in South Korea. Their responsibility is greater because of larger assets under management, yet they are being underpaid compared with the private sector.

Thus, one of the problems with the research on when the NPS will run out of funds is that the prediction for the exact year rests entirely on return on investment. In other words, a 1-percentage-point difference in the rate of return on $560 billion in the assumption can significantly change the prediction on what year will see depletion of the fund. An article from Chosun Biz says that if the total return increased by 2 percentage points, then the depletion date for the fund would be postponed by up to 11 years.

Source: National Pension Service

What is important, therefore, is to give incentives and appropriate bonuses to asset managers so that they can work really hard, feel their worth, and take responsibility for their investment decisions. It is not about increasing obligatory payments or using accurate measurements to predict which year the fund will run out; what matters is to give the managers their due and incentivize them to work harder to increase total return on NPS investments, thereby making the fund sustainable in the long run.

Less political interference

In 2015, a merger between Samsung C&T Corporation and Cheil Industries took place. The merger was successful because the state-run National Pension Service voted in Samsung’s favor, despite financial losses expected on its investment as a result. The Korea Herald reported, “US activist fund Elliott Associates has insisted the merger was possible because Samsung won implicit backing from the then Park Geun-hye government in exchange for illegal provision of massive funding to a friend of Park.”

In response, the NPS has adopted a new stewardship code to prevent such occurrences from happening again in the future. How much political interference has really taken place is unknown to the public, but it is obvious that such interference only demoralizes and dis-incentivizes the NPS to focus on its duty. The NPS should be able to maintain independence free from political interference in order to focus solely on its performance and profitability.

Lesson from Norway

Norway’s sovereign wealth fund is the largest pension fund in the world. Norway is a major oil producer and it transferred its first revenue to the fund, officially the Government Pension Fund of Norway, in May 1996. Since then, the fund has grown to become one of the world’s biggest investors in stock. It achieved a stellar 13.7% return in 2017 and 6.9% in 2016, thanks to global stock-market rallies.

Much of the success of Norway’s sovereign wealth fund is attributed to sticking to principle and resistance to political interference. According to the Center for Public Impact, the Norwegian government does not spend oil revenues – instead the full income from petroleum activities is invested in the fund. The government will only dispose of the expected yearly return on the fund, which was limited to 4% by its 2001 fiscal policy and reduced to 3% in 2017.

Such strict rules have consistently been enforced since the fund’s inception, and regardless of who was in charge of the Ministry of Finance, all administrations agreed on – and backed – the principles and objectives of the fund. The country also has a dedicated team managing the fund’s investment portfolio to secure long-term value and the creation of wealth for future generations.

In addition, the actors involved in creating and managing the GPFG display a strongly aligned interest in protecting its investment and safeguarding the Norwegian economy. Such an effective approach to protecting the fund’s interests and having a dedicated team of professionals, combined with political stability, has made it possible for Norway’s sovereign wealth fund become one of the biggest and most successful funds in the world.

In conclusion, the South Korean National Pension Service started with good intentions. However, its 30-year history is in jeopardy as return on investment plummeted in 2018. It will take structural reforms in establishing its independence and fundamental changes in its approach to compensating its employees and moving back the headquarter to ensure its long-term sustainability. Otherwise, Koreans will always be skeptical and worried about their contributions going into the NPS.

This article is originally from Joon’s Blog.