Reform on Pension Fund Governance and Management - The 1998 Reform of Korea National Pension Fund

During the past two decades, Korea went through an irreversible process of political democratization
and market-oriented economic reform. The authoritarian government‘s submission to the democratization movement in June 1987 and the outbreak of financial crisis in November 1997 were the key triggering events. But, it was in December 1997, when these two movements elevated to become the nation‘s top agendum. Immediately after confirming his victory in the presidential election, Kim Dae-jung delivered a speech and declared that he will pursuit democracy and market economy in parallel.

The reform of Korea National Pension Fund (hereafter NPF) in 1998 is one of many reforms that took place during the early years of Kim Dae-jung‘s presidency. The reform, however, is interesting in a sense that it is driven by both principles at the same time: democracy and market economy. The reform democratized the management of NPF by filling majority of seats in the NPF Management Committee with non-government civilians representing pension policyholders. The reform also abolished the practice of NPF surrendering pension surplus into the hands of government bureaucrats. With the reform, surplus funds are now invested in the market and significant portion of the fund is managed by external managers in the private sector.

The objective of this paper is to give detailed chronological accounts of this governance-cummanagement reform of NPF and to analyze its success factors, hoping to draw lessons for other countries. It is worth noting that the reform this paper focuses is limited to governance and management reforms. In other words, financial sustainability issues relating to the Korea National Pension System are not covered.

According to the latest projections by the Ministry of Health and Welfare (hereafter MOHW) in 2008, NPF – the reserve fund of National Pension System – is expected to growth substantially, peaking in 2043,and then shrink rapidly, completely depleting in 2060. A very brief discussion on this issue is provided in the next section.3

Although, the governance and the management issues of reserve fund are secondary to the financial
sustainability issue, they are important policy agendum in and of themselves. First, better governance and management structures can improve the returns on NPF and this, in turn, can postpone the year of its complete depletion.4 Second, by limiting the amount of funds government can borrow from NPF, governance and management reform measures can act as a fiscal disciplinary mechanism against the government. A strong fiscal position will become critical in later years when NPF gets completely depleted and Korea needs to proceed to a pay-as-you-go system. Third, a mega-sized fund with a long investment horizon following global best practices in investment management can have a positive spillover effect to the local asset management industry. For example, external managers complying with the investment performance reporting standards set by NPF and new types of asset management companies emerging with NPF‘s increased investment in alternative asset classes are just a couple of examples. Fourth, a governance environment that mandates NPF to solely pursue the best interest of its pension participants/recipients can place NPF in a better position to engage in shareholder activism, which, in turn, improves the governance of public corporations in Korea.

OECD also takes the matter of pension fund governance seriously, and in 2002 adopted the OECD
Guidelines for Pension Fund Governance.5 The International Social Security Association (ISSA), which is an international organization bringing together national social security administrations and agencies, also adopted its own guidelines in 2004 (Guidelines for the Investment of Social Security Funds). In 2008, countries with sovereign wealth funds and the IMF announced the Generally Accepted Principles and Practices (GAPP) – also known as the Santiago Principles – for sovereign wealth funds, which include sovereign pension reserve funds.

This paper is organized as follows. Section 2 gives an overview of the National Pension Scheme.
Section 3 gives chronological accounts of the 1998 reform, and section 4 discusses the success factors. Section 5 goes over the remaining issues, Section 6 provides a review of NPF governance versus OECD guidance and Section 7 concludes.