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South Korea: Funding requirements for defined benefit pension plans strengthened

Retirement
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March 29, 2018

The South Korean government announced future increases to the required funded status target for employer-provided defined benefit pension.

Employer Action Code: Act

The Ministry of Employment and Labor (MoEL) recently announced future increases to the required funded status target for employer-provided defined benefit (DB) pension (effective January 1, 2019), and a higher penalty for noncompliance with funding recovery plan requirements (effective January 1, 2018).

KEY DETAILS

  • At present, any DB plan that employers sponsor is required to target at least an 80% funded status (i.e., value of plan assets divided by plan liabilities) as of each financial year-end. The 80% funding objective has been in place since 2016. The DB plan liability at each financial year-end is measured as the greater of the value on an ongoing basis (actuarially determined) and on a termination basis (leaving service benefit entitlement).
  • The required DB plan funding target will increase to:
    • 90% for company financial year-ends between January 1, 2019, and December 31, 2020
    • 100% for company financial year-ends on or after January 1, 2021
  • Related requirements that are largely unchanged by the recent government announcement include:
    • If the plan’s funding level is below 95% of the applicable funding target, the plan sponsor must prepare a recovery plan to meet the funding objective over a three-year period. Once funding valuation results are received, the recovery plan should be in place and disclosed to the employees (or labor union) within 60 days, with noncompliance subject to a financial penalty. The amount of the penalty has been increased to KRW 10 million (US$9,400), from KRW 5 million (US$4,700), effective January 1, 2018. According to the government, only half of DB plans met the 95% funding level in 2017.
    • If the funding level exceeds 100%, then under the Employee Retirement Benefit Security Act (ERBSA), employers can use the surplus assets to offset contributions. If the level exceeds 150%, employers can obtain a refund of the surplus assets (above the 150% level).

EMPLOYER IMPLICATIONS

Plan sponsors should prepare for the potential increase in employer contributions the higher funding target could cause, and also reexamine elements that influence the level of contributions, such as liability calculation and investment strategy, as outlined below.

  • Liability calculation — In South Korea, DB plan sponsors may delegate funding liability valuations to pension providers, with the results becoming available within six months of the financial year-end. In this situation, sponsors should consider periodically arranging for an audit by an independent third-party actuary to evaluate the appropriateness of the actuarial methods and assumptions used in the valuation, and their application to the plan’s design. Audits are not required by law but can support good plan governance by monitoring and controlling risks associated with funding valuations.
  • Investment strategy — Over 96% of DB plan assets are currently placed in products with short maturities, with interest rates (generally under 2%, net of management fees) that are not sufficient even to keep up with liability growth generated by salary increases (generally 4% to 5%). DB plan sponsors should examine whether a longer-term investment strategy is appropriate based on the longer-term durations of their DB liabilities. Potential outcomes of such a strategy include higher investment returns and lower employer contributions over the long term.

Updates on other current retirement-related matters that could impact employers:

  • The MoEL has not yet announced a decision on the proposed mandatory adoption of corporate pension plans by 2022. It will be discussed again in the National Assembly in 2018.
  • The introduction of a trust-based funding structure for DB and defined contribution (DC) plans is also still being reviewed by the government.
  • There has been an increase in the popularity of incentive DC programs, where incentive bonuses are partially or fully contributed to employees’ DC accounts and taxed eventually as retirement income rather than as current income.
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