Paper to be presented at the Congress of KEA-APEA 2017 Conference

The Effect of both the National Pension and the Basic Pension on Alleviating the Poverty of the Old-aged People over 65 in Korea

Seung-Hoon Jeon

ABSTRACT
Our paper analyzes the effect of the social security on the retirement decision and the poverty after retirement, using the Korean Labor and Income Panel Data (KLIPS), and investigate the effect of changing the BOP system into the BP system on it. Main empirical findings are as follows: first, poverty ratio of the old-aged in terms of the current income is 64.7%, and adding it to BOP or BP are 59.8% and 55.9%, respectively. These confirms that BOP or BP alleviates the poverty of the old-aged. Second, estimates from the bivariate probit model says that the social security system directly decrease the probability of falling into poverty trap after retirement. Third, simulation results of changing the BOP system into the BP system makes a probability of the poverty after retirement increase, since BP system decreases life time pension wealth. In other words, annual BP benefit is larger than BOP system in the short term, but vice versa in the long run. It is due to BP benefit’s connection to a subscribing period of the national pension. 

Keywords: National Pension System, Basic Old Pension system, Basic Pension System, Retirement Decision, Poverty, Bivariate Probit Model
JEL Classification: H3, I3, J2 

I. Introduction

This paper analyzed the effect of the social security system on the poverty after retirement by using the Korean Labor and Income Panel Data(KLIPS). Especially, we investigate the effect of the introduction of the Basic Old age Pension (hereafter, BOP) and the Basic Pension (hereafter, BP) on the poverty after retirement. 
In 2007, Korean government revised the National Pension System Act(NPSA) and the amendment included the gradual decrease of income replacement rate of the national pension benefit from 60% to 40% based on 40 year-old subscription. It can be due to a long concern for the sustainability of the national pension fund. 
At that time, Korean government simultaneously introduced and implemented the BOP system. Tax financed BOP system was enacted in April 2007 and was put into effect in January 2008 to cope with the poverty of the old who is not covered with contribution based national pension system as well as the pensioners. However, there existed some doubts on the effects of the BOP system, since many people thought that the benefit of the BOP system which was 5% of the average income of national pension subscribers for the last three years was quite small. 
At last, the National Assembly passed the Basic Pension Act (hereafter, BPA) in May 2014. In the BPA, the basic pension benefit is calculated by increasing 5% of the average income of national pension subscribers for the last three years to 10% and its amount connects to the benefit amount of the national pension. To maintain the real value of the benefit, the BP benefit is indexed to the consumer price index, while the BOP benefit is indexed to the nominal wage growth rate. 
In this context, we can consider the different impact of the BP benefit on the poverty after retirement in both the present and future generation. The old-aged people in living at the present receives the BP benefits more than them in the future generation who might receive less BP benefits because of the connection for the national pension. It implies that the basic pension system is more favorable to the old in the present generation. We can also consider the relative size of the BP and BOP benefit. BP benefit is indexed to the consumer price index, while BOP benefit is indexed to the nominal wage growth rate. Thus, BP benefit is larger than BOP benefit in the short term, but BOP benefit will be larger than BP benefit in the long-run. This implies the importance of considering the effect of the lifetime BOP and BP benefit on the poverty to evaluate the introduction of the BP system.  
Until now, many researches attempted to examine the effects of the social security on the behavior of the old. Researchers such as Boskin (1977), Quinn (1977), Boskin and Hurd (1978), Burkhauser and Turner (1978, 1981), Clark et al. (1980), Burtless (1986), Gruber and Wise (1999, 20002, 2005), and Gustman and Steinmeier (2005) attempted to examine the effects of the social security program on labor supply and they concluded that social security wealth decrease the labor supply of the old and induce the early retirement, since higher social security benefits are guaranteed. Blinder, Gordon, and Wise (1980, 1981), however, showed that the provisions of the social security provided strong work incentives for older man, since highter current earnings lead to higher future socail security benefits. Other researchers such as Feldstein (1974, 1995), Gale (1998), Attanasio and Brugiavini (2003), and Attanasio and Rohwedder (2003) paid attention to the effects of the social security on private saving and they reported that the social security system crowded out private savings. However, Barro (1978) strongly argued that the introduction of social security was likely to induce private intergenerational transfers so that the effect of social security on private saving was reduced or eliminated. 
Compare with these previous researches, our paper develops the topic on the effects of the social security in 2 ways. First, we pay attention to the effects of the socials security on the poverty after retirement. Second, compare with most researches which have been used only a single decision model, our paper consider more than one decision simultaneously, focusing on the two sequential decisions: when to retire and poverty after retirement subsequent to the retirement decision. Investigation of this two sequential decisions leads to more accurate conclusions about the effects of social security since we can capture not only direct effect of the social security system on poverty but also indirect effect of the social security system on poverty which is based on the retirement decision. 
This paper is organized as follows: In the second chapter, we briefly introduce the pension system in Korea. In chapter III, we evaluate the effect of the public pension system on the poverty of the old generation. In this chapter, the effect of the public pension system on the poverty of the current old generation was analyzed by using the 15th wave of KLIPS. In chapter Ⅳ, we discuss the effect of the social security on the post-retirement poverty based on the results of the bivariate probit model: in this model, we estimate the early retirement equation and then estimate the post-retiremetn equation conditioned on the 1st stage early retirement decision. In chapter Ⅴ states the conclusions

Ⅱ. Pension System in Korea

1. National Pension System 

1.1 History 

In Korea, the National Pension System was enacted in February 1973 specifying how the national pension plan and its funding scheme would operate. This was the precursor for the National Pension Insurance Law enacted in December that year. The pension laws were to help ensure stability in the lives of the Korean people, and to promote public welfare through a pension scheme for people in need including the aged, those with incurable diseases, the financial dependents of deceased, and so forth. 
The new pension plan was originally scheduled to be put into operation from 1974, but an amendment was passed deferring implementation for a year in response to sudden economic instability in the wake of the Middle East oil crisis. A series of subsequent actions including further legislative amendment, a Presidential Emergency Measure and a presidential order enabled the government to stall enactment of the plan until 1986, and the National Pension Plan was finally put into effect in 1988.

1.2 Eligibility 

Initially, in 1988, only wage earners were covered under the national pension scheme. But, in 1999, pension coverage was expanded for the self-employed and now all residents in Korea from 18 to less than 60 years of age, regardless of their income, are covered under the Scheme. However, those falling under any of the following items are excluded from the coverage of the scheme even if they satisfy the general coverage criteria: The government employees, military personnel, private school teachers, and employees of specially designated post office. They are covered under their own pension plans. National Pension beneficiaries from 55 to less than 60 are also excluded from the coverage of the National Pension Scheme. 

1.3 Contribution

The contribution is calculated by multiplying the insured person's Standard Monthly Income by contribution rate which is 9%. The contribution rate will be adjusted afterward according to the financial recalculation planned to be conducted every five years. Monthly Income is the amount equivalent to the monthly income reported by an employer or the insured person, within the scope of a minimum of 220,000 Korean won (now after KRW) but not exceeding 3,600,000KRW. The Standard Monthly Income is a basis for the calculation of contribution and also is an important factor for the calculation of pension amount. 

1.4 Benefit Computation 

The pension benefit amount is generally composed of two factors. One is the basic pension amount(BPA) based on the current or former insured person's contributions paid in the event of the old age, the disability, the death, etc. The amount varies between the benefit types, the insured period, the age of the first benefit, the existence of income, the degree of disability, and so on. The other is the dependents' pension amount (DPA). This is additionally provided to pensioners (in the case of the survivor pension, the current or the former insured person) for their dependents. Therefore, the dependents' pension amount will not be paid to those who do not meet a recognition criteria regarding the livelihood support. Also, it shall not be provided under an active old-age pension. 
BPA is applicable only to an insured period of 20 years or longer. The factors determining the amount of the BPA are insured period, average income of all the mandatorily insured person and the insured person's average income during his insured period. Equation (1) is a formula of the basic pension rule adopted during 1998~2007. In this formula, the income replacement rate for an insured person with 40 years of the coverage is 60%
. 
                    (1)

A: the average of the price-indexed average monthly income for the 3 years prior to pension payment, 
B: the average amount of the standard monthly incomes of an insured person during the insured period. 
N: the number of insured months in excess of 20 years. Every month not exceeding one year is calculated as 1/12 year.  
P: the number of total insured months
P1: the number of insured months before December 31, 1998
P2: the number of insured months after January 1, 1999

Korean government made a reform of the national pension system in 2007 to be prepared for a rapidly ageing society as well as to ease the next generation’s burden through a long-term financial stability. After 2007 amendment of NPA, the formula of the basic pension rule is modified as eq. (2). In this formula, 60% of the income replacement rate will be adjusted to 50% in 2008, then reduced annually by 0.5% until reaching 40% in 2028.

    (2)

A: the average of the price-indexed average monthly income for the 3 years prior to pension payment, 
B: the average amount of the standard monthly incomes of an insured person during the insured period. 
N: the number of insured months in excess of 20 years. Every month not exceeding one year is calculated as 1/12 year.  
P : the number of total insured months
P1: the number of insured months before December 31, 1998
P2: the number of insured months from January 1, 1999 to December 31, 2007
P3: the number of insured months in 2008

1.5 Indexation of benefits

A price indexation system is adopted to maintain the real value of the pension amount. Accordingly, BPA and DPA, which are bases of calculating benefit amount, shall be adjusted in proportion to the rate of change in the Consumer Price Index every year. The adjusted pension amount is applied from April of the year through to the following March. 
 Accordingly, the reduced old-age pension for an insured period of less than 20 years, is calculated by multiplying the BPA by the payment rate based on the insured period. 

2. Basic old age pension(BOP) and Basic Pension(BP)

2.1 History 

In Korea, the BOP system was enacted in April 2007 and was put into effect in January 2008 to cope with the poverty of the old who is not covered with the National Pension system as well as pensioners. The National Pension system will be substituted with the National Pension system in July 2014.  

2.2 Eligibility 

BP as well as BOP cover the residents over 65 years, excluding the upper 30% income class. 

2.3 Contribution

BP as well as BOP are tax-financed pension system.

2.4 Benefit Computation  

Base benefit of the BOP is 5% of A-value in equation (1) and (2). Until 2028, base benefit of the BOP is going to increase gradually to 10% of A-value. 
Base benefit of the BP will be 200,000 KRW in 2014, which is 10% of the A-value. The BP benefit will be reduced in proportion to the NP benefit.

2.5 Indexation of benefits

Benefit level of BOP amounts to 5% of A-value in equation (1) and (2), and originally plan to escalate up to 10% of A-value until 2028. Under BOP, those recipients who have higher income or much wealthier are paid less benefits which is calculated considering the subtracted amount between the appraisal amount and the criteria income for selection. 
On the contrary, the basis income is set to 200,000 Korean Won as of 2014. However, they are paid a monthly allowance of 140,000 Won and 200,000 Won, depending on a recipient's income level in addition to what a national pension plan pays, if recipients may be a national pension subscriber. 
Note that the amount should be 80% of monthly allowance if recipients under two systems are a couple. 
BOP benefit is adjusted in proportion to the rate of change in the A-value every year. Because A-value is the average of the price-indexed average monthly income for 3 years prior to a pension payment, we can say that BOP benefit is indexed by a nominal income. 
The base benefit of the BP system will be indexed by a consumer price index every year, and an appropriation of the base benefit of BP system is set to evaluate in every 5 years. 

Ⅲ. Public Pension and the Poverty Ratio of the Old-Aged

In this chapter, we analyze the effect of the public pension system on poverty of the old aged 65 and over by using the 15th wave of the Korean Labor and Income Panel Data(KLIPS). KLIPS is a longitudinal survey of households and individuals residing in urban areas on their labor market and income activities. 
Analysis methods are as follows: first, a national pension in the old-aged people is used as a national pension benefit reported in the KLIPS. Second, the basic old-aged pension is paid 100,000 Korean Won per a household. Third, the basic pension is assumed to be 200,000 Korean Won for an old person who belongs to 90% of them, the rest 10% of them receives 100,000-200,000 Korean Won per a person. Fourth, the income class is divided into decile group in the basis of the income for the old-age person. A written recognition amount is a sum of the income and a amount resulted from converting the asset into the income. The ratio of the asset conversion is approximated to be 5%. 
Table 1 shows the monthly public pension benefit by income decile. NP benefit is reported value in the KLIPS, and BOP and BP benefit is calculated by the BOP and BP Act, respectively. It says that the lower income the higher the income security effect of the basic old-aged pension and the basic pension. 

<Table 1> Public Pension Benefit by Income Decile
(Unit: 1,000 Korean Won(KRW))	
	The old age 65 and over	
	NP	BOP	BP	
~10%	1.1 	100.0 	200.0 	
10~20%	10.7 	100.0 	200.0 	
20~30%	26.9 	100.0 	200.0 	
30~40%	36.4 	100.0 	200.0 	
40~50%	52.8 	100.0 	200.0 	
50~60%	53.3 	100.0 	200.0 	
60~80%	91.5 	931 	186.2 	
70~80%	105.7 	-	-　	
80~90%	144.9 	-	-	
90%~	247.7 	-	-	
total	77.2 	99.0 	198.0 	

Table 2 shows the effect of the public pension on the poverty ratio of the old. Poverty ratio of the old measured by the current income excluding BOP or BP is 64.7%. And poverty ratios of the old measured by the current income including BOP or BP are 59.8% and 55.9%, respectively. 
These results show that BOP and BP system have the effect to decrease the poverty of the old, and the effect of the BP system is large relative to the effect of the BOP system in the short run. However, in the long run, relative size of the effect to decrease the poverty may be changed. In the short run, BP benefit is larger than BOP benefit, so the relative size of the effect of the BP benefit to decrease the poverty is large. But, in the long run, due to the changes in the indexation system, BP benefit will be smaller than the BOP benefit, so the relative size of the effect of the BP benefit will be small. This will be analyzed in chapter Ⅳ, by using the lifetime BP and BOP wealth. 

<Table 2> Public Pension and Poverty Ratio of the Old-aged
(Unit: %, %p)	
Category	Poverty ratio	
Category	Income	Income + BOP	Income + BP	
Below 65 year-old	13.0	
The old-aged	64.7	59.8 (-5.0)	55.9 (-8.8)	
Total	25.4	24.2 (-1.2)	23.2 (-2.1)	

Ⅳ. Early Retirement and Poverty after Retirement

1. Data
In this chapter, we analyzed the effect of the lifetime pension wealth(LPW) on the retirement decision and the poverty after retirement by using the 1st~15th KLIPS data. We must know his retirement age, the pre- and post-retirement income level, and the lifetime pension wealth (LPW) to analyze the effect of the social security on the retirement decision and the poverty after retirement. Thus, among the KLIPS data, we eliminated the respondents who had already been retired in 1999 and who had not been retired yet in 2010. As a result, the number of observations is 460. 

<Figure 1> Retirement Age Distribution

The different retirement age distributions are shown in <Figure 1>. We can find that most people have been retired between 50 and 65. In this paper, we define the early retirees as individuals retiring before 60. Thus 207(45%) are early retirees in our sample. 
Table 3 shows post-retirement poverty of early retiree sample and normal retiree sample. Post-retirement poverty ratio of the early retiree sample is 33.8% while post-retirement poverty ratio of late retiree sample is 52.2%. This implies that those who earns more income and accumulates more wealth tends to retire early.

<Table 3> Early Retirement and Post-Retirement Poverty
	Post-Retirement Poverty	
	0	1	Total	
Early 
Retirement	0	121
(47.8%)	132
(52.2%)	253
(100.0%)	
Early 
Retirement	1	137
(66.2%)	70
(33.8%)	207
(100.0%)	
Early 
Retirement	Total	258
(56.1%)	202
(43.9%)	460
(100.0%)	

Lifetime pension wealth(LPW) was calculated based on the predicted lifetime earnings profile and pension Acts. Mean of the lifetime National Pension wealth is 81,277 (1,000 KRW). 

<Table > Basic Statistics for the LPW
(Unit: 1,000 KRW)	
# of Observation	Mean	S.S	
460	81,277	74,462.9	

2. Empirical Methodology 

Our econometric model has the following simultaneous equation system.

Early Retirement Decision
                                  (3)

Post-retirement Poverty equation 
                               (4)

Where is the choice of early retirement and is the experience in falling into poverty subsequent to retire earlier than normal retirement age. 

                                        (5)

          (6) 

 (7) 

By normalization, . Then, the covariance matrix between (3) and (4) is given by 
The Z vector contains exogenous variables that are expected to influence the choice   and . The variable K in eq. (5) is also used as an explanatory variable in the two decision equations. 
Under selection rules eq. (6) and eq. (7), the probability pj that the individual will fall into the jth subsample is given by

                                 (8)

              (9)

                   (10)

Where and  denote the standardized univariate and bivariate normal distribution functions, respectively. 
We can partition the original sample into three mutually exclusive subsamples: 
: Those who do not retire earlier than regular retirement age; 
: Those who retire earlier than regular retirement age, but do not sink into the poverty after retirement; 
: Those who retire earlier than regular retirement age and sink into the poverty after retirement. 

The likelihood function for the entire sample has the following form:

                                (11)

The estimable parameters of this model are , , , , and . The maximization of eq. (12) with respect to are , , , , and  will yield consistent estimates , , , , and . This model is fit by maximum likelihood techniques. 
We group the independent variables employed in our analysis into four categories: (1) demographic and background information on the characteristic of the worker and his or her family structure; (2) measures of the economic circumstances of the family in the pre-retirement period; (3) dummy variables related on pre-retirement job characteristics of the worker; (4) measures of the life time pension wealth calculated using the National Pension System Act (NPSA) adopted during the sample periods.  

3. Results

Table 5 shows the maximum likelihood estimates for the early retirement and subsequent post-retirement poverty, estimated in a bivariate probit model. In the early retirement equation, sex and job security have a negative sign with a statistical significance. This implies that the male and those who worked at more stable job tends to retire late. Marital status, the number of children, and the occupation 3 dummy variable which include clerks, service workers, sales worker, skilled agricultural, forestry and fisher workers have significant positive signs. The significant and positive sign of the life time pension wealth implies the income effect. Those who have a lager life time pension wealth tends to retire earlier, since higher social security benefits are guaranteed. 
In the early retirees' post-retirement poverty equation, years of education, the number of the other workers, a logarithm of the pre-retirement annual the wage income and the life time pension wealth have a negative sign with a statistical significance. This implies that the high educated person, and those who earned more income before retirement have a low probability to fall into poverty after retirement. And this also implies that those who have sufficient retirement resource have a low probability to experience poverty after retirement. This is the direct effect of the life time pension wealth on post-retirement poverty. 

<Table > Bivariate Probit Model Estimates 
　Variables	Early Retirement Eq.	Post-Ret. Poverty Eq.	
　Variables	Coefficient	S.E.	coefficient	S.E.	
Constant	-2.743 	0.406 	***	2.476 	0.345 	***	
Background variables during the pre retirement period					
  SEX (1=male)	-1.026 	0.200 	***	0.120 	0.153 		
  Years of education 	0.088 	0.023 	***	-0.075 	0.017 	***	
  Marital status (1= married)	0.753 	0.235 	***	-0.132 	0.193 		
  Number of children	0.422 	0.075 	***	0.085 	0.060 		
  Number of other workers 	0.035 	0.104 		-0.205 	0.092 	**	
  Health status (1=bad)	-0.041 	0.179 		0.441 	0.146 	***	
Economic status during the pre retirement period			
  Logarithm of annual wage income	-0.022 	0.061 		-0.345 	0.059 	***	
  Logarithm of annual non-wage income	-0.002 	0.050 		-0.058 	0.042 		
  House  (1= Own)	-0.047 	0.208 		-0.293 	0.172 	*	
  Logarithm of monetary asset	-0.039 	0.024 	*	0.005 	0.019 		
Dummy variables on Pre-retirement Job Characteristics					
  Job security (1=Stable)	-0.453 	0.178 	**				
  Occupation 1	-0.285 	0.435 					
  Occupation 2	0.037 	0.353 					
  Occupation 3	0.646 	0.239 	***				
  Occupation 4	0.234 	0.265 					
  Industry 1 (1= primary industry)	0.240 	0.327 					
  Industry 2 (1=secondary industry)	0.284 	0.229 					
Life time pension wealth 	0.221 	0.023 	***	-0.037 	0.016 	**	
RHO(1,2)	0.039 	0.110 		　	　	　	
Log   Likelihood 	-406.02	
Note: *: 10%, **:   5%, ***: 1%  significance level
      Occupation 1 include the legislator, senior   officials and managers, and Occupation 2 include the professionals,   technicians and associate professionals, and Occupation 3 include the clerks,   service workers, sales worker, skilled agricultural, forestry and fisher workers, and Occupation 4 include craft and related trades workers, plannist, machine operators and assemblers, and elementary occupations	

4. Simulated Results of the 2014 Amendment of BP

In this section, we simulate the effect of changes to BP system in 2014 on the post-retirement poverty subsequent to the early retirement decision. The first step of the simulation is to compute a life time BOP wealth and a lifetime BP wealth across all observations. The mean of the net LPW in the simulated system decreases slightly comparing to that in original system; the mean of the net LPW is 1,417 (1, 000KRW) in the BOP system, and 1,182 (1,000 KRW) in BP system. 

<Table 6> Basic Statistics for the life time BOP and BP wealth
Category	Mean	S.D	
Life time BOP wealth	1,417	1184.27	
Life time BP wealth 	1,182	1454.16	

After computing the lifetime BOP and BP wealth, all the stages in the estimations are undertaken again, based on these new data on life time pension wealth (=life time NP wealth plus lifetime BOP or BP wealth). Finally, we compare the sample mean of probabilities of the post-retirement poverty in each system. 
The simulation result is shown in table 7. As shown in the table, there is little differences between the means of probabilities of experiencing the poverty after retirement subsequent to the early retirement decision in each system. 

<Table 7> Simulated Effects of Lifetime BOP and BP wealth
	NP	NP + BOP	NP + BP	
Mean of Pr(post-retirement poverty subsequent to the early retirement decision)	45.23%	44.99%	45.01%	

V. Concluding Remarks

In this paper, we analyzed the effect of the social security on the retirement decision and the poverty after retirement by using the Korean Labor and Income Panel Data (KLIPS). We also investigate the effect of the changes in the BOP system to the BP system on the poverty after retirement.
Main empirical findings are as follows: First, poverty ratio of the old-aged measured by the current income is 64.7%. If the current income are summed up by BOP or BP are 59.8% and 55.9%, respectively. These confirms that BOP or BP has the effect of alleviating the poverty of the old-aged. Second, estimates of the bivariate probit model says that the social security system directly decrease the probability of falling into poverty trap after retirement. Third, simulation effects of changing the BOP system into the BP system is to increase the probability of the poverty after retirement, since this scheme change decreases life time pension wealth. In other words, annual BP benefit is larger than BOP system in the short term, but vice versa in the long run. It is because BP benefit is connected to a subscribing period of the national pension. It is also because BP benefit is indexed to the consumer price index, while BOP benefit is indexed to the nominal wage growth rate. 

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Appendix 
Estimation Results of Fixed effect model for log earnings 
	Individual Income Function	
	Coefficient	Standard Deviation	
Constant	-4.728 	0.141 	***	
Age	0.222 	0.006 	***	
Age2	-0.002 	0.000 	***	
Years of Education	0.033 	0.007 	***	
Marital Status (1=married)	-0.085 	0.020 	***	
Regional dummy (1=metropolitan city)	0.056 	0.021 	***	
Household dummy (1=household)	0.357 	0.022 	***	
Employment status (1= wage earner)	3.234 	0.011 	***	
Health status(1=bad)	-0.302 	0.017 	***	
_ within	0.491 			
_ between	0.514 			
_ overall 	0.492 			
Note: *: 10%, **:   5%, ***: 1%  significance level