Korean corporate pension plans are too focused on cash preservation rather than returns, raising potential questions about their ability to pay pensions in the long term, says Towers Watson.

In its annual Korea pension report, the consultancy’s research shows 93% of corporate pension plan assets are allocated to principal-guaranteed products, of which 58% is invested in cash instruments. Term savings and guaranteed insurance contracts (GICs) dominate the portfolios.

“This conservative allocation is largely influenced by corporate sponsors’ cash-reserving mentality, which is rooted in legacy severance schemes and the first competition among service providers offering attractive or inflated rates for new clients,” says Jayne Bok, director of investment services for Korea at Towers Watson.

“As a result there is also an inappropriate focus on capital preservation rather than on income or return generation, which would be more suitable given allocations should be focused on the ability to pay pensions in the longer term.”

There was a 5% increase in allocations to principal-guaranteed products last year, finds the research, indicating that both sponsors and members were more conservative in 2011 than 2010.

However, it acknowledges that much of this rise is a result of two service providers being awarded significant mandates, mostly invested in GICs, from defined benefit plans affiliated to them.

Still, Bok warns: “Sponsors and members investing in principal-guaranteed products established under trust agreements could suffer financial loss if the service provider, such as a bank or security firm providing in-house products, faced financial difficulties.

To address these issues, she notes, the Korean government introduced measures last year to regulate declared interest rates for principal-guaranteed products and to limit the amount of pension assets that can be invested in the service provider’s own products.

Total corporate assets grew 71% last year to almost W50 trillion, with large corporate defined benefit (DB) plans accounting for most of the assets, finds the research, which covered 57 service providers and their fund products and includes two new entrants this year: Hi Investment Securities and Lotte Insurance.

It was notable that during 2011, the assets of the top 20 service providers increased by more than 50% to about W45 trillion, largely because of DB plans invested in principal-guaranteed products, which totaled W33 trillion by year-end.

Korea’s corporate pension schemes are not based on trust law. Instead they operate on the basis of contractual agreements with various financial entities that perform as service providers. Service providers perform two functions: plan administrator and asset administrator, similar to trustee and fund administrator.