Translation of a paper originally published in an academic journal of Yokohama National University “Yokohama Management Research” vol. 38, March 2018.
Prof. Osamu Yamaguchi presented a nine-chapter odyssey of Japan’s corporate pension scheme, covering from primitive plans in the early days to issues to be fixed in the future. IJ introduces each chapter over several months.
Past, Present and Future Perspective of Japan's Corporate Pension Scheme
Emeritus Professor of Yokohama National University
Current situation and immediate tasks of corporate pension scheme
8.1 Implementation situation of retirement benefit
To provide a balance in retirement benefits between private and public sectors, the National Personnel Authority conducted a survey of retirement benefit status at 4,493 private companies with more than 50 employees. According to the survey, which went public in April 2017, 92.6% of them had retirement benefit plans. Among them, 48.3% had only retirement lumpsums, 12.0% had corporate pension plans, and 39.6% had both.
It indicates that more than 90% of private companies have some kind of retirement benefit plans and that about half (12.0+39.6=51.6%) of them adopt corporate pension plans.
8.2 Current situation of corporate pension plans
Defined Benefit (DB) corporate pension plans and Defined Contribution (DC) plans (Corporate-type) are the two major systems of Japanese corporate pensions. Recent situation is as shown in the following table.
At this point, the total asset of corporate pensions was 89 billion yen and the number of participants was 15.49 million. The number of participant is equivalent to 41% of 37.71 million¹ of which the number of Primary Insured Person of employees' pension ('1st repartition' belonging to private companies) excluding sailors. However, the actual corporate pension coverage may be lower than 41%, since some participants are covered by more than one plan.
8.3 Asset management of corporate pension plans
According to an asset management fact-finding survey by the Pension Fund Association, average asset mix of DB type plans (EPFs and DB corporate plans) is as below.
While EPFs put 33.81% of their asset in stocks (domestic 17.33 + foreign 16.48), DB corporate plans own 22.99%, which is more than 10% less than EFP, take less risk.
Same survey conducted in March 2006 showed that EPFs held 53.6% and DBs held 44.0% in domestic and foreign stocks. In 10 years, both plans lowered about 20% of each stock investment showing less risk-taking drift. But even so, there is about 10% difference between them, which means DB corporate plans have consistently kept to less risk investment.
This is because, listed companies tend to avoid risk investments as loss from risky investment will increase the amount of debt to be recognized. On the other hand, EPFs (mainly multi-employer EPFs) tend to select higher-risk asset mix, expecting higher returns in order to reduce funding deficiency.
8.4 Changes in DB type corporate pension plans
Corporate pension plans cannot escape the fate to share their sponsoring companies' fortunes.
Fortunately, Japan has many long-running companies that are so-called 'living companies'. There are 33,069 living companies that have been in business for more than 100 years as of 2017.² A lot of them with high adaptability to change and robustness.
Chronological changes of DB type corporate pension plans are as follows:
Revision in the reflection of increase in base-pay to benefits
Traditional benefit method of retirement allowances in Japan was to calculate benefits based on final salary multiplied by benefit rate accumulation (final salary method). Corporate pension plans that adopted this final salary method in the 1970's tended to reflect increases in base pays to final wages. The increases in payments reflected in retirement lumpsums and corporate pensions became major liabilities to companies. In an effort to avoid this burden, many corporate pension plans started to revise their base-pay scheme so that they will not have to reflect all of the increased amount. This movement was called 'revision in the reflection of increase in base-pay to benefits'.
Transition to point method
The final salary method could not sufficiently reflect contributions of employees to their companies in retirement allowances or in corporate pension plans. Therefore, many companies introduced point method that linked ability-based career qualification system to benefits. This method defines points, annually based on years of service or the qualifications etc., and benefits are determined by accumulated points multiplied by point unit price.
Revision of benefit interest rates
Corporate pension plans shifted from retirement allowances usually add interest portion of waiting period between retirement age and qualifying age to their benefits. Certain discount interests are also used when converting lumpsums to pensions. These interest rates are called benefit interest rates and they were the same as assumed interest rates for pension financing calculations.
Later, when interest rates decreased in Japanese financial market, assumed interest rates for pension financing were also revised. However, benefit interest rates had not been lowered because it meant less benefit levels. Under this situation, more and more companies adopted ways to decrease benefit interest rates such as compensating by increasing transferred portion from retirement allowance, so that they could keep their benefit interest rates on the level of interest rates of financial market.
Cash balance (CB) plans
CB plan is a hybrid DB plan from the United States first introduced by the Bank of America in early 1980's. In Japan, CB plans were approved in 2002 as the new type benefit design tool. Many big companies, such as Panasonic, Kao, IBM Japan, Hitachi and NEC, adopted it. By 2011, more than half (53.6%) of DB type corporate pension plans with more than 1,000 participants were reported to have introduced CB plans or CB-like plans.³
CB plans share investment risk between companies and participants. Their asset managements are operated not by individual participants but by pension funds collectively. With this plan, individual quasi-accounts are set for deemed interest credit depending on indexes such as yield of government bond to grant benefits adjusted to financial market fluctuations. CB plans automatically revise the benefit interest rate mentioned above, so that companies can avoid taking entire risk of fluctuating financial market.
Later in 2014, performance of investment return of assets (above contribution amounts) was added to the indexes and the benefit design came to have similar characteristics of DC type plans. But it is reported that the DC-type designing has not gained popularity.⁴
With the introduction of CB plans, whatever the case, companies are able to increase sustainability of pension plans and decrease fluctuating impacts of asset management on retirement benefit accounting.
Risk adjusted contributions
Risk adjusted contribution system was newly introduced in January 2017 by amendments of DB plan regulations. The system is to give preliminary contributions within risk amounts by reflecting assumed future risk of decreasing assets by fluctuations. It can be considered to have widened the range of financial balancing. By setting the contributions within an adequate range, companies might avoid funding deficiency caused by volatility of asset investment. It could be a possible option for companies during favorable corporate performance.
Due to these amendments, it became possible to include contributions reflected in risk for unrealized loss as expenses on taxation. This was an epoch-making change in taxation because it stepped boldly from the conventional thinking of not allowing excessive expenses.
Looking from the conventional needs of companies, they may now take opportunity gains of interest rates by reducing taxable income when the company is doing well and by tax timing. The effect, however, may not be significant under the current environment of extremely low interest rate.
Risk sharing DB plans
Risk sharing DB plans were introduced at the same time as the risk adjusted contributions and is the practical applications of the contributions.
The method is, companies fix contributions by making new risk adjusted contributions and annually adjusted benefit rates to maintain financial balance. By doing so, companies bear contributions for future risk, while participants accept the risk of less benefit caused by poor investment returns etc. In this way, both of the parties share the risk.
The risk sharing DB plans are set to take, as risks of financial deterioration in the future, not only risk from asset fluctuations but also risk of lowering assumed interest rates. It is expected to cover for assumed risks as broadly as possible since contributions are fixed with no additional contributions.
Process of the risk sharing DB plans in business accounting needs attention.
The guideline states 'these plans are to be classified as Defined Contribution plans if the contribution obligation of a company is limited to contributions described in their terms and condition and that they are not bearing obligations for additional contributions.'
With this provision, periodical contributions excluding special ones are reckoned as accounting expenses as they are and need not be treated as retirement benefit liability. Therefore, corporate earnings will no longer be affected negatively by financial market fluctuations of interest rates or prices through retirement benefit accounting as they were before.
DB type corporate pension plans may now be managed like DC plans in business accounting as far as the risk adjusted contributions are set adequately for future risk of financial deterioration and benefits are not substantially lessened by adopting smoothed adjustment ratios.
This may contribute to improve risk management of business operations. So, the risk sharing DB plans are expected to be one of the most promising options to revise DB type pension plans⁵.
8.5 Improvement of DC pension plans
By the revised DC law enacted in May 2016, individual type DC plan expanded its coverage to the 3rd insured persons, participants of corporate pension plans and public servants as of January 1, 2017. It also has the flexibility to meet various life courses.
By this, DC plans came to be a truly universal scheme that can ameliorate decreased benefit level of public pensions and provide means for old-age income regardless of life courses.
In link to corporate type DC plans, simple-type DC plans were established. This substantially eased introduction process for small-sized companies (with less than 100 employees). Matching contributions by small-sized companies with individual-type DC plans were also introduced. They will be executed within 2 years from its announcement date (June 3, 2016) of the law. And moreover, the change of monthly base to yearly base of DC contributions, that makes contribution flexible, will be enforced on January 2018.
In addition, the following issues are discussed in detail by the 'Special task committee on operation of DC plans' to improve DC investment management:
(1) Making continuous education effort obligatory
(2) Limiting the number of available investment products
(3) Enhancing the procedure to omit investment products
(4) Changing the selection standard of investment products
(5) Enhancing the guidelines of default products
(* The above goals have all actualized at this point.)
|1||Ministry of Health, Labour and Welfare, 'Employees' Pension Insurance Coverage Survey by business genre and size, as of September 1, 2016'|
|2||Counted companies that started before 1917 in Tokyo Shoko Research' data of about 30.9 million companies. The oldest company was KONGO-GUMI Co., Ltd. in Osaka prefecture that was founded in 578.|
|3||The National Personnel Authority, 'Survey of working condition scheme etc. in private companies (retirement benefit survey of private companies) 2011'|
|4||NLI Research Institute (Sep. 2015), 'The points of considerations of Performance-based CB plans and Hybrid plans.' "Pension Strategy", 231|
|5||Nikkei, 14 July 2017, reported Koizumi Sangyo and Koizumi Seiki, furniture and appliance makers, are going to be the 1st Risk sharing plan on October 1, 2017, after the dismissal of their collectively established EPF.|
( to Chapter 9: https://investmentjapan.jp/japans-basic/1028/ )
< Translated by Tomoyuki Kubo >