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.