The Japanese pension system is in need of change. Given the size and sophistication of the country, Japan ranks a lowly 31 out of 37 on the Melbourne Mercer Global Pension Index (MMGPI), a gauge of how well a developed market's pension system is geared to meeting long-term needs.
The urgency for pension reforms is highlighted in the country's demographic statistics and government budgets. People aged 65 and over make up 25% of Japan’s population and is projected to reach 33% by 2050. Social benefit costs, which are currently about a third of Japan’s annual budget, could balloon by 50% in the next two years.
The crux of the problem is Japan’s relatively low state pension age of 65, and in particular the employment dynamics in the private sector, where many people can retire when they reach 60. Given the longer life expectancy, the retirement age must follow suit, according to the MMGPI’s recommendations.
Shintaro Kitano, principal at multinational client group at Mercer, has overseen the firm’s retirement advisory practice in Japan since 2007. He points out the major issues that need to be dealt with.
Ironically, this is what is now happening with the corporate pension market – but the motivations are quite the opposite. Japan’s companies are increasingly implementing defined contribution (DC) plans to replace defined benefit (DB) plans, shifting the liabilities on their balance sheets onto their employees.
Having been introduced in fiscal year 2001, DC plans now account for 40.3% of all corporate pension plans in Japan, according to 2017 government data (see chart).
The push from DB to DC not only rids corporations of financial risks, it also promotes the Japanese government's general agenda to make individuals more self-reliant for life after retirement and more investment savvy. It could also be viewed as a way of palming off the difficult structural issues around retirement to the end users.
Corporate pension funds made up the lion’s share of pension savings for 41 million people living in Japan. This is out of an active workforce of 67 million, according to Japan’s Ministry of Health, Labor and Welfare from 2016.
However, not all Japanese companies actually have a pension scheme for their employees. According to data from Japan’s Ministry of Health, Labour and Welfare, only 22.6% of all companies had a pension scheme for employees in 2018. Yet for companies with 1,000 or more employees, the share is as high as 71.8%.
Many companies – 55.2% in total – give a lump-sum payment when employees retire. The model is preferred by employees because they incur less tax compared with running pension scheme payments. They also like the certainty of getting the full amount upfront rather than risking dying earlier than projected. Alternatively, employees can set up an individual defined contribution plan – dubbed Ideco.
Due to regulations, another issue specifically with the surge of DC plans are their limited ability to take on risk and invest actively, which could help them grow the size. This is compared to DB plans that are able to invest into alternative assets, for instance.
When Japanese people already holding 50% of their private savings in passive assets, such as bank savings accounts or insurance policies, the combination with as DC plan makes it hard to get an overall return on savings both inside and outside their pension plans, according to Katsuyuki Tokushima, chief pension advisor at NLI Research Institute’s Pension Research Center.
The overall investment profile gets too heavily weighted toward placements in investments with guaranteed returns and no downside risk.
“Japanese people have been encouraged to become more assertive and invest a bigger share of their savings in equities because their fundamental diversification already makes it sensible,” Tokushima says. “But so far they don’t listen.”
Mercer's Kitano believes that there is a need for more structural changes to alter the culture of the Japanese labour market. Currently, it is too hard to fire and get rid of employees before they reach the retirement age at 60.
“The employees gradually become more expensive without necessarily learning new skills, which make them relatively less productive and thus less attractive.”
Japanese companies have embraced the concept of a traditional retirement age as a means of resolving the issue of expensive senior employees, by rehiring workers who retire at 60 under new terms with lower salaries and fewer benefits.
“If things are really going to change, it has to become the standard practice to compensate based on skills rather than seniority, while increasing the focus to upgrade the skill sets of employees,” Kitano said.
A more robust employment law combined with a higher retirement age, may also make the need to replace DB corporate plans with inferior DC funds a less pressing issue. That’s something Japan’s workforce should take into consideration if they want greater guarantees in retirement.