Japan’s retirement system is falling under financial duress.

The country’s social benefit costs currently take about a third of the country’s annual budget, and they are set to balloon by 50% over the next two years.

These mounting costs are down to the growing number of retirees who are some of the longest-lived people on earth. Japan offers state pensions to everybody who is 65 or older, and many private sector employees retire at 60. But Japanese men lived to an average of 81.25 in 2018, and its women lived to 87.32, according to the Ministry of Health, Labor and Welfare (MHLW).

That’s left the system with a sustainability issue.

The latest Melbourne Mercer Global Pension Index (MMGPI), a study on the health of 37 pension systems around the world, placed Japan in 31st place with a score of 48.3 out of 100.

To ensure its expanding elderly populace have sufficient funds, the country needs its corporate pension system to play a larger role. Corporate funds already make up a decent portion of pension savings; they accounted for 41.29 million out of Japan’s active workforce of 67.12 million as of March 31 2016, (the latest available data), according to MHLW.

But corporate funds need to expand further, even as they undergo a seismic shift. More and more corporates are exchanging their defined benefit (DB) plan structures with a defined contribution (DC) scheme, putting the risk and decision-making onto employees.

The government’s aim is for individual Japanese citizens to become more engaged with managing their retirement savings, while shifting the reliance and risk away from employers. But the country’s savers need to change their investing habits fast, because under current trends they risk being too conservative.

SHIFTING RESPONSIBILITY

Japan’s corporate pension plans already cover a lot of people.

As of March 31, 2018, 16.06 million people were enrolled in the country’s corporate pension schemes, MHLW data reveals.

That’s far from everybody. In fact, 22.6% of all Japan’s corporations had a pension fund scheme for employees in 2018, according to the ministry, while another 55.2% offer a lump-sum payment on retirement. The bigger the organisation, the more likely they offer a plan; 71.8% of companies with a 1,000 or more employees did so.

For the past two decades DB plans have been the default model of corporate pension funds. But companies have gradually shifted from them to self-reliant DB funds. This trend accelerated after a tax-exempted version of the plans was phased out in 2010, while another version that includes some public sector supplements has become obsolete, said Katsuyuki Tokushima, chief pension advisor at NLI Research Institute’s Pension Research Center.

Corporations have a good reason to switch from DB to DC: it reduces their balance sheet risk

Meanwhile, DC plans were introduced in the 2001 financial year. They have since grown, and covered 40.3% of the people enrolled in corporate pension schemes by the end of March 2017.

Corporations have a good reason to switch from DB to DC: it reduces their balance sheet risk.

It is the responsibility of businesses that offer a DB plan to save enough for retiring employees. If their plan fails to raise enough to cover the promised defined benefits, they have to make up the shortfall from other capital sources.

However, DC plans make individual employees more responsible for their retirement savings, instead of their employer.

Retirement experts say that larger corporations in particular are making the push for DC plans, to cut their future pension payment risk.

The situation evolved last year, when Japan’s Defined Contributions Act was updated. Konosuke Kita, Japan director of consulting at Russell Investments, noted that under the new rules any type of fund can be designated as a default fund by employer-employee agreement. However, the default funds must have an expected return, their risk must be both reasonable for this expected return and acceptable to participants, and they must charge a reasonable fee.

One complicating factor is if a balanced fund is chosen as the default; in this instance the individual pension saver has no liability. That means they can sue their employer for responsibility if, for example, savings are lost when equity markets sour.

Despite this caveat, the new rules offer more motivation for corporations to change to a DC plan. Some have simply stopped any payments into the old DB plan, even for employees already enrolled. Instead they see future pension scheme contributions going to the DC plan.

CORPORATE SWITCHING

Many of Japan’s biggest and most famous companies have made the switch. In January 2019, Hitachi Corporate Pension Fund said it would implement a “risk-sharing pension plan” from April 2019.

This is similar to the collective DC scheme used in the Netherlands, where savers pool their money into one fund rather than save in individual accounts. Effectively, members of the scheme share the risk of investing into and paying out pensions – known as longevity risk. But it still shifted the pension payments risk away from Hitachi’s balance sheet.

Earlier, in October 2018, rival Sony fully transitioned approximately 30,000 employees still enrolled in the Sony Corporate Pension Fund’s DB plan to a DC plan it had originally introduced to its entire 45,000 workforce in April 2012. It said the transition would decrease the corporation’s financial liabilities. Panasonic has done the same.

Not every company is shifting from DB to DC, however. Kentaro Otani, executive director at the institutional sales department at JP Morgan Asset Management, said some small and medium-sized corporations are sticking with DB plans for now, because they want employees to “focus on jobs rather than managing their private investments”.

In addition, many smaller, more traditional, often family-owned employers almost treat employees as part of an extended family, sources point out.

“The relation can be closely weaved between employers and employees in Japan,” the Asia head of a global asset manager, asking not to be named, told AsianInvestor. “It is not unusual to have housing units near the corporate site, owned by the corporation, rented out exclusively to employees and their families, creating a sort of symbiosis.”

This article was adapted from a feature focusing on the Japanese pension industry, which originally appeared in AsianInvestor's Winter 2019 edition.