A number of reports over the past year have lifted the lid off the simmering pot of pensions discontent within corporate Japan. The picture is one of a system in deep crisis and widespread fears that things will get worse.
Late last year 71 corporate pensions plans issued a report under the auspices of the Council for Harmonising Corporate Fundraising. It was to the point: Japanese corporate pensions plans are suffering from a sharp deterioration in their finances, such as huge unrealised losses in assets resulting from low investment returns.” They also have to cope with “unprecedented structural changes in Japanese society, such as the decline of lifetime employment and the rise of a mobile labour force”.
The companies say they are losing money because of inflexibility in plan design to deal with the changing situation or for effective asset management: “Pensions plans are subject to uniform and unreasonable regulations and traditions.” These, the report spells out, are numerous investment regulations, inflexible plan design, rigid rate of return assumptions and insistence on defined benefit plans, which assume lifetime employment. If these are not removed, further deterioration is predicted in the finances of pensions plans, with serious long-term consequences for retirees and have a negative effect on the financial activities of corporate sponsors.
They also see these “regulations and traditions” as having hampered free competition among institutions looking after plan asset management and restricting “the smooth assignment and adjustment of pension asset managers”.
Another hard-hitting report came from the Japan Federation of Employer Associations, demanding radical pension change in the aftermath of collapse of the “bubble economy”. It points out that in 1994, social security costs, health care and employee pensions insurance have risen to 16% of gross salary, up from 14% a decade ago. But corporate liabilities to their pension plans are expected to keep increasing, with companies’ financial performance fluctuating greatly according to how they respond to pensions costs.
In particular, the federation’s report latches on to the stipulated 5.5% expected rate of return used by actuaries to calculate the present value of future benefits, contributions and liabilities. Where this has hit companies hard is that retiring employees, instead of taking the traditional lump sum, are opting for a pension based on this rate. This has become legally fixed at a higher level than prevailing market rates, resulting in an accumulation of future liabilities. Support for pension plans is under threat, it warns. The rate should be based on pension plans’ financial position and asset management results and funds should be able to choose a rate from within a range of return calculations to be reviewed periodically.
But employers’ and plan sponsors’ pleas could well be falling on receptive ears, judging by a Health & Welfare Ministry study group report on reforming the employee benefits pension system. By June last year, the report says there were nearly 2,000 employee benefit plans (EBPs), with some ¥30 trillion ($242bn) in assets. “EBPs have become an influential force in financial and capital markets.”
Many EBPs have unrealised losses, because the market value of their portfolios is below the book value. This increase in under-funded plans has resulted in an unexpected increase in contribution liabilities for EBPs’ sponsors, the report only, it says.
“The current EBP system does not provide adequate measures to stabilise plan finances, so that they can adjust to changes in the social or economic environment, nor are there effective procedures for inspecting the financial condition of EBPs,” says the report. Arguing that flexibility to respond to future change is necessary, it proposes a minimal role for government and argues for the independence of EBPs’ management, which should be the responsibility of the directors, trustees, actuaries and pensions consultants.
The group wants the “pre-funding principle” of EBPs to be maintained, but thinks it appropriate for them to be able to choose from a wider range of methods. To deal with the risks of poor investment performance as the maturity ratio with an EPB increases, plans should be able to establish standards for reasonable funding targets and have discretion about how to fund systematically.
Of the then current practice of using book values, the study says these made it “difficult to assess objectively the financial condition of EBPs”. The change to market values is of “epoch-making significance in ensuring the soundness of EBP financing,” it says.
The report highlights asset management as “the most important issue for pension finances in the future”. It calls for liberalisation of existing rules that inhibit efficient management of assets. “Flexible rules for asset management need to be established such as ‘the prudent man rule’ in the UK and US to clarify the responsibilities of the parties involved in asset management and to increase the sophistication of the asset management systems of each EBP.” An integrated law regarding corporate plans is important, making clear the responsibilities of EBP directors, trustee institutions and others, such as consultants.”