No. 4 — January 28, 2000


Weekly Review

--- by Jon Choy

To the chagrin of financial institutions jockeying for advantage, the Liberal Democratic Party and its coalition partners, the Liberal Party and the New Komeito, have put out the yellow flag in the race to overhaul Japan's pension system. Government officials stress that their recent decision to delay the introduction of defined-contribution pension plans by three to six months does not mean a retreat from Tokyo's commitment to financial market reform. Some smaller financial institutions and the government-run National Pension Fund Association, they say, need more time to prepare for the revolutionary change. Market watchers are less charitable, asserting that Tokyo put off the reform for both financial and political reasons. Despite the delayed timetable, everyone agrees that a defined-contribution pension system will be implemented eventually.

The public and private pension systems in place today in Japan are defined-benefit plans. They promise a certain amount of money at retirement. Therefore, contributions are variable, rising or falling in inverse relation to the performance of plan investments. Increasingly, though, business and government-administered pension systems face two major issues: the number of retired people is expected to rise sharply over the next three decades, but investment returns during the past 10 years have been well below what is necessary to meet projected needs. Tokyo already has proposed fixes for both corporate and government pension systems (see JEI Report No. 9B, March 5, 1999, and No. 10B, March 12, 1999). However, the consensus is that systemic reforms are required to put Japan's retirement regime on a solid financial footing for the long run.

Movement toward such a complete overhaul has been stymied by unique accounting rules and by a cloak of government secrecy that has allowed companies as well as Tokyo to keep the condition of their pension plans out of the public's view. Since FY 1998, authorities have been bringing Japanese accounting practices into line with U.S. and international standards (see JEI Report No. 12B, March 26, 1999). For example, companies originally were given until March 31, 2000 to adopt consolidated financial statements for affiliates they effectively control and for cash-flow statements. Citing pressures on small businesses, however, Tokyo recently extended this deadline by 12 months.

For pension managers, the biggest change comes in FY 2001, when they must report postemployment benefits on an accrual basis. Companies will have 15 years to cover underfunded pension liabilities — a problem that is thought to be pervasive. So far, Tokyo has not changed the schedule for implementing this reform.

Some big-name members of corporate Japan already have adopted more transparent pension reporting rules in their financial statements. Fujitsu, Ltd., for example, uses Japanese accounting standards but also notes any divergence from international accounting standards. In FY 1998, it reported a ¥397.9 billion ($3.3 billion at ¥120=$1.00) gap between pension plan assets and projected benefit obligations. Toyota Motor Corp. has used U.S. accounting standards since last September, when its shares were listed on the New York Stock Exchange. The vehicle maker's FY 1998 financial statement showed a projected payout of about ¥1.8 trillion ($15 billion) but pension assets of only ¥780.5 billion ($6.5 billion) for a stunning shortfall of ¥983.8 billion ($8.2 billion). Executives of Hitachi Software Engineering Co., Ltd. have said that their firm will book a ¥7.3 billion ($60.8 million) extraordinary loss in the year through March 31, 2000 due to the write-off of its underfunded pension liabilities. While such openness may have a negative impact on the bottom line in the short term, management clearly expects a long-run payoff in terms of greater investor confidence and healthier finances overall.

Although there has been little talk of forcing similar open reporting rules on the various government pension plans, Tokyo is under pressure to release clear and complete details of this important program. Moreover, citizens could force Tokyo to provide such information under Japan's government information access law (see JEI Report No. 20B, May 21, 1999). While they do not like the idea of complete transparency, government pension officials realize that only such a policy will reassure voters that the system will be able to fund the benefits they expect in retirement.

As stories began to appear regularly about all the companies with pension plan funding shortfalls and questions were raised about the true health of the government's social security-like system, policymakers and analysts came to appreciate the advantages of the defined-contribution, 401(k)-type pension plans that have become so popular in the United States. Besides enabling companies to economize on their pension costs, these plans have spurred individuals to invest in equities and mutual funds, in the process powering the record bull market on Wall Street. Seeing this kind of system as a way to help corporate Japan avoid problems in the future, the LDP and its allies developed a framework for defined-contribution pension plans similar to the 401(k) model. However, disagreements over such important details as tax breaks and implementation schedules as well as other legislative priorities prevented the coalition from passing its plan during last fall's special Diet session (see JEI Report No. 47B, December 17, 1999).

It appears that the three parties finally have worked out their differences and are united behind a single scheme. In brief, this plan would allow anyone to have a 401(k)-style account. Annual ceilings on tax-deductible contributions — a major issue among the alliance partners and with the bureaucracy — are ¥816,000 ($6,800) for self-employed individuals and nonworking spouses, ¥432,000 ($3,600) for employees not covered by corporate pension plans and ¥216,000 ($1,800) for workers who participate in such programs. Although Tokyo had expected to have the new system in place by the fall of 2000, implementation has been pushed back to January 10, 2001 for companies and to sometime in March 2001 for the National Pension Fund Association, which provides retirement benefits for people not covered by company programs.

Government spokespeople explained the delay by saying that neither the private sector nor the government would be ready to meet the anticipated high demand for the new plans by the original date. Moreover, Tokyo claimed that it was best to wait until after the January 1, 2001 merger of the Ministry of Health and Welfare with the Ministry of Labor as part of the overall reorganization of the central government bureaucracy (see JEI Report No. 27B, July 16, 1999) because the new entity would play a key role in the forthcoming pension system. Finally, it was argued, Tokyo was not breaking any pledge since its only commitment was to implement the pension plan changes before the end of FY 2000.

Analysts do not give these explanations much weight. The more likely reason for the delay, they say, is that the Ministry of Finance is unwilling to sanction a program that cuts into tax revenues and upsets budget plans. Experts also propose that the upcoming elections for the Diet's lower house could have factored into the decision. Coalition members might have concluded that this was not the time to fiddle with such a political hot potato as the pension system.

Of greater concern to some pundits is the cumulative psychological effect of Tokyo's postponement of major financial deregulation initiatives. Before the announcement that the introduction of 401(k)-style pension plans would be deferred, the government had decided to put off the imposition of a ceiling on deposit insurance coverage (see JEI Report No. 2B, January 14, 2000) and, as noted, to extend by a year the deadline for changes in corporate accounting rules. Even if Tokyo had good reasons for the delays, analysts warn that by seeming to reverse course on financial market reform, the government risks projecting the wrong image at home and abroad.

Although the three ruling parties have ironed out important details of the new pension system, they still must negotiate the final terms with key ministries. The Finance Ministry, in particular, has issues with the coalition's scheme. It accepts the idea of giving tax breaks for the contributions that companies make to their employees' 401(k)-like plans and for funds deposited in the government system. However, MOF draws the line at giving favorable tax treatment to the money that people covered by pension plans put in their retirement accounts. That, it is argued, would be an income-tax cut in disguise. However, such discrimination would deliver a severe blow to the appeal of the new system.

Also of concern to the Finance Ministry is the impact of the proposed deduction ceilings on existing pension plans. Under current rules, for example, the maximum deductible for employee contributions to tax-qualified corporate pension plans is only ¥50,000 ($400) a year. Since this amount is meager compared with the proposed limits for the 401(k)-style system, MOF fears a huge shift of resources out of existing plans into the new pension vehicle. While that is exactly what corporate executives want to happen in hopes of saving money, the fallout from such a wholesale shift on companies that manage the bulk of old-style plans — trust banks and insurance companies — might be severe.

In the meantime, many companies are jockeying for the pole position in this new market (see JEI Report No. 30B, August 6, 1999). Top Japanese banks, insurers and securities firms are striking alliances left and right, hoping to build the credibility and the market muscle to attract the money that people will put in their new pension accounts. Foreign financial services providers also continue preparations, confident that their greater expertise in investment strategies for pension plans will give them an edge. Some are grumbling about the delayed arrival of 401(k)-type plans, but the irritation level among U.S. firms has not gotten high enough to raise the issue with Washington. Certainly no one is quitting the race just yet.

The views expressed in this report are those of the author
and do not necessarily represent those of the Japan Economic Institute

Issue Index aaaa 2000 Archive Index aaaa Subscriber Area aaaa Home