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Japan: New risk sharing pension plans are here

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May 26, 2017

A new type of pension plan, referred to as a risk sharing plan, is now possible in Japan.

Employer action code: Act

A new type of pension plan, referred to as a risk sharing plan, is now possible in Japan. It provides companies with a new option to reduce or eliminate their pension risks while offering their employees a collectively managed funded pension plan. Similar to target benefit plans in Canada or collective defined contribution plans in the Netherlands, a Japanese risk sharing plan is a hybrid pension plan that combines features of both traditional defined benefit (DB) and defined contribution (DC) plans. While further guidance on some uncertain aspects of the new plan is anticipated, the first risk sharing plans are expected to be established by the end of 2017.

Key details

A Japanese risk sharing plan is a collective funded pension plan, pooling investment and actuarial risks, with predefined benefits that can be adjusted upward or downward, and flexible employer contributions. Notable aspects of these risk sharing plans include:

  • Collective funded pension plan: Plan assets will be pooled as in a traditional DB plan and managed in aggregate centrally. There will be no individual accounts as in a traditional DC plan.
  • Pre-defined benefits that can be adjusted: Benefits will be predefined according to a DB formula. Any traditional type of DB formula (e.g., final pay, cash balance, point-based) should be acceptable. Participants may, however, ultimately receive benefits that differ from these predefined benefits as the benefit amount may be adjusted upward or downward depending on the plan’s financial status. Actuarial valuations will be performed periodically to determine the level of the benefit adjustment.
  • Flexible employer contributions: Employers will have flexibility regarding how their contributions are determined.
    • Employer contributions may be set at the plan introduction, with no possibility under the plan rules that the employer will be required to make additional contributions. In this case, the plan will essentially be a collective DC plan with all risks borne by the participants.
    • Alternatively, employers will be able to specify that their contributions may vary depending on plan circumstances.
    • Employers may choose to contribute in excess of the normal contributions in order to build up a risk margin and reduce the probability that any unfavorable experience will lead to a benefit reduction for the employees in the future.

The framework for Japanese risk sharing plans took effect at the start of 2017. Adoption of such a plan will require employee consent as well as approval from the Ministry of Health, Labor and Welfare. When transitioning from a traditional DB plan to a risk sharing plan, employee consent requirements will depend on the level of the funded status and future contribution commitments.

Employer implications

As in many countries, in recent years companies in Japan have increasingly used DC plans to avoid the various risks associated with DB plans. Japanese DC plans, however, have some drawbacks:

  • The DC tax-efficient contribution limit is relatively low (JPY 55,000 per month; JPY 27,500 per month if the company also sponsors a funded DB plan).
  • It is generally challenging to transfer assets for past service DB liabilities to a DC plan, so companies moving from a DB approach to a DC approach often have two (or more) plans to manage after the change.
  • Investment education is often an issue in Japan, where approximately 50% of the DC individual account assets are invested in cash or equivalents.
  • The employee cannot access the account until age 60.

These issues won’t affect the new risk sharing plan as they will accept higher tax-efficient contributions, allow for a transition from an existing DB plan without establishing an entirely new plan, and have centrally managed, pooled investments.

Companies should start to analyze how they may take advantage of this new opportunity, including potential implications for the company (e.g., cost, accounting) as well as for participants.

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