Jap a nese P ension S y st em and Its Outlook

1. JapanesePensionSystemandItsOutlook www.japanmacroadvisors.com info@japanmacroadvisors.com

2. ExecutiveSummary TheJapanesepublicpensionschemecoversallpeoplebutsofarahouseholdofaretiredindividualseemstohavereceivedenough,butstillthereplacementratioisoneofthelowestamongdevelopedcountries. Asclaimedbythegovernmentthatthepensionissustainableforthenext100yearsandalsoforecastedthenotionthatthereservewillincrease.However,theforecastrestsuponextremelyoptimisticassumptions. Pensionreformssofarhasworkedon:(i)simplifyingandintegratingschemes;(ii)providingprotectiontotheweak(peopleearninglowwages,irregularworkersetc.);and(iii)implementingmechanismstoensurethesustainability. Nevertheless,stillthereisadoubtofsustainabilityinthepensionplans.Thefactorsincluding:mechanismsusedforsustainabilitysuchasbenefitdeflator,andthestartingageofanindividualmuststillbeimproved.Anotherlargearenaofdiscussionisaboutsecuringapublicfundsource. Pensionreformsmustbeconsideredinconjunctionwithothereconomicpolicies, suchastaxandmedical/welfarereforms. 2

3. OverviewoftheJapanesePensionSystem Inanutshell,therearethreepensionschemes,twoamongthemarepublicpensionschemesandtheotherisaprivateoneandthiscoverthreelayers. 3.CorporateandPrivatePensions Layer3 voluntarilysavings EPI Layer2 asmuchasyouearn 2.EmployeePensionInsurance Layer1 BasicPension– Nationpayshalfofthepremium 1.NationalPension GroupI. Self-employed(19.0mnpersons) GroupII. Employees(38.9mnpersons) GroupIII. Housewives(9.8mnpersons) Source:MinistryofHealth,LaborandWelfarewebsite.NumberofparticipantsareasofMarch2012 3

4. OverviewoftheJapanesePensionSystem • AllJapanesepeoplearecoveredbyoneofthetwopublicpensionschemes,theNationalPensionortheEmployeePensionInsurance. • GroupI. • Self-employed or small business owners participate in the National Pension (“NP” or “kokuminnennkin”), while they have opportunities to save more voluntarily. Non-workers also have to participate in it and pay the premium. • GroupII. • CompanyemployeesparticipateintheEmployeePeŶsioŶIŶsuraŶĐe;͞EPI͟, or͞kouseinennkin͟).Premiumǁill ďe deduĐtedfroŵtheirsalariesautoŵatiĐally,aŶd eŵployers’ĐoŶtriďuteto ŵatĐhit.Mosteŵployers offer/introduceopportunitiestoaccumulatemoreundervariousschemes,includingdefinedbenefitanddefinedcontribution. • Preciselyspeaking,publicofficialsandteachershaveseparatemutualfunds,buttherecentreformhassetthesemutualfundstobemergedintotheEPI. • Thecorporatesponsoredprivateschemeistobeterminatedaspartoftherecentreform,whichaimedatintegrating • thepublicpensionschemeintoonesingleentity. • GroupIII. • HousewivesareautomaticallyconsideredpartoftheNationalPensionscheme,althoughtheydonotpaypremiumbythemselves.

5. OverviewoftheJapanesePensionSystem ThreebasicprinciplesoftheJapanesepensionsystemare: Allparticipantsmustpaypremiumbylaw.Theywillbecoveredandevaluatedbythepensionschemeonaconditionthattheymeetcertaineligibilitycriteria. Thebenefitwillbepaidlife-longandalsobeadjusted.Inshort,youwillreceiveinaccordancetowhatyoupaid,butthebenefitamountwillbeadjustedtomacro-economicchangessuchasCPIsandwages. Inadditiontothelargereserve,italsoincludesfeaturesasaninter-generationsupportsystem. Premiumpaidbyworkingagepopulationisusedtopayfortheretired.

6. OverviewoftheJapanesePensionSystem AnaveragehouseholdaboveAgegroupof65seemstobereceivingjustasmuchastheyspendsongoodsandservices. AnaveragehouseholdaboveAgeof65includesahusbandandawife.IfthehusbandisundertheEmployeePensionInsuranceandthewifeisundertheNationalPension,thecombinedhouseholdincomeseemstobejustequivalenttotheaveragehouseholdconsumption. MonthlyBenefitReceivedbyActualRecipient(JPY)and AverageHouseholdMonthlyConsumption Expenditure(JPY) FY200720082009201020112012 BenefitsReceived ConsumptionExpenditure Source: Ministry of Internal Affairs and Communications Statistics Bureau, “Survey of Household Economy,” and Ministry of Health, Labor and Welfare, “Financial Report on the Public Pension System 6

7. InternationalComparison TheJapanesesocialsecurityexpenditureisabout10%ofGDP,andisthe8thhighestamongOECDcountries. PublicExpenditure onCashBenefitsforOld-Age Survivors(%GDP) 18.0% 16.0% 14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% 18.0% 16.0% 14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% CanadaUKUSOECDAvg.SwedenJapanGermanyFranceItaly Canada UK US OECDAvg.Sweden Japan Germany France Italy “ourĐe:OECD,͞PeŶsioŶsAt AGlaŶĐe ϮϬϭϯ.͟Data forϮϬϬ9 7

8. InternationalComparison However,thereplacementratioislessthantheOECDaverage.TheJapanesepensionsystempaysbenefitworthc.36%basedonthelastincomeearnedbytheretired. ThelowerreplacementratioindicatesthattheJapaneseretireemaynotreceivethesameamountashewasreceivingbeforeretirementtosustainthesamestandard. ReplacementRatio 80.0% 70.0% 60.0% 50.0% 40.0% 30.0% 20.0% 10.0% 0.0% UK Japan US Canada Germany OECDAvg. Sweden France Italy UK32.6% Japan35.6% US38.3% Canada39.2% Germany42.0% Sweden55.6% France58.8% Italy 71.2% OECDAvg. 54.0% “ourĐe:OECD,͞PeŶsioŶsAt AGlaŶĐe ϮϬϭϯ͟ 8

9. ExaminingSustainability Thegovernmentclaimsthesystemissustainableforthenext100years. Bylaw,thegovernmentconductstheFinancialVerificationofthepublicpensionsystemtodeterminethesoundnessofthepensionsystemonceineveryfiveyear. EstimateofReservein the2009FinancialVerification(JPYtn) 9,000.0 If the pension system can sustain a sufficient reserve to pay for the retired for next 100 years, it is viewed as “financially sound.” If not, then the government has power to implement a means to improve the system, for example, by cutting down the pension benefit. 8,000.0 7,000.0 6,000.0 5,000.0 4,000.0 The last Financial Verification in 2009 assured the system’s sustainability and the government claims the same. 3,000.0 2,000.0 1,000.0 0.0 2008 2013 2018 2023 2028 2033 2038 2043 2048 2053 2058 2063 2068 2073 2078 2083 2088 2093 2098 2103 Source: Ministry of Health, Labor and Welfare, “The 2009 Financial Verification” of the Public Pension Scheme. The National Pension and 9 theEmployeePensionInsuranceCombined(ex.Thebasicpension)

10. ExaminingSustainability TheReservehasbeencontinuouslydeclining.Theactualreserveamountislowerthantheprojectioninthe2009FinancialVerificationunderthebasecasescenario. ReserveAmount(JPYtn)fortheNationalPension ReserveAmount(JPYtn) fortheEmployeePensionInsurance 160 12 140 10 120 8 100 09EstimateHistorical 80 6 60 4 40 2 20 0 0 2002200320042005200620072008200920102011 2002200320042005200620072008200920102011 Source: Ministry of Health, Labor and Welfare, “The 2009 Financial Verification” of the Public Pension Scheme and “Operational Review of 10 Pension Schemes”

11. ExaminingSustainability Theassumptionsusedinthe2009FinancialVerificationseemtobeveryoptimistic. ThebasescenariooftheforecastassumedmodestGDPgrowth,slightinflation,goodwagegrowthand4%of investmentyield.Therealityhasbeenasluggisheconomywithdeflationinpricesandwages. GovernmentAssumptionsHistorical The 2009FinancialExamination Performance Optimistic Base Pessimistic 10yrAvg 20yrAvg Source: Ministry of Health, Labor and Welfare, “The 2009 Financial Verification” of the Public Pension Scheme 11

12. ExaminingSustainability GPIF’s yield has been, on average, 2.02% since FY2001. In most of the years, the pension fund’s investment yield is below the government assumption of 4.1% in the 2009 Financial Verification. GovernmentPensionInvestmentFund(GPIF)isanindependentagencywhichmanagesthereserveofthe EmployeePensionInsuranceandtheNationalPension. GrossInvestmentYield 12.00% 10.23% 9.88% 10.00% 8.40% 7.91% 8.00% 6.00% 3.70% Average01-12: 2.02% 4.00% 2.00% 3.39% 2.32% 0.00% 200120022003200420052006200720082009201020112012 -2.00% -0.25% -1.80% -4.00% -4.59% -6.00% -5.36% -8.00% -7.57% -10.00% Source: GPIF, “Review of Operations in FY2012” 12

13. ExaminingSustainability GPIFisamediumforimprovements,asin,bytakingmorerisksinitsinvestmentapproachwithalargergroupofinvestmentprofessionals. GPIFtakesveryconservativeinvestmentapproachwithabout61%ofitsassetsindomesticequity.Italso employslesserinvestmentprofessionalsthanthewayitisexecutedintheothercountries. Solely,Improvinginvestmentyieldisnotenoughtoassurethesustainabilityofthepensionsystem. BreakdownofAssetsUnder Management Short-termAssets,1.48% ForeignEquity,12.35% ForeignBond,9.79% DomesticEquity ,14.57% DomesticBond,61.81% Source: GPIF, “Review of Operations in FY2012.” Data as of March 31, 2013 13

14. TheSystemReformandProspective • In2011,theMinistryofHealth,LaborandWelfareidentifiedfiveareasofissues. • Theincreasednumberofirregularworkers. • Theyarenottobecoveredunderthepensionscheme,orelsetheywillreceiveonlyalittleamountofbenefit. • Impact on people’s choices • The difference in pension plans affect both employees’ and employers’ choice. • SomepotentiallabormaybediscouragedbytheexistenceofGroup3. • Under-coverage/Inadequacy. • Somereceiveonlyalittleamountofpensionornopensionatall • Anxietyoverthesystem. • Highdelinquencyanddistrustamongtheworkingagepopulation • Anxietyoverthesustainability. • Publicfundsourcehasnotbeensecured • Needtoincreasethestartingage • TheMacro-economicslidemechanismisnoteffectivelybalancingbothincomeandexpenditure. “ourĐe:The MiŶistry of Health,LaďoraŶdWelfare,͞DisĐussioŶMaterialoŶthePeŶsioŶ“ysteŵ,͟ϮϬϭϭ 14

15. TheSystemReformandProspective The2012pensionreformdecidedtoonedayestablishanewandintegratedpensionscheme.Meanwhile,itaimsatimprovingthecurrentsysteminitssimplicity,stability,andsafety.However,discussionsonfundamentalsolutionswerepostponedtillthefuture. AdoptedMeasuresIdentifiedIssues(UnmentionedIssues)GOAL Integrat-ion IntegratingofGroup1and2 Group2Integration Privateandpublicemployeestoshare thesameEPI Group3Termination Housewivesalsomustpaypremium NationalContributionupto 1/2Thenationtopayhalfofthebasicpensionbenefits(1stlayer) SecuringPublicFund Taxincreasesintendedtosecureastablefundforpensionbenefit SecureFunds SingleNewSystemforEveryone Benefitasmuchasyoupay Guaranteedminimum standard Trustedassafeandsound ImproveStabilityandSafety ShorterPeriodto PayPremiumMustpaypremiumatminimum10yearstoreceivebenefits:downfrom25 LaterStart Benefittbepaidatlaterage;graduallyincreasedto68. ExpandPrivatePensions ProtecttheWeak Promoteprivatesavingsforpensionpurpose. ExtendedCoverage Toincludepart-timeworkersandotherworkersofirregularforms ImproveMacroeconomicSliderToimprovetheeffectivenessofthismechanismtobalancethepremiumpaidandthebenefitspaid. ExtendedExceptionMaternityleaveaddedtotheexemptiontopremiumpayment Restriction on WealthyElderly Tolimittheirpensionbenefit Seenextpages. Source:VariousmaterialsfromTheMinistryofHealth,Laborand WelfareandTheCabinetOffice 15

16. TheSystemReformandProspective The2012reformaddressedpotentiallyinadequatepensioninrelationtothelowincomepeopleinvariousforms.However,itwaspostponedtore-examinethebenefitspaidtoawealthyelder. ThecoverageoftheEmploymentPensionInsurancewillbeexpandedtotheshort-timeworkersfromthestartof2016.Whilepeopleinmaternityleavewillbeexemptedfrompremiumpayment,andsingle-parentfamiliescanreceivethebereavedinsurancebenefitstartingfrom2014. Ideally,strongersupporttotheweakshouldcomealongwithareviewofbenefitsfromtherichbeneficiaries.Althoughadiscussiontookplacerelatedtoit,andthe2012reformexcludedthisissuefromtheconcretelegalamendmentitems.The2013reportbytheCouncilforIntensiveDiscussiononSocialSecurityReformpointsoutthistobeafutureissueandhastobereviewed.

17. TheSystemReformandProspective The government recognizes an issue with the current benefit deflator, or the so-called “Macroeconomic Slider” mechanism, which was introduced in the 2004 pension reform. Thismechanismaimsatadjustbenefitsinlinewithchangesindemographicandeconomicindicatorssothatthesystemwillremainfinanciallysustainable. However,sinceitcannotbeusedindeflation,ithasnotbeenusedandhencehasnotadjusted thepensionscheme. The2012reformidentifiesthisissuebutwithoutmentioningconcretecountermeasures.

18. TheSystemReformandProspective Thegovernmentcontinuestoexaminepossibilitiesofincreasingthepensionstartingage. Italonewillnotfundamentallysolvethefinancialdifficultiesofthesystem.Basedontheprinciple,youwillreceiveasmuchasyoupay.Additionally,duetothelongerlifeexpectancy,totalbenefitstobereceivedbyanindividualisunlikelytodecreasesignificantlydespitethelaterstart. LifeExpecatancy atAge 65- Actualand Estimate Themainimpactitwillhaveonthepensionsystemistoalleviatethenegativeimpactofthebenefitcutonthepensionbeneficiaries.Thecutmaybesmallerthanitwouldbeinacasewherepeoplestartreceivingbenefitsearlier. The2013reportbytheCouncilforIntensiveDiscussiononSocialSecurityReformsuggeststhatpoliciesmustcomeinpackagewithasupportmeasuresfortheoldtoworkuponandtheothertopromoteprivatesavings/pensionplans. Source:The2013reportbytheCouncilforIntensiveDiscussiononSocialSecurityReform 18

19. TheSystemReformandProspective Thediscussiononthepensionsystemwillcontinuealongwithanotherontaxreforms.Tosecurethepublicfundforthebasicpensionportionisessentialforgainingtrustfromthepublic. Otherthanthebenefitdeflatormechanismandthehigherstartingage,safetyforthelowerincomepeopleandreviewofbenefittotherichwillcontinuetobediscussed. In2014,theFinancialVerificationwillbeconductedagain.Itsresultwillhaveimpactsonthepensionreformdiscussion.

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