I. General Characteristics

The Japanese pension system is multi-tiered, consisting of public and private pension schemes (Fig.2.1). The distinction between public and private pensions depends on whether the insurer of pensions is the government or not. The first tier is the Basic Pension (public), which provides the flat rate basic pension of a universal coverage. As a non-income-related pension, it works for income redistribution, and participation is mandatory to all residents. The second tier (public) covers most of employees and provides an income-related payment. It is mandatory to all firms over a certain size, and premium is shared by employers and employees. The third tier is an optional scheme for larger pensions. It is private or public and is provided either by private firms (employers) for their employees, or by collective national pension funds for the self-employed with the government as the insurer.

The second tier (Employees' Pension Insurance) is managed by social security administration associations within a firm or a group of firms. For convenience, the first and second tiers for employees are jointly operated by these associations and are sometimes jointly called Employees' Pension Insurance. The Employees' Pension Insurance covers both employees and their spouses (Categories No.2 and No.3). The first tier for the self-employed, farmers and other non-employees (Category No.1) is operated by municipalities and is called National Pension. Thus, the entire adult population, in principle, is insured either by the Employees' Pension Insurance, or by the National Pension.

The coverage of the Basic Pension is universal, i.e. it extends to all residents 20 years old or above in Japan including foreigners. However, the eligibility to receive pensions requires a minimum of 25 years of premium payment.

The insurer of the National Pension and the Employees' Pension Insurance is the government. They form the two pillars of Japan's public pension system. According to a survey, more than 60% of the elderly households earn their livelihood entirely depending on the public pension. Other schemes are private pensions. Employees' Pension Funds, Tax Qualified Pensions and Mutual Aid Pensions, the third tier for Category No.2 (employees), are run by each private firm. National Pension Funds, which provide the third tier coverage to Category 1, are run by local and occupational funds.

For public pensions, premiums are paid by employees and their employers for Category No.2 (employees). For Category No.1 (self-employed, etc.), a premium is paid by the insured only, but supported by a substantial government subsidy. The premium for Category No.3 (spouses of employees) is not collected, as it is regarded as included in the premium which his/her spouse pays.

Premium for private pensions differs from scheme to scheme, but mostly is paid by the employers for Category No.2 and by the insured for Category No.1.

For the first tier (Basic Pension), one third of the benefits and all of administrative costs are paid by the general budget of the government. For the second tier (Employees' Pension Insurance) and mutual aid association pensions for central and local civil servants, the administrative costs are paid by the central government. For the third tier (private pensions including Employees' Pension Fund and National Pension Fund), there is no subsidy from the government.

Japanese firms traditionally offered to its employees a retirement allowance as a one-time lump-sum payment. Together with the introduction of public pension schemes, private ones also began to be arranged. Currently, most firms provide a mixture of lump-sum payment and pension scheme. Since the two types of scheme are interchangeable in many instances, the entire retirement package is seen as the income security for the retired.

II. Types of Pension Scheme

As described above, all residents in Japan between ages of 20 to 60 are eligible and required to become subscribers of the Basic Pension. Whereas employees automatically enroll in the Basic Pension when they subscribe to the Employees' Pension Insurance, the National Pension is for those who are not employees. A fixed amount (\13,300 per month in 1999) is levied on each subscriber as a premium. However, low-income persons (about 5% of all No.1subscribers) and non-working spouses of employees are exempt from paying premiums, partially or entirely. Current benefits are paid out of currently collected premiums (pay-as-you-go system), but as much as one third of the benefits are subsidized from the general budget of the government.

Category 1: All residents who are not Category 2 or 3, i.e. self-employed, farmers, students, etc.
Category 2: All employed persons whose workplace has more than 5 employees
Category 3: Non-working spouses of Category 2
Source: MHW, 1999

Currently, 1.4% of the eligible persons fail to participate in the Basic Pension, and 96% of all persons aged 60 and over receive the Basic Pension, thus its scheme has achieved near perfect universality. The average monthly benefits for the old age are \47,000.

The Employees' Pension Insurance forms the core of the income security for retirees. All workplaces with more than 5 employees and their employers are required to participate in this scheme. Both employers and employees contribute 8.68% of employee's salary as premiums (including a premium for the National Pension), and the pension payment is income-related. There is no discount system for low-income persons/household (or his/her employer), but employers of those who are on maternity leave (up to 1 year) are exempt from paying a premium .@ However, a maximum amount of premium is set at the premium rate multiplied by \590,000 (maximum category of monthly salary). The average monthly benefits for the old age are \154,000, which amount to 48% of average monthly salary of subscribers (1997).

90% of all Japanese firms offer retirement packages for their employees. A retirement package can be either a one-time lump-sum retirement allowance, or a life-long pension, or both. In 1997, about a half (52.5%) of firms with some kind of retirement package offered a pension scheme, while nearly 90% provided a lump-sum allowance. Even though pension style is gradually spreading its share, the traditional style of lump-sum allowance is still the main stream and most employees choose to take a part or whole of retirement money as the lump-sum payment. Thus, public pension, private pension and lump-sum retirement allowance, all together make up the total income maintenance support for a retiree.

There are three types of private pension schemes: 1) Employees' Pension Fund, 2) Tax (Exempt) Qualified Pension, and 3) each company's individual pension scheme. The break-down of different retirement packages is shown in Fig. 2.4.

Source: "H11 Kigyo Nenkin Hakusho "

Firms of more than 500 employees are allowed to set up an Employees' Pension Fund. Currently, about one third (36%) of all employees participate in this scheme. A fund is set up to top off the public pension to ensure a higher level of benefits, and is based on the contributions from both employers and employees of 1.6 to 1.9% each of the employee's salary. Employees' Pension Insurance and the Employees' Pension Fund are closely related, and some portions of the Insurance is managed by the Fund on its behalf. Thus, even though the Fund is a private pension scheme, it has a public nature and enjoys tax favored treatment, but at the same time, is regulated by the government.

Another type of private pension is the Tax Qualified Pension scheme. Under this scheme, employers are allowed to exempt its contributions from corporate tax. About one third (31%) of all employees join it. Compared to the Fund, this scheme is fairly free from regulations of the government, and is the second most popular form of retirement package next to the lump-sum retirement allowance. Most of the pensions under this scheme is fixed-term (typically 10 years), different from other pensions with a life-long term. Average monthly benefits are \92,830.

One-time lump-sum allowance is still the most preferred form of retirement money, as seen from the fact that 42% of total workplaces have only this type of retirement benefits. The benefit level depends on each workplace, but is usually 40 to 46 months worth of monthly salary for employees, who have worked a full-term (38 years for college graduates, and 42 years for high-school graduates).

III. Current Issues of Pension System

Aggravated by rapid aging, low rate of growth, and near-zero interest rates, National Pension and Employees' Pension Insurance are facing a difficulty to secure enough funds to meet the future requirements of pension payments. There is currently a hot debate on how to restrain the payments in order not to put too much burden on the future generations. An increase in the government subsidy seems inevitable, but securing financial sources (for example, an increase in the consumption tax) has been politically difficult.

One of the administrative problems in National Pension is that there is a growing number of eligible and required persons who have not become participants or have not paid the premium in full. According to the last survey (FY 1995), 8.2% of Category No.1 (i.e. self-employed, students, farmers, etc.) and 0.9% of Category No.3 (spouse of employees) have not participated. However, there is no non-compliance in Category No.2, as they automatically become subscribers when they become subscribers of Employees' Pension Insurance, so that overall non-compliance rate is 1 to 2%.

Even larger problem is the default rate of premiums among Category No.1. In 1997, the ratio of monthly premiums actually paid to fully expected premiums was 79.6%. In addition, 18.6% of Category No.1 are legally exempt from paying the premium, making the financial situation of the National Pension even worse. Every effort is being made at central, prefectural, and municipal government levels to decrease the default rate.

In the private sector, firms are realizing a huge burden of future pension payments, which is now labeled as liabilities under the new accounting system. Together with low-returns on their funds due to a recession of the economy, an interest has been increasing in converting their defined-benefit pensions to an American 401(k)-type defined-contribution pensions, in which future payments are related to the investment performance of funds, as opposed to the current system in which future payments are fixed at the beginning. The government is reviewing a new private pension scheme of the defined contribution type.

Another motivation behind the introduction of a 401(k)-type pension is the changing employment patterns. The traditional Japanese pattern of life-long employment has gradually been disintegrating. Thus, firm oriented pension schemes based on long-term employment at a fixed workplace must be changed to fit the new situation. One of the advantages of the 401k-type pension is that it is portable from a company to another.

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