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A3.3 Outline of the 2004 Pension Plan Revision

Faced with these difficulties, Japan drastically reformed its pension system in 2004. The reform has three basic aspects.

First, the portion of the basic pension funded from the tax revenues of the general account of the central government was raised incrementally from one-third to one-half, beginning in fiscal 2004 and ending in fiscal 2009. Second, a freeze on increasing employee and national pension premiums was ended. Third, issues regarding women and pensions were addressed. Let us explain the reform in more detail.

At least once every 5 years, reviews of the system’s finances with a 100-year horizon will be carried out. Before the 2004 revision, the “whole-future-balancing method” was adopted for pension finance. This meant that the reserve for public pensions was maintained at a level that looked at a continually updated 100-year period in order to balance benefits and contributions into the indefinite future. In the 2004 revision, it was decided that the pension reserve should reduce further in order to reduce the disparities in benefits and burdens among generations.

With reform, the whole-future-balancing method was replaced with the “closed- period-balancing method.” With this method, the pension reserve is managed with a view to balancing it over a finite but long period of time. The target level of the reserve is set so as to maintain about one year’s worth of benefit expenditures for 95 years ahead. The reserve is funded at a level that should allow the payment of benefits for 95 years into the future, given current benefit levels and various assumptions regarding future contributions and fund earnings.

Second, Employees’ Pension contributions are being raised by 0.354 percentage points each year from October 2004 until fiscal 2017, when they will reach 18.3 % of employees’ incomes. Their level will then be fixed at 18.3 %.

Third, the monthly benefit of the National Pension is being raised 280 yen each year, beginning in April 2005 and reaching 16,900 yen in fiscal 2017. Thereafter, the benefit level will be automatically adjusted to keep benefits within the scheme’s income.

The adjustment of benefits is to reflect the increased capability of society as a whole to contribute. This is called “macroeconomic indexation.” Comparing the benchmark scenario with this revision, if the average growth in the number of total insured persons paying into the public pension scheme declines, and there is an increase in benefits as a result of longer-than-expected average life expectancy, benefits will decrease.

More precisely, demographically modified indexation is defined as the inflation rate minus an adjustment rate. The adjustment is expected by the government to be about 0.9 % per year. The actual level is based on the growth rate of total insured persons in the public pension scheme and the increase in benefits attributable to longer average life expectancy. Benefits will be adjusted using this demographically modified indexation. However, the formula will not be applied when demographically modified indexation is less than zero; for instance, when consumption prices and wages fall.

The nominal amount will be at the lower end of the possible adjustment. Basic support for a standard household will be approximately 50 % of the average income of the active generation. More specifically, income substitution will be 50.2 % in a standard model pension (including a couple’s basic pension) from 2023 on.

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