Automatic balancing mechanism adjusting benefit according to

demographic conditions

Nobuyuki Uda Director-General of the Research and Co-ordination Department

Policy Research Institute, Ministry of Finance Japan

1

Category 1

17 million

(Self-employed and dependents) 国 民 年 金 （ 基 礎 年

金 ）

(Example)

EPI

Hypothetical Household case

¥222,000/month

Japan’s public pension system

Basic Pension

¥65,000/month

Premium (contribution)

Employees' Pension Insurance (EPI), Mutual Aid Associations (MAA)

National Government

Subsidy

Category 2

40 million

(Employees: Private sector (EPI) and public sector (MAA)

Category 3

9 million

Dependents of

category 3 (As of March 2015)

National Pension (Basic Pension)

(Source: Ministry of Health, Labor and Welfare)

2

Pay-as-you-go and funded-pension: combined in Japan

Past Future

Premium and tax

Public Pension Reserve

Premium and tax

Public Pension Reserve

¥139～221 Trillion (2040) (Depending on the 8 economic assumptions.)

¥173 Trillion (2016)

(Source: Actuarial Valuation of Public Pension Plans, Ministry of Health, Labor and Welfare (2014)

Age↑

3

Aging of the population

0

5

10

15

20

25

30

35

40

1950 1970 2000 2030 2050

（％）

Japan

2010

Japan:23.0

Germany:20.8

France:16.8

UK:16.6

USA:13.1

Germany

France

UK

United States

1970 2016 2025 2050Japan 7.1 27.5 30.3 38.8Germany 13.6 21.4 25.0 32.3France 12.8 19.5 22.4 26.3United Kingdom 13.0 18.0 19.6 24.7United States 9.7 15.2 18.9 22.2

<Source>

Japan (-2010): Ministry of Internal Affairs

Japan (2011-2050): Ministry of Health, Labor and Welfare

Others: World Population Prospects, the 2012 Revision, the United

Nations

<Source>

Department of Economic and Social Affairs,

the United Nations

男性 女性

Japan (2010)

Japan 2050

The population pyramid of Japan The trend of old-age dependency ratios

% of population

% of population

age

age

4

Public Pension Reserve (Projection)

(Source: Actuarial Valuation of Public Pension Plans, Ministry of Health, Labor and Welfare (2014)

(Trillion JPY)

0

50

100

150

200

250

2016 2024 2032 2040 2048

Case A

Case H

5

Three ways to reform

1. Raise the minimum age to receive public pensions

2. Reduce benefit

3. Raise pension premium

6

How the minimum age (scheduled to) changed

Start of reform (completion of

reform)

Average years of receiving pension

Working population (20-64 years old) per the aged (65

onwards) Change from 2012 to 2015

Japan 6065

Male: 2013 (2025)

Male: 21.9 ２．４→１．３

Female: 2018 (2030)

Female: 27.0

USA 6567 2003

(2027) Male: 18.8

Female: 21.7 ４．４→２．５

UK 6568 2018

(2046) Male: 18.2

Female: 20.9 ３．５→２．２

Germany 6567 2012

(2029) Male: 19.1

Female: 22.0 ２．９→１．５

France Full pension: 65→67 (Partially: 6062)

Full: 2016 (2022)

Partially: ２０１１(２０１７)

Male: 18.9 Female: 23.1

３．３→２．０

Canada 6567 2023

(2029) Male: 19.0

Female: 22.3 ４．２→２．２

Italy

66 (Ex. 62 for female in private sector) 66 for all

[Changeable according to the average life

expectancy] 67 in 2021

2012 (2018)

Male: 17.9 Female: 21.4

２．９→１．５

The minimum age for full pension

. The minimum age for full pension has been raised in the G7 countries

7

Revenue (premium)

Reserve fund

National government subsidy

Pension expenditure

The government decided to adopt a fixed contribution schedule coupled with a mechanism to rebalance pension finances through automatic adjustment of benefits. The former scheme conducted recalculation (Actuarial Valuation of the Public Pension Plans) every five years to change (raise) the pension premium to finance the benefits.

(1) Pension premium to be raised every year from 2004 to 2017, and fixed thereafter

(3) Long term plan for withdrawing the public pension reserve(*)

(2) National government to raise its subsidy to the basic pension from a third (33%) to 50%

(4) Introducing the automatic balancing mechanism that adjusts the benefits with the financial resources.

Fixed 2017～

Japan’s public pension system reform in 2004

※ The Public Pension fund is scheduled to be used on the 100-year plan. At the end of the plan,

the amount of remaining fund is expected to be equal to one-year pension expenditure.

Macro-Economic Slide

8

10

15

20

25

Premium Rates: Employees' Pension

（％）

(Year)

～～

［2017］

16(2004)

２５.９％

8(1996)

13.58%6.79% (Employee) + 6.79% (Employer)

29(2017)

18.3% (2017 onwards) 9.15% (Employee) + 9.15% (Employer)

10,000

15,000

20,000

25,000

30,000

13,300

National Pension Premium（JPY）

(Year)

～～

［2017］ 16,900JPY (2017 onwards)

2005

13,300JPY

1998 2017

29,500JPY

Without the 2004 reform

Without the 2004 reform

※ 2004 Price Level - The pension premium is

set at 2004 price level. - The premium will be

adjusted according to the wage growth rate

Scheduled hike of public pension premium

15,590JPY (2015)

2015

9

Macro-Economic slide ～Automatic balancing mechanism adjusting benefit according to demographic conditions～

・People who newly start receiving pension (Age 65-67 / case of full pension) : wage growth － slide adjustment rate

・People who are currently receiving pension (Age 68 – / case of full pension) : price growth － slide adjustment rate

where, Slide adjustment rate = Increase rate of the total number of people covered by public pensions ＋ fixed rate with consideration of growth rate of average life expectancy (total about 0.8% → 0.9%)

• Start the adjustment of the amount of benefits in the case where it is anticipated, in the actuarial verification that is held at least once every five years, that keeping the financial equilibrium of pension is difficult throughout the financial equilibrium period, even though keeping necessary amount of pension reserve (approximately one year of the amount of benefit) so as not to be detrimental to pension payment at the end of the approximately 100 years of the financial equilibrium period.

• The amount of pension usually increase in response to wage and price increase. However during adjustment period of pension benefit, the revision of pension benefit will be reflected in the decrease of the ability to support pension system and growth of average life expectance so that the increase of the amount of pension shall be suppressed to be lower than the increase of wage and prices. (This system is called as “Macro-Economic Slide Formula”)

• In subsequent actuarial verification, at a time when the financial equilibrium of pension is anticipated to be sustainable, those adjustment of the amount of benefits shall be concluded.

Price (wage) growth

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Constraints of Macro-Economic slide

Slide adjustment rate (0.9%)

±0%

Slide adjustment rate (0.9%0.5%)

±0%

±0%

Revision rate of benefits: 4.1%

Revision rate of benefits: 0%

Slide adjustment rate (0.9%0%)

Revision rate of benefits: -1%

・Price (wage) growth ＞ Slide adjustment rate ＞ 0 ・The amount of reduction is full.

・ Slide adjustment rate ＞ Price (wage) growth ＞ 0 ・The amount of reduction by Macro-Economic slide equals to wage increase. (Macro-Economic slide is partially applied)

(The Macro-Economic slide is suspended)

① High price (wage) growth

② Low price (wage) growth

③ Negative price (wage) growth (deflation)

・Slide adjustment rate ＞ 0 ＞ price (wage) growth ・The amount of reduction by Macro-Economic slide equals to zero.

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Replacement rate during the adjustment period of pension benefits

Replacement rate = Average disposable income of hypothetical household

Annual social security pension benefits at age 65 (for hypothetical household)

Wage growth rate

Wage growth rate – slide adjustment rate

Decrease of Replacement rate ≈ slide adjustment rate

Replacement rate

50%

Time

Slide adjustment period

Slide adjustment ceases when projected benefit is fully covered by projected contributions and pension reserve in the long run (from 2036 to 2058 according to Actuarial Valuation of Public Pension Plans).

The replacement rate is required to be above 50%. Reform will be required if replacement rate is projected to be lower than 50%

The hypothetical household comprises a working husband and a non-working dependent wife of identical age. The husband was enrollee in the EPI (employees’ pension insurance) scheme from age 20 through 59, throughout which time he earned an average salary.

※

※

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Description of the projection for Japan’s public pension benefit

○ The Model and Estimation Method

Following the method of European Commission (2006; 2009; 2012a; 2012b; 2015) and Ueda et.al (2014), estimation is made by assuming the current systems.

○ Fiscal assumptions (expenditure and revenue)

“Age-related spending”: It is an expenditure where per person expenditure is different by the age. Includes social security benefits (pension, health care, long-term care) and for education etc.

“Age-related spending” is estimated in consideration of the benefit levels based on per person by-age-group that reflects the change of population structure, various systems, and policies.

“Non-age-related spending”：Extended by nominal GDP growth .

Government revenue (tax revenue, social security premium, other revenues)：Extended by nominal GDP growth rate, reflecting the increase in future tax/insurance premium rate stipulated by law.

For the population structure, “Population projection for Japan (medium projection)” (National Institute of Population and Social Security Research, January 2012) is used.

○ Economic assumption (economic growth rate, interest, etc.) By 2023,

“Economic and Fiscal Projections for Medium to Long Term Analysis” (the Cabinet Office, July 2015).

After 2024 Actuarial Valuation of Public Pension Plans ” (the Ministry of Health, Labor and Welfare, June 2014) ・Real GDP growth 0.4% ・Nominal GDP growth 1.6% (real growth + inflation rate), ・Nominal long term interest rate 3.8%

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Change in “age-related spending”

14

11.0%11.3%

6.4%

9.5%

1.7%

6.1%

4.0%

3.1%

0.8%1.0%

0.4% 0.2%0%

2%

4%

6%

8%

10%

12%

2012 2024 2036 2048 2060

Public Pension Health Care Long-Term Care

Education, et.al Public Assistance Employment Insurance

(% of GDP)

0.45

0.47

0.49

0.51

0.53

0.55

0.57

0.59

0.61

0.63

0.65

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47

The effect of suspension of Macro-Economic slide

・Under deflation economy, Macro-Economic slide is suspended (Delayed Case). ・The suspension prolong the adjustment period by Macro-Economic slide, and reduce the replacement rate of future generations

The prolonged period

A B C D E F

The Start of Macro-Economic Slide

Normal Case

Delayed Case

Normal Case

Delayed Case

The End of Macro-Economic Slide

The End of Projection Period

=

The decrease of replacement rate of future generation due to suspension of Macro-Economic slide due to deflation

The increase of replacement rate of present generation due to suspension of Macro-Economic slide due to deflation

From A to D From D to F

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Pension reform bills submitted to the Diet in 2016

• Macro-Economic slide has been suspended due to deflation.

• However, the suspended amount of reduction (carry over) will be deducted from benefits when the economy recovers.

<Reform of rules about pension amount>

[From April 2018] The nominal amount of pension does not get

lower. However, the increase of benefit due to price-growth will

be constrained until carry over is fully offset.

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Summary

• The 2004 Reform has adopted an automatic balancing mechanism that adjusts the benefits according to the demographic conditions.

• The PRI’s model simulates that the “Automatic balancing mechanism” would significantly constrain the pension expenditure compared with other age-related spendings. (Assuming that the prices (wages) will continue to increase)

• In case when the prices (wages) do not increase, the automatic balancing mechanism would not work.

• If the replacement rate reach the minimum level of 50%, it would require another reform in the public pension system.

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Reference

• European Commission (2006), “The Long-term Sustainability of Public Finances in the European Union,” European Economy, No.4.

• European Commission (2009), “Sustainability Report 2009”, European Economy, No.9.

• European Commission (2012a), “Fiscal Sustainability Report 2012”, European Economy, No.8.

• European Commission (2012b), “The 2012 Ageing Report: Economic and budgetary projections for the 27 EU Member States (2010-2060),” European Economy, No.2.

• European Commission (2015), “The 2015 Ageing Report: Economic and Budgetary projections for the 28 EU Member States (2013-2060)”,European Economy, No.3.

• Ministry of Health, Labor and Welfare (2014), “Actuarial Valuation of Public Pension Plans”

• Ueda, J., Yoneta, Y., Ohta, I. (2014)，” A Quantitative Analysis for Required Adjustments for Japan’s Fiscal Policy”, Public Policy Review, Vol.10, No.4, pp.577-604.

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