JAL may spark major revamp in pension finance

Change critical if other firms to avoid carrier's underfunded fate

by Jason Clenfield and Tomoko Yamazaki

Bloomberg

Japan Airlines Corp.’s $25.5 billion bankruptcy may be the impetus for such companies as Hitachi Ltd. and Toyota Motor Corp., Japan’s biggest private employers, to shore up their deficit-ridden pension plans.

Japan’s top 278 companies were a combined ¥21.5 trillion behind on their pension funding in fiscal 2009, a 50 percent jump from the previous year, according to Daiwa Institute of Research in Tokyo. Hitachi’s unfunded liabilities totaled ¥1.1 trillion — triple the deficit that helped push Japan’s former national carrier into bankruptcy.

The pension plans suffer from two decades of slumping markets, an aging population and a dependence on packages that are immune to investment performance. Japan Inc. stuck with defined-benefit plans even as the nation’s stock market slid and interest rates hovered near zero.

“It’s going to be very difficult to improve their underfunded status,” said Yoichi Okamoto, a pension consultant at Towers Watson & Co. in Tokyo. “Companies will be earning money from their operations and losing it to their pension plans.”

JAL, which the government supported with four bailouts in nine years, filed for bankruptcy Tuesday with ¥2.3 trillion in debt that left it unable to pay full pensions. Current workers agreed to a 50 percent cut in retirement benefits, and retirees accepted a 30 percent reduction.

Benefit cuts may spread through Japan Inc., analysts said. Companies are behind on their promised funding obligations by an average of 16 percent, data from Stamford, Conn.-based research firm Greenwich Associates show.

Japanese companies will divert more of future earnings to plug the funding gap while also asking retirees to shoulder some of the burden, said Yuuki Sakurai, chief executive officer of Fukoku Capital Management Inc. in Tokyo.

“Balance sheets are going to get worse and worse,” said Sakurai, who oversees $7.6 billion. “A lot of companies are going to do what JAL has done: tell employees they have to cut promised benefits.”

Yet those pension plans are healthier now than they were in 2003, when firms were behind by an average of 38 percent. The last time pension funds were fully funded was in 2007, at the peak of Japan’s most recent economic recovery.

“Japan has gone through a couple of meaningful dips in funding ratios,” said Dev Clifford, a consultant at Greenwich who focuses on Japan. “So there’s precedent for having dug one’s way out of this.”

The hurdles are high, said Jacob Kirkegaard, a research fellow at the Peterson Institute for International Economics in Washington. Almost 23 percent of the nation’s 126 million people will be older than 65 this year, compared with 13 percent in the United States, according to data compiled by Bloomberg.

People under 15 comprise 12.5 percent of the population, compared with 19.4 percent in the U.S., the data show.

The benchmark Nikkei 225 stock average is trading 72 percent below its 1990 peak, and yield on Japan’s 10-year government bond is 1.3 percent, compared with 3.7 percent in the U.S.

“That translates into severe difficulties in getting return on investment,” said Kirkegaard, coauthor of the 2009 book “U.S. Pension Reform: Lessons from Other Countries.”

“If you continue to have fairly generous corporate pension plans — as was clearly the case with JAL — you are going to have these problems.”

Companies will be under pressure to change because of accounting rules being adopted in the wake of fraud cases like Enron Corp. International standards likely to take effect within two years will require current pension losses to be posted on a company’s balance sheet instead of being spread out over a longer period.

Under current rules, about ¥8.6 trillion in pension shortfalls are not included on Japan’s balance sheets, according to Daiwa.

Unfunded pension liabilities for the top automakers — Toyota, Honda Motor Co. and Nissan Motor Co. — exceeded ¥1.5 trillion last year, the companies said.

Toyota, the nation’s second-biggest employer, had a pension shortfall of ¥654 billion as of March and will fill the gap with “future cash contributions,” according to its annual report. Nissan’s unfunded pension liability was ¥430 billion on March 31, according to its annual report.

Defined-benefit programs like those favored by Japan contributed to last year’s bankruptcies at General Motors Co. and Chrysler Group LLC. These plans give workers predetermined benefits that don’t change when investments fall, leaving companies responsible for making up the difference.

Defined-benefit plans make up 60 percent of Japan’s corporate retirement funds, Clifford said. About 4 percent of assets are invested in defined contribution or 401(k) programs, which only became legal in 2001 and have a cap of ¥25,500 per month.

That’s too low, Clifford said.

“That’s a big part of why defined benefit plans have stayed in place,” he said. “There hasn’t been a viable defined-contribution plan.”

In the U.S., more than half of companies use defined-contribution or 401(k) plans, according to Greenwich.

Japanese companies also are trying to get better returns by scrapping a bias toward domestic investments. Overseas investments accounted for 25 percent of assets at Japan’s corporate pension funds in fiscal 2009, Pension Fund Association data show.

Honda, which says it has ¥457 billion in unfunded pension liabilities, last year lifted a requirement that its fund managers buy Japanese assets.

“There is a greater focus among Japanese pension funds on the efficiency of their plans and the investment selections that they make,” said Justin Balogh, president and representative director at State Street Global Markets (Japan) in Tokyo. “The tolerance for sustaining underperforming managers has shortened.”