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Japanese Society of Certified Pension Actuaries October 8,2003 | 
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The 32th Workshop
Mr. Leslie Lohmann
I would like to start with a little joke. As you know, that is the way presentations begin in the west. Two actuaries are walking down the street, the one says to the other, why do we have such problems in the world? The companion replies "Go figure!" OK. That wasn't so good. |  |
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| How about this? What famous season appears in this formula? |
| "3+5=?" |
| How about simplified into Japanese? |
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| (Kanji)３足す５幾つ |
| (hiragana)さんたすごいくつ |
| Perhaps a little katakana |
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| サンタすごいクツ |
| and, for Americans who like spaces between their words, |
| サンタ すごい クツ |
| The answer, of course, is Christmas. |
| Not only is that word play pretty much impossible in the west, few westerners would find it funny. While Japanese would not begin with a joke, I find that many Japanese find this wordplay amusing - maybe even funny. |
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| Culture. It is at the root of everything we do that we don't think needs explanation. Culture makes us efficient. Unfortunately, culture also makes us blind. |
| Japanese generally don't see laundry hanging on the balcony and, when they do, especially if it is the futon, they admire the hard working people who live there and think it is probably a pretty good neighborhood. Americans always see laundry on the balcony, thinking they wouldn't want to live near those people! |
| Closely related to culture is naming. We choose the names of our children carefully, but the names we adopt for things in our cultures usually just happen based on circumstances. I believe that, had Japan called their plans that provided a lump sum benefit at severance, "severance plans," Japan could have escaped the scrutiny of FAS 87. But, since they are "retirement plans," everyone just automatically assumed that FAS 87 applied, and, of course, now it does. |
| I will talk about names along with culture. |
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| Most of you have met me previously and have some idea of my background. For the others, I am a Fellow of the Canadian Institute of Actuaries, a Fellow of the Society of Actuaries, a Fellow of the Conference of Actuaries, a Member of the American Academy of Actuaries and an Enrolled Actuary. I took a lot of qualifying exams! |
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| I have been an unrecognized Japanese actuary for over thirteen years of practice here in Japan; I consult with companies on the liabilities of their corporate retirement plans - primarily providing the accounting numbers under FAS 87, IAS 19 and the new Japanese standard. I am an actuary, not a linguist and, thus, still do not speak, read or write Japanese. Many have offered valid criticisms of this shortcoming. |
| During my actuarial career of over 30 years, I have made my living in the U.S., Canada and Japan. Doing so has made me wonder about the differences among countries. It has also made me think about the similarities. |
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| A big part of my educational background was science; I believe in the value of the scientific method. As such, like Thomas Edison, I have made a great deal of progress in my life by being wrong; I observe, I make conjectures, I look for ways of establishing the truth of the conjectures. I often find them wrong - often with the help of a client or an associate who depends upon me. Some who know me find this irritating! |
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| On the contrary side, I also try to find the defects in others' arguments. My graduate school Statistics Department Head did a lot of anti-smoking work. He taught us to find the errors in the cigarette company arguments that smoking did not harm smokers or others. Having studied and worked with ERISA since 1974, there is a similarity; like smoking, ERISA is killing the people it is advertised as improving the lives of. |
| This same thinking process led me to reject the doomsday prophecies for Y2K. It also leads me to believe that industrialized countries are not in a demographic crisis affecting their retirement systems. I have a strong belief in the ability of we humans to do the right thing. |
| Similar thinking has led me to a sincere admiration of the Japanese retirement plan system before the recent changes. I am publicly on record as saying that the Japanese system is the best in the world. The admiration I have of the retirement system does not extend to the economy. I disagree with those who believe that the problems caused by the economy can be corrected by changing the design. |
| What I am talking about today is conjecture resulting from observation. It is my opinion. I am either right or I am wrong and I hope that airing these ideas will get you thinking of ways to prove me wrong so that the correct solutions can be found. Japan is at a crossroad where Japan can either lead and improve the lives of Japanese, or follow the ideas of others. |
| It also reflects portions of my philosophy of life; I believe there are reasons for most everything, including our cultural preferences and aversions. In my work, I look for those reasons in order to help my clients understand what is happening and why. Like in marriage, understanding is sometimes the best that can be done. |
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| My basic premise is "Japan is not America. They are different." Each has strengths. Each has weaknesses. Each can improve the lives of citizens by learning from both the strengths and the weaknesses of the other. |
| Some time ago I attended a presentation here in Japan sponsored by the Society of Actuaries in the U.S. You all probably didn't attend, as it was an insurance issue. Japan was one of the last stops on the multi-country trip these actuaries were making. |
| One of the American speakers showed the Japanese audience his passport. While it seemed fairly new, it had a lot of recent stamps in it. He felt that his Japanese audience, all of whom spoke, read and wrote English fluently, should respect his opinion because he had traveled so much. This is a kind of arrogance that I believe is particularly American. |
| While I have found a particularly Japanese kind of arrogance in my many years in Japan, it usually does not present in this kind of situation. Japanese humility in international discourse is a model worthy of emulation. The Japanese are expert at discovering before recommending, at learning from others. I truly admire the Japanese ability to listen and learn. |
| Culture. It is at the root of everything we do that we don't think needs explanation. On the internet, I found the following definition: |
| "The totality of socially transmitted behavior patterns, arts, beliefs, institutions, and all other products of human work and thought." |
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| Sounds quite universal in application. While there is certainly a "world culture," I am more inclined to use this definition: |
| "The predominating attitudes and behavior that characterize the functioning of a group or organization." |
| In this case, the groups are two countries. Some of what we believe about the U.S. also applies to Canada, but, please believe me, Canada is a distinct culture from America. Although Canadians are from North America, they are not Americans. I grew up only 60 kilometers from Toronto - it was a shock to discover all of the differences. There were sentences that my friends in Toronto could not understand, and this was before French had moved much west of the Ontario/Quebec border. |
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| The point I hope to leave you with is that, when one culture adopts from another culture, the results are seldom those expected. In fact, it can be dangerous. |
| Japan has adopted much from America. Of what has been adopted, little has remained American. |
| Consider 洋服. |
| I am always amused when American executives come to Japan, meet their Japanese counterparts and assume, incorrectly, that, since the Japanese are wearing suits and ties, they must be just like American executives - like themselves. Of course, another cultural characteristic of Americans, Americans would believe the Japanese were just like Americans if the Japanese showed up in 浴衣 - Americans have a hard time understanding that there are successful systems in the world that differ from America. |
| Supporting this conjecture, even though, right next door in Mexico, real property cannot be owned by individuals, Americans believe that their sense of private ownership is universal! Imagine the misunderstanding when the distances exceed a few kilometers! Put the Pacific Ocean in between and things get very interesting. Interestingly, on the other side of the same issue, their sense of eminent domain leads them to not understand why the roads in Tokyo can't be widened. I wonder that myself, sometimes. |
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| Culture is more controlling than "PC" or politically correct. When an issue is cultural, one does not need to ask questions about it, in fact, often, one is not permitted to ask questions. Imagine your own feelings in these situations; a non-Japanese guest walks into your house with shoes on, walks out of the toilet with the slippers still on or, your misgivings when your guest gets the first お風呂 in your home. I am not Japanese, but I have been here long enough to share these feelings. I always remind visitors to wash before getting in the tub and absolutely not to put anything other than their body into it! And, I don’t really believe they do what I ask. |
| Considering retirement plans, a cultural issue coming from America and now shared by Japan is the idea that a retirement plan is underfunded when assets are less than the total of all immediate termination benefits. As an aside, please think about termination benefits - they are a big part of this lecture. |
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| The trusty internet defines "retirement plan" as |
| "a plan for setting aside money to be spent after retirement [syn: pension plan, retirement program]" |
| Interestingly, there was no entry for "retirement scheme!" It is an American dictionary. |
| Notice the emphasis on the saving side. Despite the overwhelming evidence that a retirement plan provides benefits at, or during a period of, retirement, this definition focuses on the pre-retirement savings. Before discussing this further, I will tell you my definition of a retirement plan; "planned benefits provided at or after retirement." I claim that the purpose of a retirement plan is to provide benefits when due; not before and certainly, not after. |
| I wonder if you can see the impact of American culture in the internet definition? "syn" stands for synonym. In English, a synonym is a word that is different from another word that means the same thing. The definition states that a retirement plan is the same as a pension plan. |
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| "Is a plan that provides lump sums a "pension plan?" I think we should agree that it is not, since lump sums are not pensions. What about a plan that provides annuities but bases all calculations on the value of a lump sum? I would argue that it is not. I would argue, however, that these are retirement plans. |
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| Why would the dictionary emphasize savings? This goes back to the late 60's, early 70's. Thanks to a lack of sophistication and early favorable legislation, insurance products were taxed very favorably in the U.S. One of the very attractive features to high-income, high-tax indeividuals was the tax-free inside build up of cash surrender values of insurance products. In the U.S. annuities were insurance products. In particular, deferred annuities permitted tax-free accumulation of capital until surrender or annuitization. High inflation brought high emphasis on selling these deferred annuities with the customer never having any intention of ever taking the proceeds as an annuity. |
| While annuities were an available product, they really were only a theoretical nicety; it was the deferred annuity that had all of the attention. Deferred annuities, in fact, provided lump sums. While I knew of insurance company customers purchasing single premium immediate annuities, I was never aware of anyone converting their deferred annuity into the guaranteed annuity at that company; the rate was too low. Legislation reducing some of the favored tax status was passed and always referred to the product as an "annuity." In American business English, the word "annuity" now means something something different than a periodic payment, despite what we have learned as actuaries. |
| Lately, the mutual fund and brokerage industries have entered the "savings/retirement" fields. They are more than happy to agree to call their products "retirement plans" despite the lack of any formal benefit plan in retirement! If one listens carefully, you will see it is the influence of their money that is driving the development of retirement plan legislation. As large contributors to the political process, their view that "retirement plans" should be fully funded is being heard by many leaders. |
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| Retirement plans in Japan began as Japan was being industrialized after the war. They began life as company provided "retirement allowance plans" - they provided only lump sums upon retirement. There was no "savings" involved. They were very good for the economy, providing the money for consumption before it was saved. Typically, the retirement allowance was based on length of employment, pay at retirement and reason for retiring - voluntary or involuntary. |
| This reflected the needs of Japan business at that time; lifetime employment was the norm among companies that were able to afford retirement allowance plans. Few employees at that time quit before reaching the age of retirement and, often, there was a problem that deserved understanding when they did. When an employee was fired, the employee received the full benefit for involuntary, nondisciplinary termination. |
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| As time went on, Japan became more affluent. Companies began to experience cash-flow problems when highly paid employees retired. Insurance companies and trust banks (the politics behind this is beyond our scope) began selling products to help manage corporate cash flow - essentially externally funded vehicles that were (and are) insurance products with fixed premiums. While the use of capital remains questionable, highly paid employees did not have to worry about their companies raising the required cash for their retirement benefits. Rank and file employees benefited from the additional security also. The extra cost of this cash flow management tool was considerable; taxes, administrative and profit charges. |
| But, the reason for the vehicle - cash flow management - created some problems. The typical contract had no and still hasn't any guarantees from the provider. Until the 1990's, this really wasn't a problem, since the premiums charged were based on low discount rates compared to actual rates of returns and conservative actuarial methods (I am not talking about EPF here). Plans that I encountered in the early 1990's were generally overfunded for termination benefits. |
| Japan had passed laws prohibiting discrimination on the basis of gender. Frankly, they had little "teeth" and were generally ignored. Pay for the same work was (and still is) generally lower for females. |
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| Looking at retirement benefits, we find that Japan never did take gender into account, since they were calculated from the lump sum and annuities were usually fixed term certain annuities. Based on pay; females got the same gender-neutral benefit as males. If the base pay was the same, then so was the value of the retirement benefit. This has never been true in America. |
| Japan benefited from another cultural characteristic - lifetime employment and employee-focused management. It was pretty much inconceivable that an employee would leave early - voluntarily or involuntarily. Based on pay and service, benefits were only reduced for reason for termination - voluntary retirement drew half in the early years and disciplinary retirements were treated harshly - often drawing nothing. Since the benefit was calculated as a lump sum, discounts for early receipt were not considered. Employee-focused management was not particularly concerned with reducing the cost of this low probability event. |
| Let's examine the situation in the U.S. |
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| Management in America is management focused. Other than paying the bare minimum to get the job done, companies in the U.S. are not concerned about rank and file employees. Company policy (the working regulations) can be changed at any time, without employee agreement or even notice. They can actually be changed retroactively. |
| I have always been amazed in Japan that often when a Japanese executive of a foreign capitalized firm seeks a special benefit for him/herself, an effort is often made to provide the same benefit to the employees also. This does not happen in the U.S. Executives seek and obtain special pay and benefit packages for themselves and do not consider providing the benefits to the rank and file employees. Recent scandals in the U.S. have revealed senior executives taking more than 100% of the added value they brought to the organization. What kind of phenomenon is this? I don't see the executives thinking about the issue as they do it - it is automatic. I think it is cultural. |
| Senior managers in America would never ask for a true DC plan (or anything remotely similar to "Japan 401K") as their primary company provided retirement plan. The primary plan is always DB. Secondary plans tend to be arrangements where the executive will accumulate cash with no downward risk; plans that have DC-sounding names like "phantom stock," but are, in fact, DB. They also try to have them prefunded in ways that protect them as much as possible from the risk of loss and any early tax obligations ("Rabbi" trusts). |
| Senior executives in Japan continue to rely on DB plans, but I think it is primarily related to taxation of directors, not less of a desire to have the same type of plan as the rank and file employees. |
| Culturally, American executives are far more willing to sacrifice the good of the regular employees to their own gain knowing that, whatever happens, they will be employed again at the top with sky-high pay, even after getting a platinum parachute on departure. |
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| Why do American retirement plans have all of the problems they have? Gender discrimination? Age discrimination? Miniscule benefits for retirement before the plan-specified retirement age? Etc., etc. No ability to negotiate levels of benefits or rights at termination. |
| Culture. |
| Why can't Americans see the problems and develop useful solutions? |
| Again, culture. Americans cannot conceive of any system different than what they have. Despite the very real impact that an American had upon the development of Japan's retirement system, Americans cannot imagine a system like Japan's. |
| Why is FAS 87 so hard to apply outside of the U.S? The answer, of course, is that it is culturally bound. As I said, Americans cannot conceive of a retirement system that is different than theirs. |
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| Originally, companies that provided anything at retirement provided it only at retirement and the benefit often, after the very early days of a gold watch, was a continuation of reduced pay to the former employee from payroll. Japan does this now by making former directors "advisers" and paying them a monthly retainer. The U.S. follows a similar scheme with the highest officers and directors of their companies. While some former directors take these roles seriously and actually show up at the office, most companies would rather they just stayed home! |
| For tax purposes, these payments were considered "reasonable" business expenses and were deductible to the company and taxable to the former employee as received. The payments were treated in all tax respects as if they were pay. Seldom were these amounts paid as a lump sum. Since it seemed so much like pay, few federal regulators were worried that companies were actually engaged in the business of insurance and annuities. |
| For many other reasons (spendthrift, use of capital, preservation of business secrets), companies paid retiring employees monthly stipends. These weren't really annuities, since the company had to survive in order for them to continue. Everyone pretty much understood that. |
| As retirement plans became more organized, companies made it clear that the pension benefits were available only to those employees who stayed to normal retirement. Retire before that time and there was no benefit. |
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| So, unlike Japanese plans that developed to support employees whenever they retired, American plans developed only to provide a pension to the very long-term employees who retired at the permitted retirement age. For you technically oriented actuaries, it was of the form Nr/Dx , no benefit was payable prior to the age "r." The pre-retirement D's included decrements for death, disability and turnover. |
| Companies eventually got approvable requests for retirement prior to the normal retirement age. Wanting to do what was fair (that is - no additional cost), the actuary was asked how to handle the situation. The actuary suggested calculating the annuity based on pay and service at the time of actual retirement to be paid later at normal retirement - a deferred annuity. Nr/Dx remained unchanged. There was, however, an increase in cost because, as of a specified age, the turnover and disability decrements were dropped from the pre-retirement D's. |
| Not surprisingly, the employee was keen on getting payments right away, so, the actuary developed early retirement factors. Interestingly, in the pre-ERISA days, the early retirement factors depended on the costs to the company - they were based on the funding method in use for the particular plan for the particular company. It was only later that methods to keep the value the same for the employee were developed. |
| Since, culturally, everyone agreed that the benefit was a retirement benefit due at normal retirement age only, the reductions for taking the benefit before normal retirement were acceptable. |
| Contrast this to Japan, where the retirement benefit was available at all ages of retirement; actuarially a series of c1 Cx+1/Dx , c2 Cx+2/Dx , etc. where the coefficients ci were chosen to be appropriate for someone with that much service and pay. |
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| But, the U.S. had another important issue to deal with. People began to feel that it was unfair for a person to work many years, retire before normal retirement and get nothing. There was a feeling that some part of the projected benefit at normal retirement had been earned by work before then. The problem had already been dealt with on the insurance side leading to mandatory minimum cash surrender values. Americans feel they have an equitable buildup in a future contingent payment. |
| The concept of "vesting" grew out of this belief. After a suitably long period of service, an employee had a right to an equitable portion of that future benefit. The effect of the turnover/service decrements in the D's was getting shortened, increasing the costs of retirement benefits. |
| Actuaries developed a number of methods of calculating these "vested" benefits, all of which were considered fair, given cultural predispositions. Despite the appearance of fairness, however, at least one did not pass muster with ERISA - the "double pro-ration" method. |
| But the important concept is that they were all based on the concept of equitable buildup in the future contingent benefit. CSV's for retirement plans. The retirement benefit had no relation to what a terminating employee at that career stage really needed - it was merely the cash surrender value of the "accrued" pension benefit at normal retirement age. |
| The two most popular approaches were; | |
| 1) | One treated the future pension like a "whole life" policy and used a level premium method to develop the fair value of the termination benefit. This method was derived from cost allocation methods such as Entry Age Normal and was felt to produce a result of no gain or loss to the plan sponsor who was using such a method to recognize the costs of the program. |
| 2) | The other treated the future pension more like a Term policy. This method was felt to produce a fair value for the employee, while producing a gain for the plan sponsor. |
| Because it produced a gain for the plan sponsor especially when a plan was salary related, the second method became more common and became the method dictated by ERISA. Since the deferred benefit at normal retirement was called the accrued benefit, naturally, this value was called the present value of the accrued benefit. ERISA made this the minimum value that a sponsor could provide a departing employee. Unfortunately, unlike CSV's for life insurance, ERISA determined that the amount should vary with the discount rate, as it did before ERISA with the concept of preserving employer costs. |
| Since many plans did not permit cash/lump sums, the pension payable immediately required the calculation of the present value of the deferred annuity based on the accrued benefit payable at normal retirement, then the immediately payable annuity that could be purchased with that present value. Employees never felt good about this "reduction" in monthly benefit. It is another clear advantage of providing a lump sum at retirement age - the retiring employee gets the amount he thinks he has been promised. |
| This meant that an employee quitting during a period of low interest rates could get a materially greater amount of money than one quitting during a period of high interest rates. This could result in sizably different amounts over very short periods of time. |
| I terminated a large U.S. plan in 1987 just before the crash in October of that year. Despite the reality that employees got their plan termination benefits during a period of lower interest rates, their lumpsum benefits were calculated at the higher rates when the plan was terminated. The company actually realized a profit on their retirement plan. |
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| It is important to recognize that no one in America had a problem with the approach of varying amounts with the discount rate at the point of termination since it was a cultural issue; the employer was promising a benefit at old-age retirement, not a severance plan benefit. The use of flexible interest rates seemed reasonable. Employees (actually plan participants) had an equitable right to the growing equity in the contingent benefit. It is such a blind issue that the U.S. has separate laws for severance benefits, which, despite the fact that employees have a vested interest in getting paid these amounts, no one is clamoring for external funding for these. ERISA actually permits an exception to the funding rules as long as the amounts are below a certain level (I think it is 24 months of final pay). Since American still consider these as gratuities (the original situation with retirement benefits), they don't feel there is any problem. |
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| Why have Americans accepted the legislation of the termination benefits paid from retirement plans? I claim it is cultural. Americans have not seen retirement plans as providers of termination benefits, only old-age pension benefits. The termination benefits are merely CSV's - the equitable inside buildup of the ultimate retirement benefit. Thus, since the government has long regulated the surrender values of insurance contracts, it was only a small step in the same direction to regulate the "cash surrender" benefits of old-age pensions. I think that perception is changing. |
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| Frankly, I find ERISA's requirement for definitely determinable benefits a contradiction since a retirement plan that would, as Japanese plans do, provide a fixed amount at every point of severance predictable and known in advance, would be illegal. |
| Why have American preferred the risk of DC plans like 401(k) over DB? Besides ignorance of the comparative values, I believe they see the DC plan as a true termination plan that they have some control over. Also, DC plans are never designed to provide the same scales of benefits as the DB plans they are brought in to replace. Typically, they provide much lower old-age retirement benefits and much more generous early career termination benefits than American DB plans. |
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| Obviously, I think Japan has something to learn. I believe it can only be learned if Japan sees the things that Americans cannot see about their own system. | |
| I . | Basing benefits only on the lump sum value and staying out of life annuities protects companies from the gender bias problems and, ultimately, provides a business opportunity for insurers and trust banks - the sale of life annuities. Sponsoring companies should not be permitted to provide life annuities. |
| II . | Japan needs to avoid the concept of "accrued" benefit. The benefits paid to employees at retirement should be designed to meet the business needs of sponsors and their beliefs about the needs of their employees. Frankly, the current "S" curve of Japanese design is ideal, in my opinion. |
| III . | Japan should lead the world in properly recognizing whose promise a retirement benefit is and when the work was done that earned it. Retirement benefits should have priority in sponsor insolvency. |
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| This brings us to another interesting phenomenon; ERISA was supposed to bring some benefit security to American retirement plans. |
| By way of introduction, consider taxes in Japan. March 15 following the end of the calendar year is the date they must be done. No extensions are permitted. In contrast, the U.S. has a similar requirement for April 15… but is it? Well, no. |
| Every American is entitled to a four-month further delay - to August 15. This is without any reason needed whatsoever. Americans can actually, fairly easily, defer the tax return even longer. Corporations have even longer periods to get the work done. |
| Pension law in America began as tax law. Thus reporting the status was delayed until nine months after the close of the year. Extensions were available beyond that. So there was a minimum of 21 months after the valuation date before anyone legally knew the funded status of a plan as of that date. |
| Plans could be amended retroactively - reflecting the lack of any contractual rights for non-bargaining employees in America. This ended up being codified in ERISA - valuations do not need to be finished until 9 months after the end of the plan year. Over time, ERISA has dealt with this failure by requiring installment payments, but, the reality is, the valuation and reporting are done too late (21 months after the valuation date) to have any real protective power for employees. |
| That's why it has taken over two years to get the bad news of the market crash impact on U.S. plans. |
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| As I close, I will admit that there is not much I like about ERISA. However, being in the depths of a worldwide recession (or are we coming out now?), I will point out a very positive impact. ERISA prevent retirement plans from buying many investments during boom times. The full funding limitation is very powerful. I would expect that the U.S. bubble in the 90's would have been far worse if companies had been allowed to purchase additional investments with their retirement plan money. |
| Perhaps that is one of the reasons that the mutual fund industry and the brokerage industry are so against DB plans. |
| ERISA then forces retirement plans to buy investments when there is a recession. How more quickly would the U.S. have begun to recover if sponsors would have had to start making up deficits within weeks of the valuation date rather than 21 months? |
| Perhaps this is the other reason! |
| Think of where Japan's stock market would be right now if, in 1991, the government had insisted that EPF's and TQPP's lower their discount rates and start charging higher premiums. More money would have flowed into the market, buoying prices. Now that the market seems to be recovering, all those cheap securities would be helping the funded statuses of their plans, supporting the overall economy even more than the misguided government support of security prices we have seen. |
| The time to face the music is while it is playing! |
| Thank you for your time and your patience. |