BUILT-UP PENSION

A Japan-Version 401(k) Has the Financial World Drooling

In its first session this year, the Diet will discuss the finer points of a bill proposing a defined-contribution (DC) pension program similar to the 401(k) plan of the United States. The plan is epoch-making in that it will allow individuals - for the first time -- to make major decisions on how their retirement savings are allocated. If just a small percentage of those eligible -- which includes almost everyone -- accept personal risk and take advantage of this opportunity, the impact on the financial market will be huge. If one-fifth of the nation's individual savings moves into the program, Sakura Bank estimates, it will create a market worth ¥48 trillion, or about $466 billion at current rates.

The world's biggest financial institutions are scrambling for position. Despite a lack of detail on how the program will be structured under law, just about every player in the Japanese market already expects to make boatloads of yen. Profit expectations, further, help explain the rush to offer online financial services to individual Japanese. The public is paying attention too, drawn by media coverage of reduced corporate pension payout, job instability, underfunded company pension programs, and higher contributions and later start of payout in the national pension program.

The timing is spot-on: Both the stock market and the economy are finally showing life, brokerage commissions have been deregulated, and just about all the institutions and ways of doing things in Japan are caught up willy-nilly in change. A huge sum still locked into high-interest term deposits at the post office will mature soon, and at top insurer Nissay Life alone, about ¥1.3 trillion worth of policies matures each year. The insurance industry as a whole will pay policyholders a record ¥10 trillion in 2001. Furthermore, the low return on other instruments, like government bonds and bank deposits, is creating opportunities for financial firms to attract light-footed money from existing clients, and perhaps from competitors. The combination of a very high level of liquidity and low returns from the major alternatives means that changing the pension market will provide immense potential for retail marketing. But no one is chilling champagne bottles just yet.

Several factors threaten to limit the plan's success: (1) a risk-avoidance mentality, (2) the need for labor-management agreement, (3) the small size of the proposed maximum annual contribution, and (4) a danger that the tax incentive will not be adequate. The industry is betting that all will be overcome.

Many analysts doubt the willingness of the Japanese to voluntarily take on more responsibility for their own post-retirement income. Kumi Fujisawa, who as director of a Standard & Poor's division concentrating on financial information services, speaks at seminars on the pension program, says the task is daunting. "The answer is education," she says. But attendance at typical seminars offered by brokers is only 30 to 50 people -- hardly enough for education to be effective. Education is a major aspect of the business strategy for all firms planning on offering products, which mostly means mutual funds. Money market funds and global equity funds will be among them, and will increase offshore investment by individual Japanese.

Any employer wishing to sponsor a plan must obtain the agreement of the company's labor union. Most observers doubt that large companies will be successful in reaching such agreements. Fujisawa says that for this reason the market during the early stage of development is going to be mostly confined to smaller companies.

And if anything can help the Japanese overcome their fear of losing assets, it's an even greater fear that the national and corporate pension systems don't work well anymore. Reminders abound. In mid-December, the electronics giant NEC asked the union to negotiate a decrease in the corporate pension payments; Hitachi has already done this, and Toshiba has made a similar request to its union.

While financial companies like Morgan Stanley Dean Witter -- which recently opened up a Japanese-language website -- rev their engines in anticipation of new pension business, few Japanese companies so far are showing interest in the plans being offered. Clarion, for example, says no action at all has been taken. A maker of stereos and navigation devices for automobiles, Clarion has some 2,200 employees and is probably representative of many medium-scale enterprises.

Some companies with special motives have begun to offer defined-contribution plans even in advance of their formal establishment, even though there's no tax incentive yet. Pasona, Japan's leading supplier of just-in-time workers and other HR services, became in October 1998 the first company to announce a DC plan. Ippei Abe, who works in the personnel department, was among the 100 employees who signed up. "I'm worried about the future of the national pension system," he says. Yasuda Fire & Marine, a non-life insurer that's set up a joint venture with US life insurer Cigna, announced a plan for all Yasuda group employees and corporate clients. The motive here is clearly the desire to be among the first to accumulate experience in offering DC plans for consideration by corporate-benefit managers.

Employees participating in company-sponsored plans will be given a rather narrow choice of funds and other instruments -- which means the real battle for banks, brokers, and insurers will be getting on the ballot. Each sponsor, assisted by advisors, will create a limited menu (mostly of mutual funds), selecting from just a few choices.

Pasona employees, for example, may choose one offering from each of the following categories: Japanese equity, global equity, global bond, and balanced (stocks and bonds). The Yasuda plan offers five mutual funds, a Morgan Stanley Dean Witter package, six.

Because the menu will be limited, fund hawkers are working hard at strengthening brand consciousness (one of the push factors behind trying to do more online business in Japan), and are doing some heavy marketing to the companies that intend to offer plans. Last October, when Goldman Sachs offered an Internet-focused US fund called netWIN, it arranged for New Japan Securities, Nomura, and 14 other firms (including an online broker) to sell it. That was more companies than Goldman had used in the past, and the target of ¥613 million ($5.95 million) was easily exceeded by the end of November. Fidelity, looking to establish brand recognition and future market share, has set up what are basically mutual fund convenience stores in nearly two dozen banks.

Keizo Mizude, a Daiwa Asset Manage-ment representative, anticipates the pension market will generate a surge in the mutual fund market in Japan. He says the strategic objective of many financial firms in this arena "is to have a tenth of the mutual-fund market at the time it reaches ¥10 trillion."

For the mutual fund market to grow on the strength of the new pension plans, the scale of contributions might have to be raised. The government bill to go to the Diet calls for maximum annual contributions of no more than ¥432,000 for employees in a company-sponsored plan, or ¥216,000 if their participation is in addition to a company pension program. Housewives and independent businesspeople, who have no corporate pension option, will be permitted to put up to ¥816,000 in a nonsponsored plan. These amounts, many in the industry have complained, are far too low. It would be enormously difficult, they contend, to achieve significant benefits over the long term by putting together such small sums. Getting an increase - at least at the outset -- will be tough, because the Ministry of Finance anticipates a ¥3 trillion annual tax loss based on the present plan.

The current regulatory framework may impede funds being shifted from existing defined-benefit plans to the new 401(k)-like ones, says Hiroshi Miyai, executive director of the Institute of Pension Research at the Nikko Research Center. He sees the extent that the regulatory framework permits funds to be transferred as one deterrent to market growth. The US experience demonstrates that a good legislative and regulatory framework is critical to success, and in Japan success will largely depend on refinements made in the DC scheme before it is finally approved.

The government, however, could impede private firms in another way -- by competing with them. The amazing announcement made by the Ministry of Posts and Telecommunications - eager to increase business at the post offices -- of its intention to enter the DC market threatens the potential earnings of all the would-be players.

Whatever the government does, the number of companies aspiring to offer funds to the Japanese will only rise. As it is, the country's financial institutions are increasing their offerings. In Gifu Prefecture, for example, the small Ogaki Kyoritsu Bank started modestly when the market was opened in December 1998, but now has greatly expanded the number of funds offered. Many other Japanese financial companies, however, are reluctant to develop solid business plans until the features of the new pension scheme are known.

But opportunities in this area already abound. The most important are (1) the supply of investment instruments to banks, insurance companies, and fund retailers, and (2) the management of funds. Account management, custodial services (including the immense job of record keeping), education, and information supply, all related to marketing mutual funds to the Japanese, are also certain to increase in demand, in turn increasing demand for product research, translation services, call-center operations, software and hardware, and Web designers and support functions.

Companies from overseas are a big part of the preparations -- sometimes in a complicated fashion. Imminent creation of a large new market, by promoting realignment among the Japanese financial institutions, is having ripple effects touching those institutions. For example, State Street Bank, a US provider of pension-related services, is part of a group with Nomura Securities and the Industrial Bank of Japan that's been set up to make money from individual pensions. State Street, already marketing funds through Sakura Bank and other Japanese companies, is going to increase hiring in Tokyo largely on the basis of pension market growth.

Further, the number of pension personnel at American Express Asset Management (Japan) is reportedly set to double over the next year or so. And Deutsche Bank is part of a group -- including Mitsubishi Trust, Nissay Life (already in a mutual-fund tie-up with Putnam), Toyo Trust, and Meiji Life (already in a mutual fund arrangement with Dresdner Bank) -- that will set up a new bank specifically for the pension market.

US financial behemoth Morgan Stanley Dean Witter is preparing to market plans to both large and small corporate clients. It will reportedly offer smaller companies a full-service menu, including products, account management, and education. The firm will work with life insurers and consultants for account management and education, so business opportunities are being generated right down the line.

Decisions on the major parameters of the new pension program will largely determine the scale of free-agent activity in the mutual fund market. Although specifics will not be available until later this year, all financial institutions are nevertheless convinced that the demand for mutual funds, including funds investing in securities outside of Japan, will grow greatly as a result of introduction of the new pension program. This coincides with the advent of online trading and the high growth of Internet investment, and with a power drive by foreign institutions to gain and improve access to the pool of Japanese savings. As one result, many companies are certain to give much greater attention to the Net as a marketing medium for mutual funds.