Current market turbulence is compelling plan sponsors in Japan to rethink their investment and funding strategies. Strong equity market performance between 2019 and 2021, coupled with rising interest rates, saw the funded status of defined benefit (DB) plans rise to their highest levels in years. The WTW Pension Index for Japan, which measures the change in the projected benefit obligation (PBO) funded ratio for a hypothetical benchmark plan, is at its highest peak since 2011, close to 100%.
At such a turbulent time, examining the different outcomes of various pension risks can help. Asset liability management (ALM) can take into account different risk scenarios and assumptions to help navigate the uncertainty.
Let’s start with the positive – strong equity markets between 2019 and 2021, coupled with recent increase in interest rates, has driven a rise in funded status.
Source: The WTW Pension Index for Japan as at June 30. The WTW Pension Index measures the change in the project benefit obligation (PBO) funded ratio for a hypothetical benchmark plan.
Source: The Pension Fund Association (PFA) for the years 2014-2021, WTW estimate for 2022; Funded ratios as at March 31.
On the other hand, there are many challenges facing fund sponsors. Key drivers of asset and liability returns, such as economic growth, inflation, and interest rates – the cornerstones of capital market assumptions – are currently very uncertain.
The yen has weakened
The Japanese yen has fallen to a 20-year low against the USD.
With equity markets remaining volatile and interest rate increases on the horizon, DB plan sponsors are gradually reducing allocations to traditional bonds and equities.
| Allocation to alternatives | <3% | 3-5% | 5-10% | 10-15% | >15% |
|---|---|---|---|---|---|
| Prevalence among Japanese DB plans | 8% | 7% | 19% | 18% | 49% |
Plan sponsors are increasingly including ESG criteria in investment decisions. Our research reveals that 62% of plan sponsors already invest or are considering investing part of their assets in sustainable investments.
Source: WTW 2021 DB Plan Governance Survey (Japan).
With a stronger focus on pension governance in Japan, many DB plan sponsors have recently taken actions to improve governance.
Source: WTW 2021 DB Plan Governance Survey (Japan).
The DC contribution limit is changing. Effective 1 December, 2024, the DC contribution limit for companies sponsoring both a DB and a DC plan, would depend on the funding discount rate used to determine DB contributions. A higher risk-return investment strategy would permit to support a higher DB funding discount rate, resulting in a higher DC limit.
With this myriad of market changes and dynamic economic and social environment, DB plan sponsors are required to carefully review their investment and funding strategies in Japan.
Employers are making use of asset liability management (ALM) studies to guide the way. ALM involves consistently projecting assets and liabilities, under multiple economic scenarios in the future, to determine the strategies that best support the plan sponsor’s financial and business objectives relative to the plan.
Pension sponsors can use ALM studies to review:
