Über die Autorin bzw. den Autor

Yasuyuki Fuchita is a senior managing director at the Nomura Institute of Capital Markets Research in Tokyo. He is coeditor of After the Crash: The Future of Finance (2010) and Prudent Lending Restored (2009), both published by Brookings.

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GROWING OLD

BROOKINGS INSTITUTION PRESS

Contents

Preface.................................................................................................................................................vii1 Introduction Yasuyuki Fuchita, Richard J. Herring, and Robert E. Litan...............................................................................12 Trends in Pension System Reform in East Asia: Japan, Korea, and China Akiko Nomura...................................................................113 The Crisis in Local Government Pensions in the United States Robert Novy-Marx and Joshua Rauh........................................................474 Managing Risks in Defined Contribution Plans: What Does the Future Hold? Olivia S. Mitchell..........................................................755 Asset Allocation by Institutional Investors after the Recent Financial Crisis Robert C. Pozen, Betsy Palmer, and Natalie Shapiro.....................95Contributors............................................................................................................................................143Index...................................................................................................................................................145

Chapter One

The recent financial crisis and subsequent recession resulted from a series of major failings: excessive incentives for lenders to originate subprime mortgages and for others to securitize them; poor risk management by financial institutions; serious failures of oversight by state and federal financial regulators; and far too much leverage in too many financial institutions and households. While the immediate dangers from the crisis have abated—the financial system has returned to profitability and the economy is growing, albeit slowly—the damage to the economy will linger for years.

Among the many impacts of the crisis is the growing interest in early retirement, perhaps because so many of the older unemployed are unlikely to find another job. That, in turn, has highlighted a problem that may be most acute in the United States: how government and private companies will honor their obligations under "defined benefit" (DB) pension plans—those that promise a post-retirement stream of payments based on some combination of workers' seniority, their average or highest level of pay, and perhaps other factors. The yawning gap between the costs to support pension obligations and the funds available to cover the costs is, without overstatement, highly disturbing if not alarming. In part the problem is one of demographics: the number of workers relative to the number of retirees has been shrinking and will continue to do so. But that challenge has long been known and therefore cannot fully explain the shortfalls. Why, then, are so many pension schemes so hard pressed?

One widely publicized answer lies in the generosity of many plans. The anecdotes are many. In California, for example, more than 9,000 state and local managers have retirement incomes of over $100,000 a year. Public schemes often calculate benefits based on final salary rather than average salary and allow employees to cash out unused sick days without limit. Private companies have been shying away from such commitments for some time now, but the original plans still exist and the residual commitments are significant. Although most pension plans in the United States today are "defined contribution" (DC) plans—which are based on a worker's own contributions, typically with some employer match—as of 2006, DB plans could still be found in two-thirds of the companies in the S&P 500.

A second answer lies in the tangle of accounting standards and actuarial conventions that allow DB plan sponsors, especially those in the public sector, to obscure the extent of their obligations and to scrimp on funding. To be sure, calculating those obligations is complicated, but current rules often permit generous return estimates of 8 percent while eschewing best practice techniques such as risk adjusting expected returns. That is especially pertinent because regardless of financial performance, pension fund obligations will need to be paid. With market returns on risk-free or low-risk assets having been driven to record low levels by the Fed and other monetary authorities, how will or can these obligations be met? That question vexes not only pension funds, but insurance companies, university and charitable endowments, and other institutional investors.

Questions regarding the future of pension plans and institutional investment following the financial crisis were the centerpiece of the 2010 conference on financial policy issues jointly organized by the Nomura Institute of Capital Markets Research, the Brookings Institution, and the Wharton Financial Institutions Center and held at Brookings in October 2010. This volume contains revised versions of four papers presented at the conference.

This introductory chapter provides a summary of the chapters that follow. The broad theme that runs throughout the chapters is that DB pension systems are in direct need of reform and that there exists no better time than the present to reckon with the challenges involved.

Akiko Nomura, of the Nomura Institute of Capital Markets Research, contextualizes the global nature of pension reform in chapter 2 by examining what has been happening in Japan, Korea, and China. The discussion in this chapter provides a useful introduction to many issues that relate to the United States and Western Europe as well, which are addressed in the remaining chapters.

Nomura identifies three global trends in pension reform: a shift from public to private pensions, increased levels of prefunding, and a shift from DB to DC plans. She finds that the three countries that she examines in detail are broadly following the global trends but with particular and important deviations.

The three countries—Japan, Korea, and China—were not by chosen by accident. They are the subject of analysis because of both their global prominence and their diversity relative to one another. Japan is a country of 127 million people; Korea, 48 million; and China, 1.3 billion. Their histories with pensions are similarly varied. Japan began a public scheme as far back as 1942, whereas Korea and China launched their public programs much more recently, in 1988 and 1990, respectively. Japanese corporate pension plans also are by far the oldest, dating back some fifty years; corporate launches took place only in 2004 for China and 2005 for Korea. For all the differences in their program history and design, however, each country faces the same demographic challenge: the share of the population aged sixty-five and older is growing, meaning that a larger base of beneficiaries must be supported by a relatively smaller base of workers. While Japan's issues with a shrinking and aging population are well known, Korea and even populous China must grapple with the aging of their populations. How these countries are attempting to deal with this challenge is instructive.

A pension scheme that functions well will be both sustainable and adequate. That is, its funding will be secure and it will provide a respectable standard of living. While both of those goals are necessary, each places tension on the other. As budget pressures grow, steps must be taken to reduce that...