By Chikafumi Hodo and Nathan Layne
KOBE/TOKYO (Reuters) - Tarumi Taxi in western Japan's port city of Kobe is teetering on the brink of bankruptcy, offering a glimpse of the crisis facing tens of thousands of small and mid-sized companies across Japan with little hope of meeting their pension obligations.
Owner Satoshi Nagata, 59, has been pressing banks for a loan before a deadline in September when a contractual trigger will quadruple the hole in the firm's pension account. Without it, Tarumi Taxi and its fleet of 40 cars and 80 drivers will likely fold.
"We've been in the red every year since 2007. The additional funds needed for this pension installment is killing our business. I've sold everything from stocks to golf memberships to keep us afloat," said Nagata, sitting on a torn sofa on the second floor of the old wooden building that has served as company headquarters for half a century.
"I'm talking with banks now in preparation to make the repayment by the end of August. But if I can't then we'll be in serious trouble."
Nagata didn't invest in AIJ Investment Advisors, the Tokyo-based advisory firm at the centre of a $2 billion fraud that came to light late last month. But he says he knows why other pension funds struggling to meet the obligations for their growing ranks of retirees would.
"We're not involved in AIJ but I can understand why they invested in this kind of high-yielding instrument," Nagata said.
In one of Japan's worst financial scandals, AIJ is under investigation for falsifying performance records on roughly 200 billion yen ($2.4 billion) in pension money. Nearly all of that is believed to have disappeared, dealing a blow to the 84 pension co-operatives representing 880,000 employees that entrusted it with funds.
The financial regulator, under fire for failing to prevent the scandal, has launched an investigation into all 265 discretionary asset managers in Japan. Politicians are considering regulations such as limiting risky investments and safety-net measures to support ailing pension funds.
But new rules and inspections will do little to help the legions of pension funds already nursing big shortfalls and failing to meet annual return targets of up to 5.5 percent, realistic decades ago when they were set but no longer probable in an era of zero interest rates and deflation.
Around a sixth of the 595 co-operatives that manage the bulk of the 27 trillion yen ($324 billion) in pension assets for small and medium-sized firms are designated by the health ministry to be in a state of critical financial health. As of March 2011, the collective shortfall was 630 billion yen.
"For companies that fail to manage their assets well the pension becomes a huge weight on profitability," said Hitoshi Suzuki, chief researcher and pension system expert at Daiwa Institute of Research. "Reserve shortfalls tend to grow in a deflationary environment, which Japan has experienced for a long time. It's a serious structural problem."
FALLING LIKE DOMINOES
Tarumi Taxi is a cautionary tale of the knock-on impact of winding down a troubled pension fund.
The current corporate pension system dates back to the 1960s when the government allowed companies to borrow a portion of the national employee pension fund to leverage their investments, a system that worked well before 1990 when Japan's bubble economy and share prices collapsed.
In the aftermath mostly large companies with the financial strength to pay back the borrowed portion did so because this allowed them to either dissolve their pension funds, lower the payout target or switch to a 401K-style defined contribution scheme. These changes put the burden of managing the pension on the employees themselves.
"Bigger companies have the ability to allocate more funds to the pension reserves and pay back the government portion. But small companies cannot do this. This is a problem for society," said Tsutomu Okubu, a lawmaker in the ruling Democratic Party and a member of a task force tackling the issue.
As a result the number of pension funds dropped dramatically, and most of those remaining are co-operatives too weak financially to return the borrowed portion to the state. They are made up of groups of companies in the same industry like gasoline stands, printing shops or the Hyogo prefecture taxi pension fund to which Tarumi Taxi belongs.
In 2006, the Hyogo taxi co-operative decided to bite the bullet and pay back the 7 billion yen it owed to the state scheme. Of the 50 companies in the fund, 21 had the ability to pay off their share in a lump sum, ending their obligations. The remaining 29 opted for installments stretched over 10 years at about 15 million yen per year, a tidy sum for a small taxi firm.
In 2007, the first company went bankrupt, leaving an increased burden for the remaining 28. By the end of last month another 14 had gone under. It is the first known string of bankruptcies triggered by the dissolution of a pension co-operative, according to Tokyo Shoko, a bankruptcy research firm.
Tarumi Taxi needs to raise about 100 million yen by August to wipe the slate clean. If it fails to meet that deadline its burden will automatically ratchet up to 440 million yen as it would be required to foot the bill for a larger number of failed members. This would surely bankrupt his firm, Nagata says.
Similar crises could play out among any of the more than 200 pension co-operatives that are in the red on the government portion of their pension assets, warned Tokyo Shoko analyst Kunio Hashimoto.
"In the future they are likely candidates for dissolution, and the situation could develop along the lines of Hyogo taxi," Hashimoto says. "That's just how grave this problem is."
With an investment strategy centered on Nikkei options and other derivatives, AIJ had boasted to prospective clients late last year that the cumulative returns since 2002 of a flagship Cayman-based fund had reached 245 percent.
Some funds allocated more than 30 percent of their assets with AIJ, attracted by the convincing sales pitch of president Kazuhiko Asakawa, whose status as a former branch manager at Nomura Securities lent him credibility.
"Many sales people got in contact with us to offer us new products. But I have to admit that Asakawa's explanation simply stood out," said one pension manager who invested in the flagship AIM Millennium fund.
Among steps being weighed to prevent another AIJ-type scandal, the health ministry is looking at limiting the percentage of a pension fund's assets invested with any one adviser, while the financial regulator is considering reclassifying pension funds as non-professional investors to give them greater protection under the law.
Okubo wants to introduce a Japanese version of the U.S. Employee Retirement Income Security Act (ERISA) to clarify the fiduciary responsibilities of all parties involved in pension management. In Japan, where many pension funds are run by financial novices, this accountability is unclear.
This issue is at the heart of a 26 billion yen ($312 million) lawsuit brought by a pension cooperative of gasoline stand owners on the southern island of Kyushu against Resona Trust & Banking Co in 2010.
The Kyushu pension claims Resona breached its fiduciary duty in steering most of its assets into highly leveraged property funds without properly explaining the risks. The property tumbled in value after the financial crisis in 2008, triggering massive losses.
A spokesman for Resona said the bank would not comment on an ongoing case. ($1 = 83.3000 Japanese yen)
(Additional reporting by Noriyuki Hirata, Taiga Uranaka, Emi Emoto and Michiko Iwasaki; Editing by Ian Geoghegan)