Policy Options for Financing the Future Health and Long-term Care
Costs in Japan*
Tadashi Fukui** and Yasushi Iwamoto***July 2006
Abstract
As the Japanese population structure changes, health care and long-term carecosts will steadily increase. The current style of financing (pay-as-you-go) will create alarge increase in future burden of these costs. This paper studies an alternative policythat prefunds the social insurance benefits for the elderly.
During a transition process, the proposed scheme maintains a higher contribution
rate in order to accumulate sufficient funds. Under our baseline scenario, the sum of thecontribution rates toward health insurance and long-term care insurance increases from5.06 percent of earnings to 12.41 percent of the same. The rate of increase in overallburdens, including taxes and subsidies, is 63 percent.
Our sensitivity analysis has shown that the quantitative implications of theincrease in total burdens depend on social cost scenarios, the labor force, and theinterest rate. However, labor force scenarios do not have a considerable impact on therate of burden. As against this, the setting of social costs has a significant impact on thesame.
Even under the most optimistic scenario, the rate of increase in total burden is 34
percent. Even though we cannot predict the exact amount of the necessary contribution
rate that is capable enough to transfer the funded system, what we are sure of is that asignificant increase in the contribution rate is inevitable.
JEL classification numbers: H55, I10
Keywords: social insurance; pre-funding; health insurance; long-term care; long-termcare insurance*This paper is forthcoming in Fiscal Policy and Management in East Asia, edited by Takatoshi itoand Andrew Rose. Earlier versions of this paper were presented at two meetings of the Economic
and Social Research Institute (ESRI) International Collaboration Projects, February 15–16, 2005 andFebruary 14–15, Tokyo; the 16th East Asian Seminar on Economics, June 23–25, 2005, Manila; andthe Spring Meeting of the Japanese Economic Association, June 3–4, 2006, Fukushima. We would
like to thank Henry Aaron, Raj Chetty, Olivia Mitchell, Epictetus Patalinghug, Motohiro Sato, and
Wataru Suzuki and all the participants for their helpful comments at these meetings. Financial
Support from the ESRI at the Japanese Cabinet Office is greatly appreciated. Iwamoto’s Research isalso financially supported by a Grant-in-aid for Scientific Research from the Ministry of Education.
**
Associate Professor, Kyoto Sangyo University***
Corresponding author: Professor, University of Tokyo. iwamoto@e.u-tokyo.ac.jp.

1. Introduction

The 2003 annual report on the Japanese Economy and Public Finance (releasedby the Japanese Cabinet Office) stated “the sustainability of the present fiscal and social
security systems is uncertain and hence, an early commitment toward bold institutional
reforms is required.” The annual report listed for the first time social security reforms
with regard to the aging population, and presented these reforms not in the form of aproblem to be dealt with in the future but as an issue of urgent importance.
In the public pension reforms of 2004, Japan cut future pension benefits
substantially. Since the ratio of the aggregate pension benefits to the national income(NI) is designed to be stable in the future, the financial problems associated with public
pension have been resolved to some extent. Failure to reduce intergenerational
inequality is a persistent problem in the public pension program; this is because theprimary aim of the reforms was to reduce the pension benefits and contributions of
future generations.
The expenditure incurred on health insurance and long-term care insurance is also
expected to increase. It is not easy however to reduce these benefits as pension benefits
because health care and long-term care services are essential for human welfare.
Bradford and Max (1997) and Cutler and Sheiner (2000) have shown that an unfunded
health insurance creates considerable intergenerational income redistribution. If these
health insurance costs are financed using the current scheme (essentially, a
pay-as-you-go system), a large increase in the future burden of these costs will become
inevitable, thus creating an intergenerational imbalance of burden. One way of restoring
intergenerational equity is for social insurance programs to prefund the expected
increase in future costs. In this paper, we consider the effects of introducing aprefunding scheme on the intergenerational distribution of burdens. Based on thefollowing three points, this paper gives new insights into the future financial problemsof social insurance programs.
First, this paper examines both health care and long-term care programs. Feldstein(1999) proposed prefunding of the Medicare program, and Suzuki (2000) conducted asimulation study of the prefunding of the Japanese health insurance program. This paper
also explores the concept of prefunding long-term care insurance. Annual spending on-1-

long-term care services is smaller than the expenditure incurred on health care services;
however, long-term care costs are concentrated heavily on the aged population.
Therefore, prefunding the cost associated with long-term care requires a large amount ofsaving. It is necessary to take into account both health and long-term care insurance inorder to be able to comprehend the financial problems faced by social insurance
programs in the future.
Our analysis of the intergenerational inequity of burdens is along the lines of thegenerational accounting pioneered by Auerbach, Gokhale, and Kotlikoff (1991). Since
we have focused on the ways in which health and long-term care costs may be financed,
the analytical framework adopted is somewhat different from that used in thegenerational accounting approach. We specify future policy variables and calculate thecost burdens with regard to the specified policy scenario. Our focus is confined only tohealth and long-term care insurances, while the generational accounting model
considers a wider range of governmental programs. We have instead provided a detailed
discussion of these programs.
Second, our simulation has a long time horizon until the fiscal year (FY) 2100,
while the government has projected social security costs for health care and long-termcare until FY 2025. Government projections with regard to social security costs were
only until FY 2025 since the aging process was expected to reach its peak at this pointwith most baby boomers approaching the end of their lifetime. Due to a decline infertility rates after the late 1970s, aging is now expected to continue beyond FY 2025; amuch longer time horizon is required in order to examine the effects of a demographic
change on social security costs.
Third, the validity of future projections is examined. The main alternative
scenario here assumes that with the exception of population structure, all the present
factors will be sustained in the future. This projection procedure is applied mechanicallyto the labor force, health care expenditure, and long-term care costs instead of
constructing a sophisticated forecasting model. A virtue of the mechanical projection
model is that relationships between the variables under consideration can be easily
established. Comparing the projected values with the government’s forecasts can clarify
the manner in which projections are influenced by the government assumptions.
The organization of this paper is as follows. Section 2 describes the current-2-

problems in the budget of the Japanese social security programs. We point out that thegrowth of health and long-term care costs is the most serious problem for thesustainability of the government budget.
Section 3 focuses on the projections of labor force participation. The government
projection is optimistic because it assumes that a greater number of women and theelderly will participate in the labor market. We provide an alternative projection inwhich increasing labor force participation is not expected. Although the estimated labor
force depends on the assumptions of labor supply behavior, the trend decline in the totallabor force will be significant in any scenario.
Section 4 focuses on health care expenditure and long-term care service costs. We
project these costs until FY 2100 with regard to three scenarios. Even under the most
optimistic scenario that assumes stagnation in the growth of per capita cost, theabovementioned costs to income will steadily increase until the 2060s.
Section 5 explains some policy simulations that deal with the financing of future
health and long-term care costs until FY 2100. It is shown that the balanced budget
operation of health and long-term care insurances will create a large inequity of burden
across generations. Raising the premium immediately and prefunding rising future costs
will help to equate the burden across generations. However, with regard to our baseline
scenario, the total burden must be raised immediately by approximately 60 percent.
We present some concluding remarks in Section 6.

-3-

2. Long-term Projection of Social Security Benefits

The Ministry of Health, Labor and Welfare (MHLW) occasionally publishes“Perspectives on the Benefits and Burdens of the Social Security System”(Shakai-hoshou no Kyufu to Futan no Mitooshi), which projects the benefits andburdens associated with public pension, health care, and social work, including
long-term care. According to the projections made in May 2004 (we refer to it as
MHLW 2004 projection hereafter), total social security benefits are expected to increase
from 23.5 percent of the total NI at factor cost to 29 percent between FY 2004 and FY
2025 (see Table 1).1

Table 1: Projection of Social Security Benefits and Burdens

2004

Social security benefits
Public pension
Health careWelfare, etc.
Long-term care
Social security burdens
Social insurance premium
Government subsidies

23.5
12.6
7.1
3.8
1.4
21.3
14.2
7.1

Fiscal Year
2010
2015

25.4
12.8
8.2
4.3
2.2
24.2
15.5
8.7

2025

27.0
12.9
9.2
4.7
2.7
26.6
16.7
9.6

29.0
12.2
11.2
5.7
3.6
29.5
18.3
11.2

Note) Numbers indicate percentages of NI at factor cost.
Source) Perspectives on the Benefits and Burdens of Social Security
System (May 2004, Ministry of Health, Labor and Welfare).

However, future trends in these benefits vary with social security programs.
Public pension benefits will not increase and will actually become slightly lower in FY
2025 as compared to their current levels. This stabilization of future pension benefits
1

The ratio of total security benefits to NI at factor cost indicates an unnecessary
fluctuation when the VAT tax rate changes. The Japanese government had begun to use
the ratio of total security benefits to NI at factor cost long before the introduction of
VAT. In this paper, however, we shall focus on the ratio of these benefits to GDP
instead.
-4-

was achieved by the pension reform of 2004. Prior to this reform, the contribution rate
for private employees toward the pension program was planned to increase graduallyfrom 13.58 percent of total earnings to 23.1 percent of the same in FY 2020. Since thisfigure appeared to be unacceptable, controlling the contribution rate became theprimary focus of this reform. The final contribution rate was reduced to 18.3 percent of
total earnings, and a significant reduction in benefits for the future was implemented.
However, this reform does not resolve all of the major problems. As explained byMaekawa (2004), since benefits are gradually reduced, the reform fails to correct theinequity in net benefits among generations. An immediate reduction in benefits
accompanied by an increase in the contribution rate is necessary to reduce theintergenerational inequity.
An emerging component of social costs is the benefits of health insurance andlong-term care insurance. Health care benefit as a fraction of NI will increase by 4.1
percentage points until FY 2025, whereas the long-term care benefit will grow by 2.2
percentage points during the same period. The big question that needs to be answeredby the policy makers is: How to finance these costs?
If health and long-term care insurances are operated by the pay-as-you-go system,
the cost burden on workers will steadily increase, thus creating an intergenerational
imbalance of burdens. Prefunding future social security costs will help to reduce thisimbalance by forcing the present generations to pay more, thereby reducing the extra
burden on future generations. The financial condition of a prefunding system relies on
future economic variables such as the interest rate, wage growth rate, and technologicalchange in medicine. Since the reliability of a future projection is a crucial factor in
determining the success of a prefunding schemes, we shall examine how a prefunding
system is affected by the future conditions of the Japanese economy.

-5-

3. Economic Growth and the Labor ForceIn this section and the succeeding one, we shall discuss the properties ofgovernmental projections and provide our alternative projections on the labor force,
economic growth, health care costs, and long-term care costs. This section focuses onvariables that determine income.
The publication “Perspectives on the Benefits and Burdens of Social Security”
does not rely on a general equilibrium model of the economy. It assumes the growth rateof real national income to be the sum of the growth rates of wage and labor force. This
framework can be justified in the following situation. A production function ishomogeneous of degree one with capital K and labor L. This function witnesses alabor-augmenting technological progress. It is represented as
Y = F (K , AL ) .

(1)

Here, Y and A represent the output and efficiency, respectively. Differentiating (1) withrespect to time yields
Y& FK K ⎛ K& A& L& ⎞ A& L&⎜ − − ⎟+ + .
=YY ⎜⎝ K A L ⎟⎠ A L(2)When the growth rates of capital and efficiency unit of labor are the same, thefirst term in the RHS of (2) becomes zero. The economic growth rate then equals thesum of the growth rate of labor-augmenting technological change (the wage growthrate) and the growth rate of labor input.
The MHLW 2004 projection assumes the growth rate of labor input to be 0.1
percent until FY 2008, –0.2 percent in FY 2009 and FY 2010, and –0.5 percent from FY
2011 onwards. The labor force in FY 2025 will be 61.58 million, which is 7.24 percent
smaller than its level in 2004. This framework is based on a detailed projection of thelabor force titled “A Forecast of Labor Force Participation Rates” (Rodoryokuritsu no
Mitooshi), which was compiled by the Employment Security Bureau of MHLW in May
2002 (We shall refer to it as the MHLW 2002 labor force projection). The lower sectionof Table 2 indicates that the MHLW 2002 labor force projection forecasts an increase in
the labor force participation rates of the elderly and women. The upper section of Table-6-

2 however, indicates the labor force calculated by multiplying the labor force
participation rates as reported by the Employment Security Bureau and the official
population projections (medium variant) for each age group. The calculated labor force
in 2025 is 62.97 million, which is slightly greater than those estimated by the MHLW
2004 projection. The initial point of the MHLW 2002 labor force projection was 2000,
when the total labor force was 67.66 million. Due to the decline in the labor force to66.42 million in 2004, The MHLW 2004 projection starts with a smaller initial point
and adopts a similar growth rate, thus estimating a smaller labor force in the future.
Table 2: The Projection of the Labor Force by MHLW

Male

Female

Year

2000

2025

2000

2025

Labor force(thousands)

40,14036,31027,52026,655

Labor force participation
Rates by age group(percent)
18.4
15–19
72.7
20–24
95.8
25–29
97.7
30–34
97.8
35–39
97.7
40–44
97.3
45–49
96.7
50–54
94.2
55–59
72.6
60–64
34.1
65–

20.1
77.6
95.9
97.6
97.8
97.8
97.5
96.9
94.4
85.0
29.5

16.6
72.7
69.9
57.1
61.4
69.3
71.8
68.2
58.7
39.5
14.4

17.8
73.7
75.3
65.0
67.4
75.2
77.0
73.5
67.5
60.5
13.0

Note: The 2025 labor force is calculated by multiplying the projected population(medium variant) reported in the Population Projections for Japan: 2001–2050(January 2002, National Institute of Population and Social Security Research) by
the labor force participation rates by age groups.
Source: The 2025 labor force: the Perspective on the Labor Force Participation
Rate (July 2002, the Employment Security Bureau, Ministry of Health, Labor andWelfare) and the 2000 labor force and labor force participation rate: the Labor
Force Survey (the Statistics Bureau, Ministry of Internal Affairs andCommunications).

-7-

While the government projection assumes an increase in the labor force
participation, we are apprehensive of this increase not being realized. To examine theimpact of projecting a future labor supply optimistically, we considered an alternative
scenario.2 We used the labor force participation rates by age from the 2000 Population
Census and the future population estimates from “The Population Projections for Japan:
2001–2050” (January 2001, National Institute of Population and Social Security
Research). The Population Census records the labor force participation rates ofindividuals up to 84 years of age (individuals aged 85 years and above are categorized
as one age group). We rescaled the labor force participation rates of each group in sucha manner that our estimates of the total labor force in 2000 were in concordance withthe values reported in 2004 by the Labor Force Survey.3
Table 3 shows our mechanical projection. From 2004 to 2005, the labor force will
decrease by 8 million to a level of 58.39 million people. A decrease in the labor force
will continue after 2025 and every decade will witness a labor force loss of more than
five million people. In 2050, a total labor force of 44.69 million people will be available.
The rate of change in the total labor force with regard to its value in 2004 is 32.7
percent. When a population projection is based on a low variant, the projected number
becomes more pessimistic. In 2050, the rate of change in the total labor force withregard to its value in 2004 is 38 percent. Since the effects of a low birth rate appear only
after newborn generations begin to work, the labor force in 2025 does not show
considerable variations.

2

Iwamoto (1998) analyzed existing studies on labor force and also projected the labor
force until 2020. His mechanical projection assumes that the present labor force
participation rates by age groups will be sustained in the future and that the structure of
future populations will change. His estimates are not very different from preceding
estimates made in academic studies that also incorporated behavioral changes. This canbe attributed to the fact that there is no scope for drastic changes in the labor force
participation rates of working-age populations. In addition, although the trend regarding
birth rates in the future is uncertain, future population can be predicted withconsiderable surety.
3
The Population Census recorded the labor force in 2000 to be 66.1 million. According
to the Labor Force Survey, it was 67.66 million.
-8-

Table 3: Mechanical Projection of the Labor Force（thousand person)
Labor Force
Year

2004

2010

2020

2025

2030

2040

2050

the Change
from 2004
to 2025

the Rate of
Change(percent)

the Change
from 2004
to 2050

the Rate of
Change(percent)

Medium variant (baseline)
Both sexes

66,39064,43260,35358,39356,00050,12844,687-7,997-12.0-21,703

-32.7

Males

39,04038,05935,58034,44933,13429,78326,550-4,591-11.8-12,490-32.0

Females

27,35026,373

24,77423,94522,866

20,345

18,138-3,405-12.5-9,212-33.7

Both sexes

66,39064,43260,331

58,17255,30648,08041,190-8,218-12.4-25,200

-38.0

Males

39,04038,05935,56834,33632,76928,626

24,520-4,704-12.1-14,520-37.2

Females

27,35026,37324,763

23,83722,537

19,454

16,670-3,513-12.8-10,680-39.0

Low variant

Note: Author's calculation. The labor force participation rates by age group are from the 2000 Population Census, Ministry of Internal Affairs andCommunications, and the figures for future populations are from the Population Projections for Japan: 2001–2050 (January 2002, National Instituteof Population and Social Security Research). The future labor force is calculated by assuming that the labor force participation rates for 2000 will besustained.

-9-The MHLW 2004 projection regarded the labor force as a labor input. Since theefficiency of labor varies with age, the overall values of labor force and labor input may
fluctuate differently. However, the procedure followed in the MHLW 2004 projection
can be refined. We estimated an efficiency unit of labor implied by the two MHLW
projections, assuming that efficiency is directly proportional to wage. The age-wage
profile by age group and sex was collected from the published cross-tables of the 2003
Basic Survey on Wage Structure (Chingin Kozo Kihon Chosa, MHLW). For each age
the efficiency unit of labor input is calculated as the product of the total wage per
worker and the projected labor force. We rescaled the aggregated efficiency unit of laborin 2004 so that it equalled the total labor force in that year. We considered three
scenarios: our mechanical projection (pessimistic), the MHLW 2004 projection(optimistic), and the MHLW 2002 projection (more optimistic).
Figure 1 depicts the three scenarios regarding labor input. According to ourabovementioned normalization, the MHLW 2002 labor force projection estimated thelabor input in 2025 to be 63.02 million. The 2004 counterpart of our mechanicalprojection is estimated to be 59.03 million. The MHLW 2004 projection underlying thesocial security cost projection lies between these two values. While the difference
between these projections is significant, all of them project a further decline in the valueof labor input after 2025. In 2100, the value of labor input is estimated to be 30.08
million in the most optimistic case as against 28.08 million in the most pessimistic one.
The bottom line is that even in the most optimistic scenario, the large decline in theavailability of labor force will be unavoidable.

- 10 -

Figure 1: Comparison of Three Labor Input Projections

70,000Efficiency unit of labor

60,00050,00040,00030,00020,000
2004

2014

2024

2034

2044

2054

2064

Year
very optimistic- 11 -

optimistic

pessimistic

2074

2084

2094

4. Long-term Projections of Health and Long-term Care Benefits

The MHLW projection assumes that the costs incurred by health care andlong-term care will grow more rapidly as compared to income. If our mechanicalprojection procedure is applied to both these costs, the estimates will be smaller thanthose estimated by official projections. To clarify the meaning of the official projections,this section describes a sensitivity analysis employing alternative settings for the key
variables. Combining the two scenarios of health and long-term care costs with the threeprojection scenarios of labor forces, we apply six cases of projections. The following
two subsections describe a procedure used for projecting the two costs. We then present
the results obtained for the sensitivity analysis.

4.1 Health Care Cost
Table 4 compares five recent projections about health care and long-term care costs.
Since projections in different years assume different inflation rates, comparing nominal
variables is misleading. When we look at the ratios of social security benefits to NI,
projected health expenditures differ mildly. The real growth of health care costs appears
to be more stable than the nominal growth of the same.

- 12 -

Table 4: Perspectives on Health Care and Long-term Care Costs Reported by the Ministry of Health, Labor and Welfare(trillion yen)
Projected
date

Projected in
March 1994

Projected in November 1996

Projected in
September
1997
Introduction of Introduction of
the long-term the long-termcare insurance care insurance

Fiscal Year

Health care costs
1993
24
1995
2000
38
2010
68
2025
141
(11–19）Long-term care service costs
2005
2010
2015
2025

24

24

Projected in
October 2000

Projected in
May 2002

Projected in
May 2004

35
60
(11)

34
59
(11)

24
26

107–108(11.5–18)

96(10–16)90(10–15)

71
(11)

6
8
13–20
(2)

14–21
(2.5)

21
(3)

20
(3.5)

9
12
19
(3.5)

Note: Numbers represent benefits of each type of social insurance. The numbers in parenthesis represent the ratio of social insurance
benefits to NI at factor cost.
Source: Welfare Vision for the 21st Century (May 1994, Ministry of Health and Welfare) and various issues of Perspectives on the
Benefits and Burdens of the Social Security System (Ministry of Health, Labor and Welfare).
- 13 -

Future health expenditures are projected by extrapolating the most recent actual
values of nominal health expenditure; these do not correspond with the values ofinflation rate and economic growth rate. For example, the May 2004 projection assumes
that the per capita nominal health care cost for the nonelderly (individuals under the ageof 69) will grow at 2.1 percent and that for the elderly aged 70 and above will grow at
3.2 percent. These growth rates are based on the historical averages recorded during
1995 and 1999.4 The extrapolation of nominal health expenditure without taking into
account the effects of inflation can be problematic from the viewpoint of economic
theory. Economists generally make projections based on real values, and themethodologies adopted by them belong to a family of mechanical projections. Iwamoto(2004) analyzed several projections made in existing studies such as Ogura and Irifune(1990), Ogura (1994), Niki (1995), Iwamoto, Takeshita, and Bessho (1997), Nishimura(1997), and Tokita et al. (1997). He concluded that in the following 30 years, thenational health expenditure would increase by about 1.4 times compared to its level in
2000. Our mechanical projection follows a method established by existing studies andassumes that per capita health expenditure by age group reported in the National
Medical Expenditure (MHLW, shown in Table 5) will be sustained in the future. For the
future population data, we use the medium variant of the official projection.
Although the above projection assumes no real growth of health care cost, it canbe easily extended to cases in which the health care cost grows. When the economy
grows, we focus on the ratio of health care cost to income. When the health care costand income grow at the same rate, the ratio will not change. In such a scenario, ourmechanical projection estimates can be considered as this ratio. In the alternative
framework described in the next section, we will concern ourselves only with thedifference in growth rates between costs and income and not with the absolute levels ofeach growth rate.

4

The MHLW provides an estimation of the growth rate in medical expenditure after
adjusting for the effects of population aging since 1980. Overall, the per capita medical
expenditure had grown less than per capita GDP; however, this correspondence wasreversed during the1990s.
- 14 -

Table 5: Expenditures on Health Care and Long-Term Care per
Capita by Age Group (2004 Fiscal Year)(yen)
Long-term
care

Age Group Health care

0–4
5–9
10–14
15–19
20–24
25–29
30–34
35–39
40–44
45—49
50–54
55–59
60–64
65–69
70–74
75–79
80–84
85–89
90–94
95–

158,900
92,10066,70058,10071,20085,60097,500103,000
119,100
149,900
199,200
245,000
323,100
433,400
564,800
749,400 (75–)

5,700 (40–64)

43,80097,000203,200
429,400
799,900
1,236,100
1,786,500

Note: The values are the sum of benefits from insurers and copayments by patients.
Health care expenditure is calculated by proportionally adjusting
the FY 2002 value reported in the National Medical Expenditure(Ministry of Health, Labor and Welfare) so that the national
aggregate matches the health care expenditure reported by
MEDIAS; this system totals the costs of services covered bypublic health insurance. The National Medical Expenditurecategorizes individuals who are 75 years of age and above as one
age group.
Long-term care expenditure: the values are calculated bymultiplying the actual costs of services covered by long-term careinsurance in October 2004 as reported in the Monthly Report ofLong-term Care Benefits (Ministry of Health, Labor and Welfare)by 12. Individuals who are 40 years of age and above can be therecipients of long-term care insurance. The Report categorizes
individuals between 40 and 60 years of age as one age group.

- 15 -

Since we intend to frame our mechanical projection in such a way that it iscomparable with the MHLW 2004 projection, the data with regard to age group wereconverted so that they were in concordance with the income level of FY 2004. First, percapita health care cost by age group was proportionally adjusted so that the national
aggregate of the same matches the figures reported in the Medical Information Analysis
System (MEDIAS), which reports the health care costs paid by public health insurance.
The national aggregate of health care costs was calculated as the product of populationand per capita cost by age group. The rescaled age-cost profile was used to project
future health care costs.
Further, we decomposed the total cost toward social insurance payment andout-of-pocket expenses. Unfortunately, MEDIAS does not provide this decomposition.
We obtained the figures for social security payment from the National Medical
Expenditure survey (Kokumin Iryohi). 5 While allocating social insurance payment
across generations, we used the statutory coinsurance rates of 2004 and assumed thatthey will be sustained in the future. Since April 2003, the coinsurance rate for the agegroup 0–2 years has been 20 percent, whereas for the age group 3–69, it has been 30
percent. For individuals aged 70 years and above, the rate in principle has been 10
percent (a rate of 20 percent is applied to high-income earners). Due to the lack ofavailable data, we assume that a rate of 10 percent is applied to all individuals aged 70
and above. However, the actual out-of-pocket payments are less than the statutorycoinsurance rate because of stop-loss rules and other schemes to reduce out-of-pocket
expenses. We proportionally scaled the statutory coinsurance rates so that the sum of theestimated social insurance payments matched the aggregate values reported by
MEDIAS in 2004.
Since the available data on health expenditure does not separately report theexpenditure incurred for the age groups 0–2 and 3–4, we assumed that the healthexpenditure per capita will be uniform in these age groups; we then calculated the5

The National Medical Expenditure (NME) lags one year behind MEDIAS in therelease of data. We first estimated the 2004 NME data by multiplying the growth rate of
a comparable MEDIAS variable between 2003 and 2004 with the 2003 NME data.
Since out-of-pocket expenses for NME also include payments of medical treatmentsthat are not covered by the social security programs, we estimated the out-of-pocket
payments as a residual of the overall payments.
- 16 -

average coinsurance rate. Since actual costs are concentrated on newborn babies, thisprocedure may slightly overestimate the true social security payment value. However, atthe same time, many municipal governments offer extra benefits toward the healthexpenditure of infants from their general budget. Since we do not incorporate thesesubsidies into our estimation process, it results in an underestimation of the social
security benefits granted to these age groups. However, the overall impact of thesesubsidies on our estimation bias is ambiguous.
We then reproduced the MHLW 2004 projection of the future health insurance
benefits. The MHLW 2004 projection assumes that the nominal wage growth rate is 2.1
percent per annum. Therefore, per capita health care costs for the nonelderly will growsimultaneously with the growth rate of wage. As against this, the growth rate of percapita costs for the elderly will exceed that for wage by 1.1 percentage points. The
projection with regard to the nonelderly is the same as our mechanical projection. For
costs beyond 2025, we need to first specify the growth rate of wage for the same. If thegrowth rate of health care costs continuously exceeds that of wage, it will ultimately
exhaust all the resources available to consumers. We thus need to assume that thegrowth in health care costs will cease sometime in the future. Hence, we consider twocases in which a faster growth in health care costs will eventually stop in FY 2025 or
FY 2100. In the former case, the per capita health care cost for the elderly is 5.56 times
greater than that for the nonelderly. The counterpart in FY2004 is 4.3. In the latter case,an extreme increase occurs in the growth of health care cost for the elderly; the ratio in
FY2100 will be 13.09.
As a measure of financial burden, we focus on the ratio of social security benefits
to the compensation of employees and the mixed income in terms of national accounts.
The denominator of the ratio is assumed to be proportional to the amount of labor input.
Changes in future health care costs can be described by the following three scenarios:
the per capita health care cost for the elderly will (1) grow at the same rate as that ofwage growth (optimistic), (2) will exceed the wage growth rate by 1.1 percentage points
until FY 2025 (pessimistic), or (3) will exceed the wage growth rate by 1.1 percentage
points until FY 2100 (very pessimistic). Combining these three scenarios with futurechanges in labor input yields nine different cases of future projection. The upper sectionof Table 6 presents these ratios.

- 17 -

Table 6: Projection of the ratio of Health and Long-term Care Costs to Labor Input

2010

Health caresocial cost: optimistic
labor force: very optimistic
optimistic
pessimistic1)
social cost: pessimistic
labor force: very optimistic
optimistic2)
pessimisticsocial cost: very pessimistic
labor force: very optimistic
optimistic
pessimistic
Long-term caresocial cost: optimistic
labor force: very optimistic
optimistic
pessimistic1)
social cost: pessimistic
labor force: very optimistic
optimistic2)
pessimisticsocial cost: very pessimistic
labor force: very optimistic
optimistic
pessimistic

2015

2025

2030

2040

2050

2100

1.08
1.09
1.12

1.16
1.18
1.22

1.29
1.32
1.38

1.35
1.38
1.44

1.47
1.51
1.59

1.62
1.66
1.74

1.55
1.59
1.66

1.12
1.13
1.16

1.26
1.28
1.32

1.52
1.56
1.63

1.59
1.62
1.70

1.75
1.79
1.88

1.93
1.98
2.07

1.84
1.89
1.98

1.12
1.13
1.16

1.26
1.28
1.32

1.52
1.56
1.63

1.65
1.69
1.77

1.99
2.04
2.14

2.41
2.47
2.59

3.66
3.75
3.92

1.25
1.26
1.29

1.52
1.54
1.59

2.03
2.08
2.17

2.31
2.36
2.47

2.81
2.88
3.02

3.14
3.21
3.37

3.31
3.39
3.55

1.34
1.35
1.39

1.73
1.76
1.81

2.61
2.67
2.79

2.97
3.03
3.18

3.61
3.70
3.88

4.03
4.13
4.33

4.25
4.35
4.56

1.34
1.35
1.39

1.73
1.76
1.81

2.61
2.67
2.79

3.15
3.22
3.37

4.32
4.42
4.64

5.43
5.56
5.83

10.41
10.65
11.15

Notes: Numbers represent the ratio of health care costs and long-term care costs to labor input (FY 2004 = 1).
1) Mechanical projection. The future labor force participation rate and per capita social cost by age group will
be constant.
2) A projection that replicates the MHLW 2004 projection, which is reported in Table 1.
Source: Author's calculation.

The MHLW 2004 projection indicates that the ratio of health expenditure to labor
input in FY 2025 will exceed its value in FY 2004 by 1.58. This scenario was
reproduced in our social cost pessimistic and labor force optimistic scenarios; thisindicates that the ratio will grow by a factor of 1.56 between FY 2004 and FY 2025. On
the other hand, same ratio under the mechanical projection will grow by a factor of 1.38
during the same period. Therefore, the MHLW 2004 projection is more pessimistic withregard to a future increase in health expenditure as compared to our mechanicalprojection. However, the most pessimistic scenario is a combination of an extremely- 18 -

pessimistic projection of health care costs coupled with a mechanical projection of thelabor force in the future. In this case, the ratio of health expenditure to labor input in FY
2025 will exceed its value in FY 2004 by 1.63.
A noticeable point is that this ratio will keep increasing, and its value in 2050
under the setting employed by the governmental projection will be 1.98 times greaterthan its value in FY 2004. In other words, FY 2025 cannot be regarded as the terminal
point for examining the sustainability of the health insurance system.6

4.2 Long-term care costs
The government anticipates that long-term care costs will grow more rapidly ascompared to health care costs. According to the MHLW 2004 projection given in Table
4, the long-term care insurance benefits in FY 2025 (the ratio of long-term care benefits
to NI) will be 2.7 times greater than its value in FY 2004. The growth rate of per capita
long-term care costs is set to be higher than the wage growth rate although detailed
assumptions have not been explicitly documented.
Municipal governments prepare three-year business plans for long-term careinsurance. Prior to the first revision that was made in FY 2003, The Projection of
Demand for Long-term Care (Kaigo Sahbisuryou tou no Mitooshi, June 2002) was
provided by the MHLW; it expected an increased demand for long-term care in thefollowing five years. For example, the provisional nationwide sum of the usage ofhome-visit services will increase by 39.3 percent from FY 2003 (142,194 visits) to FY

6

We should note that our projections may be biased in an upward direction because
they do not take into account the effects of aging on terminal care expenses. In Japan,
Ohkusa (2002) and Suzuki and Suzuki (2003) provided a modified projection that took
into account this aspect. Since terminal care expenses for the more aged tend to
decrease, a longer longevity will increase the average age of death; hence, future healthexpenditure by age group is expected to be lower than its present level. Taking thiseffect into consideration, the abovementioned studies pointed out that the MHLW 2004
projection overestimated the future health expenditure. Suzuki and Suzuki (2003)
reported this overestimation amounted to approximately 4.4 percent of the total healthexpenditures for the elderly. On the other hand, Ohkusa (2002) concluded that theoverestimation reached a level of approximately 15 to 30 percent of the total healthexpenditures. The divergence in their estimates is quite large because data limitations
made it difficult to separate the medical expenditures of the survivors from the medical
expenses incurred by those who died.
- 19 -

2007 (198,033 visits).7 The projection however, did not provide the total amount oflong-term care costs. We calculated the sum of these provisions weighted by their actual
costs in FY 2003 and the resulting growth during FY 2003–2007 that amounted to 26.4
percent.
We projected the future long-term care insurance benefits by adopting amethodology similar to that used for the projections of health insurance.8 At the time ofwriting this paper, most recent data for annual spending by age group was available for
FY 2002; hence, we estimated annual spending on the basis of monthly data. The
long-term care expenditure by age group in October 2004 was calculated from theMonthly Report of Long-term Care Benefits Survey (Kaigo Kyufuhi Jittai Chosa Geppo)
conducted by the MHLW.9 We then calculated annual spending by multiplying themonthly data with 12 and reported it in the right column of Table 5. The future
long-term care expenditure was then projected under the following three settings. The
first one (optimistic) assumed that the age-expenditure profile would not change andthat only the population structure would change. We then decomposed the total
spending into social security benefits and out-of-pocket expenses by assuming that theratio of out-of-pocket payments to total costs in FY 2002 (8.99 percent10) would besustained.
We then analyzed the following three scenarios of long-term care costs: (1) the
per capita cost of each age group will grow at the wage growth rate (optimistic); (2)until 2025, the rate of growth in per capita cost will exceed the wage growth rate by 1.2
percentage points and as a result, the total cost per income well approximated the
MHLW 2004 projection (pessimistic); and (3) until 2100, the per capita cost will grow
7This projection presumed that the number of individuals certified as requiring care in
FY 2003 was 3,279,000; however, the actual number of these certified individuals was
2,983,000 at the end of FY 2003.
8
Mitchell, Pigott, and Shimizutani (2004), Shimizutani and Noguchi (2004), andSuzuki (2002) are involved in projecting the future long-term care costs.
9
The data source does not directly report cost by age group. The available cross tables
indicate (1) the cost by the severity of disability and (2) the total number ofbeneficiaries by the severity of disability and age group. Assuming that the long-termcare cost of each level of disability was the same across all age groups that wereconsidered, we estimated the total cost by age group by using these two cross tables.
10
It is slightly lower than the statutory coinsurance rate (10 percent) because there aresome measures that lighten the burden of out-of-pocket payments.

- 20 -

at a rate that exceeds the wage growth rate by 1.2 percentage points (very pessimistic).
The properties of these settings parallel those applied for health care costs. Combining
these settings with three labor force projections yields nine scenarios. The resulting
ratios are presented in the lower section of Table 6.
The rate of growth from FY 2004 to FY 2025 is projected to lie between 2.03 and2.79. According to the governmental projection, it is estimated to be 2.67, which isrelatively pessimistic. If the per capita long-term care cost grows at the existing wage
growth rate, the rate of growth is estimated to range between 2.03 and 2.17 dependingon the labor force scenario.

- 21 -

5. Simulation of Health Care and Long-term Care Insurance Policies

5.1 Procedures of the simulation
This section deals with the simulation of policies that finance future health andlong-term care insurance benefits, the projections of which were described in theprevious section. This section focuses on the effect of these policies on fiscal balancesand burdens across generations.
Since we regard the benefits derived from these insurances as necessary services
when a person becomes sick or disabled, it is not very meaningful to discuss theintergenerational distribution of these benefits. Hence, our simulation focuses only on
the financing of these benefits.
From October 2007, half of the benefits derived from the health insurance of
those aged 75 and above will be financed with government subsidies that are in turnfinanced by general tax revenues. Until October 2002, only 30 percent of these benefits
for those aged 70 and above were financed with government subsidies. From 2002 to
2007, a transition process gradually raised the eligible age and the share of government
subsidies. Half of the long-term care insurance benefit is financed with government
subsidies. The other major subsidies granted by the government are 50 percent of thebenefits of National Health Insurance schemes (Kokuho) and 13 percent of theGovernment-managed Health Insurance for Employees (Seikan Kenpo).
We assume that social insurance premiums and taxes for social insurance benefits
are paid from the same income base, which is the compensation of employees and themixed income in terms of national accounts. For simplicity, we further assume thatthese incomes will grow at the same rate as GDP (and labor input) after FY 2004 andthat there are no administrative costs involved in the implementation of such social
insurance programs.11
The initial and terminal years of the simulation process are set as FY 2004 and FY
2100, respectively, because the population projection carried out by the National
Institute of Population and Social Security Research is available only within these11

For instance, the administrative cost involved with the implementation ofSociety-Managed Health Insurance for Employees is about 0.4 percent of the total
benefits derived from such programs during FY 2001.
- 22 -

periods.
We consider the following two policies

Policy A: A balanced budget operation in which the benefits during each year are
financed by the taxes and insurance premiums of the corresponding year
Policy B: An attempt to reduce the intergenerational inequity of burdens by
prefunding future social insurance payments for the elderly (details will be described in
Section 5.3)

5.2 Balanced budget
We define burden rate as the ratio of burdens (the sum of insurance premiums andgovernment subsidies financed by taxes) to 90 percent of the sum of compensation of
employees and the mixed income. We aimed to calibrate the statutory premium rate byrescaling the sum of the compensation received by the employees and the mixed income.
The health insurance premium (including government subsidies for the nonelderly andexcluding those reserved for the elderly) for the initial year, i.e., FY 2004, is calculated
to be 8.21 percent. The actual health insurance premium for the enrollees of theGovernment-Managed Health Insurance for Employees is calculated to be 8.2 percent.
Since the enrollees of the Government-managed Health Insurance for Employees are
employed with small companies, their average salary is lower than that of all theworkers. Since government subsidies aim to offset the earnings difference, we tried tocalibrate the statutory insurance premium. With regard to long-term care insurance, thesimulated premium rate for FY 2004 is 1.11 percent; this matches the actual insurance
premium paid by the enrollees of the Government-managed Health Insurance for
Employees. Under the balanced budget, the burden is equal to social insurance benefits(excluding out-of-pocket payment). Therefore, we calculated the ratio of benefits toincomes.
Figure 2 presents the burden rates associated with health care, long-term care, anda total of both of them when Policy A is implemented under the governmental
projection (social cost-pessimistic and labor force-optimistic). The burden rate forhealth care continues to increase until FY 2059 when it touches 19.94 percent. As
against this, the burden rate for long-term care will touch 10.97 percent in FY 2066.

- 23 -

Although the paths followed by these two burden rates appear to be parallel to eachother in Figure 2, we must however, note that the absolute level of long-term care costs
is low. The burden rate for long-term care grows much more rapidly than that for healthcare because compared to health care benefits, long-term care benefits are concentrated
to a greater extent on the aged population. For the same reason, a peak representing theburden rate for long-term care will follow a peak of the burden rate for health care. The
total burden rate of both the insurances reaches a peak that is 30.65 percent in FY 2064.
The ratio of total burden to GDP then amounts to 15.63 percent in the same year.
Figure 3 presents the lifetime burden rate of each generation under thegovernmental projection. It is defined as the ratio of lifetime burden to lifetime income.
The lifetime variable is the sum of the present discounted values of the reported annual
numbers during the period between the initial and the terminal points of the simulation
process. Therefore, the burden rate is the prospective lifetime burden for the generation
born in 2001 or earlier. To estimate lifetime income, we adopted the age-wage profile,which was used to calculate the labor input in Section 3. The interest rate is assumed tobe 1 percentage point higher than the wage growth rate.
The horizontal axis of Figure 3 represents the birth year of each generation. The
curve representing the lifetime burden rates are not smooth for early generations,
possibly because our prospective calculation covers only a short period for thesegenerations. Figure 3 indicates that a balanced budget system will impose heavier
burdens on the younger generations. The inequality of burdens is particularly severe forthe current working-age generation. The lifetime burden rate for those who were born in2001 is estimated to be 26.2 percent while the same for those born in 1945 is 14.8
percent.

- 24 -

Figure 2: The Burden Rates under Policy A (Balanced Budget)
35%

30%
Total costs
25%

20%

Health care costs

15%

Long-term care cost

10%

5%

0%
2004

2014

2024

2034

2044

2054

- 25 -

2064

2074

2084

2094

Figure 3: Lifetime Burden Rates by Generation under Policy A (Balanced Budget)
28%

26%

24%

22%

20%

18%

16%

14%

12%

10%
1904

1914

1924

1934

1944

1954
birth year

- 26 -

1964

1974

1984

1994

5.3 Equalizing the burden by prefunding policies
The increasing burden on future generations, as depicted in Figure 3, may becircumvented by implementing a policy that levies a constant burden rate over time.
Such a policy aims at charging a high burden rate in advance so that sufficient funds canbe accumulated in order to prepare for increasing costs in the future. Feldstein (1999)
advocated the idea of prefunding Medicare, which is the US public health insurance forthe elderly.
As an example of the prefunding of health and long-term care costs, we consider
the following policy. With regard to health insurance, a portion of the prefunding would
be channelized in order to finance the insurance payments dealing with health care costswith regard to the elderly (age 65 and over). Workers who are aged 15 and above makepayments in the form of premiums. The health care costs for those aged 64 and below
and government subsidies in the form of benefits to the elderly are financed by a
pay-as-you-go system. Long-term care insurance employs a prefunding scheme, while
government subsidies are financed by a pay-as-you-go system. Since the enrollees of
the current system are those who are aged 40 and above, we assume that workers falling
into this age group pay these premiums.
The setting of the interest rate is a key factor in determining the performance of aprefunding scheme. When we focus on the proportion of burdens to income, it is not theabsolute levels but the difference between the interest rate and the wage growth rate thatmatters. The MHLW projection on public pension finance in May 2004 assumed thatthe nominal interest rate would be 3.2 percent and that the growth rate of nominal wage
would be 2.1 percent. Our baseline case sets a 1 percentage point difference between theinterest rate and the growth rate of wage. As an alternative scenario, the difference is set
either as 0 percent or 2 percent.12

12

Feldstein and Samwick’s (1997) simulation of the prefunding of the US social
security program assumed that the real rate of return is 9 percent, which is considerably
higher as compared to ours. Their following researches (Feldstein and Samwick, 1998)
used 5.5 percent as the rate of return, which is still higher as compared to ours. We
employed lower interest rates due to the following reasons. Firstly, their rates of returnare based on risky capital; however, we considered the risk-free rate of return. We thinkthat the investment strategies pertaining to funded health care and long-term careinsurance should be conservative because these insurances aim to finance a strictly
targeted consumption item that cannot be easily substituted. Secondly, our simulation- 27 -

Since the current health and long-term care insurance program is set within a
pay-as-you-go framework, a transition to a funded system should be designed. With
regard to health care costs, we first calculate the contribution rate that is sufficient for
the entire cohort born in FY 2001 to finance the expected value of their lifetime healthinsurance benefits beyond the age of 65 years. This rate is estimated to be 4.96 percent
under the governmental projection and the baseline scenario of the interest rate. If thecohorts born after FY 2001 pay the premium at this rate, the total accumulated funds in
FY 2100 would amount to 111.11 percent of the GDP. Hence, the transition process isdesigned in such a manner that it accumulates this level of funds with a constantpremium rate until FY 2100. Since the current generations did not prefund their healthcare costs, 4.96 percent of the premium rate is not sufficient to meet the target in FY
2100. It is therefore concluded that a contribution rate of 8.52 percent will successfully
accumulate the required funds.
The evolution of the funded system will be achieved in the following manner(Table 7 summarizes the numbers that represent the burdens under Policies A and B).
When health care costs (excluding government subsidies) are financed by a
pay-as-you-go scheme in FY 2004, the contribution rate with regard to the same forindividuals aged 64 and below is 4.32 percent and for those aged 65 and above is 3.89
percent. When a transition toward a prefunding scheme begins in FY 2005, thecontribution rate for the elderly increases to 8.52 percent under the governmental
projection and maintains this value until FY 2100. Beyond FY 2100, the contribution
rate for the elderly will shrink to 4.96 percent. As against this, the contribution rate forthe health care costs of the aged below 64 is almost stable. It ranges between 3.97
percent and 4.3 percent.

process does not incorporate the general equilibrium effect, in which an accumulatedsocial insurance fund tends to lower the interest rate of a large open economy. We
therefore, attempt to infer the consequences of this effect by looking at a particular casewhere the interest rate is maintained at a low level from the beginning. Thirdly, given
the recent poor performance of Japanese asset prices, a high rate of return does notappear plausible.
- 28 -

Table 7: Contribution Rates under the Balanced Budget and Prefunding Schemes

Total
Health insurance
Nonelderly
Elderly
Government subsidies
Long-term care insurance

2004

(A)
Balanced budget
2005–2100

12.01

12.28–28.12

4.32
3.89
2.69
1.11

3.97–4.30
3.98–9.08
2.84–10.07
1.16–4.83(B)
Prefunding
2005–2100
2101–

19.62–26.70

8.52

4.96

3.95

2.17

Note) Numbers represent the percentage of earnings (90 percent of compensationof employees and mixed income). The interest rate is based on the baseline case,and other parameters are based on the governmental projection.

The transition process of the long-term care insurance program is designed alonglines parallel to the health insurance program. The contribution rate that is sufficient forthe cohort born in FY 2001 to finance the expected value of their lifetime long-term careinsurance benefits is 2.17 percent under the governmental projection. If the cohorts bornafter FY 2001 pay the premium at this rate, the total accumulated funds in FY 2100
would amount to 68.35 percent of the GDP. This amount of funds will be accumulated
by a contribution rate of 3.95 percent during the transition process. When long-termcare costs (excluding government subsidies) are financed by a pay-as-you-go scheme in
FY 2004, the contribution rate is estimated to be 1.11 percent. When a transition toward
a prefunding scheme begins in FY 2005, the contribution rate increases to 3.95 percent,and maintains this value until FY 2100. Beyond FY 2100, the contribution rate will
shrink to 2.17 percent.
For the calibrated value in FY 2004, the health insurance payments for the
nonelderly is estimated to be 4.32 percent of the total earnings and those for the elderly
is estimated to be 3.89 percent of the total earnings, with the long-term care costs being
estimated as 1.11 percent. When social insurance premiums and government subsidies
are combined, the overall burden rate becomes 12.01 percent. Under the pay-as-you-go
system, the social costs for the elderly will grow steadily. The total burden ratio will go
up to 28.12 percent of the total earnings. The burden rate of health insurance payments- 29 -

will go up to 9.08 percent. The growth of government subsidies however, is more rapid,
the highest level attained by it being 10.07 percent.
Under the prefunding scheme, it is estimated that the burden rate will increase
from 12.01 percent in FY 2004 to 19.62 percent in FY 2005. The rate of change in total
burdens at the initial point is 63 percent. Since government subsidies are bound to grow,as in the case of the pay-as-you-go system, the highest level attained by the total burden
rate will be 26.70 percent in FY 2064.
Figure 4 compares the lifetime burden rates between the balanced budget and theprefunding schemes. We should note that the burden rates for those born after 2001 do
not cover their whole lifetime because the simulation terminates in FY 2100. When thesystem is changed from a balanced budget to a prefunding one, generations who areborn prior to 1997 will face a higher lifetime burden, and younger generations will
benefit from a lower lifetime burden. The curve representing lifetime burden in Figure 4
becomes flatter. Hence, a prefunding scheme helps to reduce the inequality of burdens.
This will be made possible only if the current generation agrees to share burdens with
future generations.
Suzuki (2000) conducted a similar study dealing with the calculation of thetransition to a fully-funded health insurance system. While our calculation unites thewhole sector of health insurance, his calculation was based on the decomposition of thesame into subsidiary systems of insurance. The transition was assumed to begin in FY
1995 and attain the state of a fully-funded scheme by FY 2100. With regard to theSociety-managed Health Insurance for Employees (Kumiai Kenpo), the contribution
rate is estimated to increase from 7.8 percent to 9.8 percent.
According to Suziki’s specification, a fully-funded scheme finances anindividual’s lifetime health care costs. Before individuals begin to work, theirpre-funding account has to borrow money. This account needs to borrow money during
the early stages of an individual’s life. The resulting number of aggregate funds would
still be lower than the number involved in our scheme. This is primarily the reason why
we reported a much larger hike in the contribution rate during the transition process ascompared to that reported in Suzuki (2000).

- 30 -

Figure 4: Lifetime Burden Rates under Policy A (Balanced Budget) and Policy B (Pre-funding)
32%

27%

22%

17%

12%

7%
1908

1918

1928

1938

1948

1958

1968

1978

1988

1998

2008

2018

birth year
Balanced budget- 31 -

Pre-funding

2028

2038

2048

2058

2068

2078

5.4 Sensitivity Analysis
Table 8 represents the contribution rates of the prefunding scheme in FY
2005–2100 and beyond FY 2100 under 27 diverse scenarios. The assumption of a labor
force participation does not affect the contribution rate to a large extent. The differencein the health insurance contribution rate between a pessimistic scenario and the most
optimistic scenario is 0.36 to 0.92 percentage points. The gap between the two is large,
when the projection of social costs is pessimistic. This reflects the fact that a funding
scheme is not influenced by a demographic change. On the other hand, the interest rateaffects the contribution rate. Under the optimistic scenario (in which the interest rate is
2 percentage points higher than the wage growth rate), the contribution rate is 1.5 to
4.68 percentage points lower than that under the pessimistic scenario. The setting ofsocial costs has an even larger impact on the contribution rate, as compared to theimpact of interest rate on the same. The difference in the contribution rates during atransition period between a pessimistic scenario and an optimistic scenario is 3.13 to6.33 percentage points.
The above findings can also be applied to the case of long-term care insurance.
The effect of interest rate is relatively large as compared to the size of the benefits. The
difference in the contribution rate between the optimistic and the pessimistic scenario
ranges between 1.08 to 3.41 percentage points.
Even under the most optimistic scenario, the burden rate associated with healthcare and long-term care costs increases at a rate of 16.05 percentage points from thestarting point. The rate of change in the total value of the burden rate is 34 percent,which is smaller than the governmental projection, but is still quite significant. Under
the most pessimistic scenario, the rate of change is 85 percent. Although quantitative
implications depend on the individual settings associated with each of the programs, asignificant increase in the contribution rate is needed to implement a prefunding
scheme.

- 32 -

Table 8: Sensitivity Analysis of Contribution Rates in a Prefunding Social Insurance Scheme(Percent)
Health care for the elderly
2005–2100

interest rate–growth rate = 2 percent
social cost: optimistic
labor force: very optimistic
optimistic
pessimisticsocial cost: pessimistic
labor force: very optimistic
optimistic
pessimisticsocial cost: very pessimistic
labor force: very optimistic
optimistic
pessimistic
interest rate–growth rate = 1 percent
social cost: optimistic
labor force: very optimistic
optimistic
pessimisticsocial cost: pessimistic
labor force: very optimistic
optimistic
pessimisticsocial cost: very pessimistic
labor force: very optimistic
optimistic
pessimistic
interest rate = growth ratesocial cost: optimistic
labor force: very optimistic
optimistic
pessimisticsocial cost: pessimistic
labor force: very optimistic
optimistic
pessimisticsocial cost: very pessimistic
labor force: very optimistic
optimistic
pessimistic

2101–

Long-term care
2005–2100

2101–

6.25
6.36
6.61

2.74
2.81
2.90

2.66
2.71
2.82

1.08
1.10
1.14

7.56
7.69
7.99

3.45
3.53
3.64

3.31
3.37
3.51

1.38
1.41
1.46

9.38
9.55
9.92

6.06
6.20
6.40

4.47
4.55
4.73

2.81
2.88
2.97

6.84
6.97
7.26

3.85
3.94
4.08

3.08
3.14
3.27

1.65
1.69
1.75

8.36
8.52
8.88

4.84
4.96
5.14

3.88
3.95
4.12

2.12
2.17
2.25

11.09
11.30
11.78

8.58
8.78
9.10

5.69
5.80
6.04

4.35
4.46
4.62

7.75
7.91
8.27

5.36
5.48
5.72

3.74
3.81
3.99

2.51
2.57
2.68

9.58
9.77
10.22

6.75
6.90
7.19

4.74
4.84
5.06

3.23
3.31
3.44

13.68
13.96
14.60

12.05
12.33
12.84

7.62
7.78
8.14

6.71
6.86
7.15

Note) Numbers represent the percentage of earnings (90 percent of compensation of
employees and mixed income). In FY2004, the contribution rate of health insurance forthe elderly is 3.89 percent and that for long-term care insurance is 1.11 percent.

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Figure 5 maps the total number of burden rates that are associated with thebaseline scenario and six alternative scenarios which in turn take an alternative scenario
with one variable among the three availables. Since the baseline scenario takes into
account an intermediate assumption regarding the three variables, it takes thecentermost line of all the seven lines. The line at the highest level represents the case of
the most pessimistic social cost scenario. Since the growth of social costs is assumed tocontinue till the end of this century, the burden rate for future generations is far larger inthis scenario as compared to that in other scenarios. The lowest line represents the caseof the most optimistic social cost scenario. Social costs have the most significant impact
on the burden rate. The impact of labor force on the burden rate is the least among thethree variables considered so far. Higher interest rates can reduce the burden rates
considerably. For the generation born in 2001, the lifetime burden rate is estimated to be
25.62 percent under the baseline scenario and 20.15 percent under the scenario with aninterest rate higher by 1 percentage point.

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Figure 5: Total Burden Rates under Alternative Scenarios
50.00%

45.00%

40.00%

35.00%

30.00%

25.00%

20.00%

15.00%
1909

1919

1929

1939

1949

1959

1969

1979

1989

1999

2009

2019

2029

2039

2049

2059

2069

birth year
baselineinterest rate: 0 percent

social cost: optimistic
labor force: very optimistic- 35 -

social cost: very pessimistic
labor force: pessimistic

interest rate: 2 percent

2079

6. Conclusion

As the Japanese population structure changes, the current approach of financing(pay-as-you-go) the social costs will create a large increase in the magnitude of futureburdens. It will also create an intergenerational inequity of burdens. We analyzed analternative policy that prefunds the benefits for the elderly aged 65 and above.
Prefunding is not very popular in Japan. Our analysis aims at providing real life
scenarios with regard to this policy option and to stimulate policy discussions.
During the transition process until FY 2100, the scheme maintains a higher
contribution rate in order to accumulate sufficient funds. With respect to the parameters
implied by the governmental projection, the sum of the contribution rates with regard to
health insurance and long-term care insurance increases from 5.00 percent of the total
earnings to 12.47 percent of the same. The rate of increase in total burdens including
taxes for subsidies is 63 percent.
Our sensitivity analysis has indicated that quantitative implications depend on thesettings of the social costs, the labor force, and the interest rate. However, labor force
scenarios do not have a considerable impact on the rate of burden. As against this, thesetting of social costs has a significant impact. Although we cannot predict the exact
amount of the necessary contribution rate that would be sufficient to transfer the fundedsystem, it is certain that a significant increase in the contribution rate is inevitable. Even
under the most optimistic scenario of the 27 possible scenarios, a necessary increase in
the contribution rates of the two social insurances is 3.91 percentage points. The rate ofincrease in the total amount of burdens is 34 percent.
Implementing a prefunding social cost program may be a challenge because theinitial increase in burdens is politically unfavorable. However, the cost of not
introducing this scheme implies a heavier burden on future generations. Raising thecontribution rate in an aggressive manner will help to reduce the intergenerational
imbalance of burdens.

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