OECD REVIEW OF PENSION SYSTEMS IN MEXICO

Main findings and recommendations

Pablo ANTOLINHervé BOULHOLStéphanie PAYET

Mexico City15 October 2015

2

• Purpose• Main features of the pension system

today• Main findings and recommendations

w.r.t.:– Public pension system– Transition period and low contributions– Design of the accumulation phase– Design of the pay-out phase

Outline of the Presentation

3

• The review assesses the system that has resulted from reforms in 1997 (IMSS) and 2007 (ISSSTE)

• The purpose is to identify areas that need to be improved and provide guidance on how to introduce these improvements to make the current pension system sustainable in the long term both socially and financially

• The review uses OECD best practices on designing pension systems

Purpose

4

THE MEXICAN PENSION SYSTEM TODAY

5

• Federal (Pensión para Adultos Mayores) and state non-contributory old-age safety nets

• Reformed public PAYG DB system, which is subject to a long transition period

• Mandatory private funded DC system (gradually replacing public PAYG DB system)

• Special pension schemes (e.g. state-owned companies, local governments and universities)

• Voluntary pension contributions in the individual retirement accounts, occupational pension plans or personal pension plan

5 Main Components of the Mexican Pension System

6

DC System: Mexico in the Middle Range in the OECD, After Only 17 Years

159.3146.8

125.6110.0

96.085.384.2

76.268.3

54.951.050.148.6

37.130.2

20.014.1

11.310.610.19.59.28.88.88.07.36.76.65.85.55.14.24.13.2

0.50.1

0.0 50.0 100.0 150.0 200.0

Netherlands (1)Iceland

Switzerland (1)Australia

United Kingdom (1)OECD weighted average

United StatesCanada

ChileIsrael

FinlandIreland

DenmarkOECD simple average

JapanNew Zealand

MexicoEstonia

Slovak RepublicPortugal

SpainSweden (1)

NorwayPoland

Czech RepublicKorea

ItalyGermany (1)

Austria (1)Turkey

Belgium (1)SloveniaHungary

Luxembourg (1)France

Greece (1)

Pension funds' assets as a % of GDP

7

• Mandatory fully funded DC system for formal sector employees who entered the labour force on or after July 1997

• Free election of AFORE• Contribution rate: 6.5% + social quota• 4 basic SIEFORE: multi-fund life-cycle scheme• Eligibility for a pension: 1250 weeks of

contributions and 65 years old – Life annuity, programmed withdrawal or minimum

guaranteed pension (PMG)

Reformed System for Private-Sector Workers (IMSS)

8

• Mandatory fully funded DC system for employees who entered the labour force on or after April 2007

• Free election of AFORE• Contribution rate: 11.3% + social quota• 4 basic SIEFORE: multi-fund life-cycle scheme• Eligibility for a pension: 25 years of

contributions and 65 years old – Life annuity, programmed withdrawal or minimum

guaranteed pension (PMG)

Reformed System for Public-Sector Workers (ISSSTE)

9

• Private-sector workers who were working and contributing to the PAYG system in place before July 1, 1997 retain the right to choose upon retirement whether their pension benefits are calculated according to:– the formula of the old DB system, based on

their contributions made over their entire career; or

– the value of the assets accumulated in their DC individual retirement account since 1997.

Transitional Workers: Private-Sector

10

• All public-sector workers who were ISSSTE affiliates at the time of the reform in 2007 had the right to choose to switch to the new funded DC scheme or to remain in the old PAYG DB plan

• The affiliates had a time limit of six months to choose between these two options, starting January 1, 2008

• Those who chose to move to the DC system (14.2%) received a “recognition bond” in their account to acknowledge their contributions in the old DB system

Transitional Workers: Public-Sector

11

MAIN FINDINGS AND RECOMMENDATIONS

THE PUBLIC PENSION SYSTEM

12

• Retirement benefits and conditions in the old system are very generous relative to the level of contributions paid:

The Old PAYG DB System Is Heavily Subsidised

0.250.3

75 0.50.6

25 0.750.8

75 11.1

25 1.251.3

75 1.51.6

25 1.751.8

75 22.1

25 2.252.3

75 2.52.6

25 2.752.8

75 30

20

40

60

80

100

120

Replacement rate for various contribution periods, %

45 years 35 years 25 years

reference wage (multiple of average earnings)

13

• Retirement benefits and conditions in the old system are very generous relative to the level of contributions paid.

• Having contributed during 500 weeks at a rate of 6.5% makes you eligible to the minimum pension which is equal to the minimum wage

• Conditions are even more generous in the public sector where it is possible to retire much before 65 with a full pension if you have contributed for 28 / 30 years

The Old PAYG DB System Is Heavily Subsidised

14

• Substantial and fast demographic changes• Long transition period of the past reforms, with

the old DB system still impacting on public finances for a long period

• Numerous non-reformed schemes • Deep fragmentation of the pension system

creating inequalities• Little incentives to contribute longer than the

eligibility period for low-income workers• Mexico has one of the lowest non-contributory

safety nets among OECD countries + overlap of state and federal programmes

Challenges Faced by the Public Pension System

• Minimum pension is high relative to the minimum wage, esp. given low contribution rates

• Might create downward pressure on minimum wage increases• Minimum wage is low as a ratio of the median wage in international comparison• Incentive to contribute further once eligibility to the minimum pension is

fulfilled is limited• Old-age safety net level (Pension para Adultos Mayores, PAM) is low

15

Nexus Between Minimum Pension and Non-Contributory Safety Nets

0

5

10

15

20

25

30

35

40

45

New

Zea

land

Denm

ark

Irela

ndCa

nada

Nor

way

Luxe

mbo

urg

Gre

ece

Aust

riaN

ethe

rland

sAu

stra

liaBe

lgiu

mIc

elan

dFr

ance

Slov

ak R

epub

licIs

rael

Swed

enU

nite

d Ki

ngdo

mSw

itzer

land

Finl

and

Japa

nSp

ain

Italy

Ger

man

ySl

oven

iaPo

rtug

alU

nite

d St

ates

Pola

ndCh

ileEs

toni

aCz

ech

Repu

blic

Hung

ary

Mex

ico*

Kore

aTu

rkey

% of average earnings

Basic (residence) Safety-net Minimum 1973 law

16

• Increase the non-contributory pension (PAM)• Drastically improve the coordination of old-age

safety nets between the federal and local governments

• Delink the minimum pension and the minimum wage• Make the minimum pension benefit grow

progressively with the contribution period or the amounts of contribution up to a ceiling

• Make the non-contributory pension subject to a low withdrawal rate against the new progressive minimum pension scheme

Better Linking Non-Contributory and Minimum Pensions

17

• Increase contribution rates in old DB schemes• Reduce government subsidy for civil servants (matching

contributions)• Link retirement age to gains in life expectancy• Tighten early-retirement rules: raise the minimum

retirement age (private and public sectors) and the contribution period to get a full pension in the public sector

• Harmonise the rules for all pension plans to reach a truly national pension system equal for all :

- gradually converge IMSS and ISSSTE parameters- eliminate special regimes in public firms and universities- condition part of the transfers to local governments on the adoption of the national scheme

Improving Financial Sustainability and Efficiency

18

MAIN FINDINGS AND RECOMMENDATIONS

ADDRESSING THE PROBLEM OF THE

TRANSITION PERIOD AND LOW CONTRIBUTIONS

19

• This is the result of low contribution rates (6.5% + social quota) and high promises to transitional workers based on the old DB formula

• Drop less dramatic for public-sector workers

Sharp Drop in Pension Benefits Expected After the Transition Period Ends

0.0

20.0

40.0

60.0

80.0

100.0

120.0

140.0

1 minimum wage 2 minimum wages 3 minimum wages

4 minimum wages 5 minimum wages 6 minimum wages

Private-sector workers

% o

f fina

l sa

lary

20

• 60% of working-age population have an individual retirement account but only 30% have an active account (with contributions during last 3 years)

• Density of contributions about 38%, with 48% of workers contributing 10% or less of the time

• Low voluntary savings and pension awareness do not help addressing the issue

Low Coverage Rates and Contribution Densities Compound the Problem

21

• Increase mandatory contribution rates– Link it to increase in wages to avoid a

reduction in take-home pay• Earmark for retirement part of the

contributions to INFONAVIT• Introduce automatic voluntary

contributions with an opt-out option• Improve incentives for voluntary

pension savings

Contribution Levels Need to Increase

22

Up to What Level?

8.89.09.510.010.010.010.010.010.310.4

12.013.3

16.016.016.416.716.8

17.918.018.4

19.619.619.820.020.020.0

22.022.0

22.922.9

24.428.028.3

33.034.0

0.0 5.0 10.0 15.0 20.0 25.0 30.0 35.0 40.0

Mexico (IMSS) (2)Korea

AustraliaDominican Republic

CanadaChile

BoliviaPeru

El SalvadorUnited States

IcelandMexico (ISSSTE) (2)

LuxembourgColombia

BelgiumFranceJapan

NetherlandsSlovak Republic

SwedenGermany

PolandSwitzerland (1)

GreeceLatvia

TurkeyIsrael

EstoniaAustriaFinland

SloveniaCzech Republic

SpainItaly

Hungary

Contribution rates in mandatory pension plans

23

Up to What Level?

30 40 50 60 70 80 90 10050 5.3 7.0 8.8 10.3 12.0 14.0 15.5 17.375 7.8 10.5 13.0 15.5 18.0 20.8 23.5 26.090 11.0 14.5 18.0 21.8 25.3 28.8 32.3 36.395 12.8 17.3 21.8 25.8 30.5 35.0 39.0 43.399 17.3 23.3 28.5 34.5 39.3 45.8 51.5 57.0

Target replacement rate (RR)

Probability of reaching the

target RR

Contribution rates needed to achieve different target RRs with a given probability

24

• DB component:calculated based on the old DB formula and the number of years spent in the DB system up to today

• DC component: calculated based on new accumulation in the individual retirement accounts from today until retirement

Introduce a Pro-Rata Mechanism to Smooth-Out the Transition Period

0.010.020.030.040.050.060.070.080.090.0

100.0

2015

2017

2019

2021

2023

2025

2027

2029

2031

2033

2035

2037

2039

2041

2043

2045

2047

2049

2051

2053

2055

2057

2059

Today Higher contributions Higher contributions + pro-rata

25

• Consider introducing mandatory contributions for self-employed workers to increase coverage and lengthen contribution periods

• Public understanding and confidence in the pension system could be improved by – better aligning public and private-sector pensions;– improving the information provided in pension

statements; and – organising well-designed National Pension

Communication Campaigns to better promote pension savings and increase financial literacy

Increase Coverage and Densities of Contributions

26

MAIN FINDINGS AND RECOMMENDATIONS

IMPROVING THE DESIGN OF THE ACCUMULATION

PHASE

27

• Workers have very limited choices in the multi-fund system

• Despite increased diversification, Mexico’s pension funds are still significantly concentrated in debt relatively to other OECD countries

• The investment limits for equity and foreign securities are binding for most basic SIEFORE and thus prevent diversification and negative correlation between investments

The Current Investment Regime of SIEFORE Is Too Restrictive

28

• Between 2008 and 2015, fees charged by AFORE have declined by 70 basis points (from 1.81% to 1.11% of assets on average)

• However, they remain high in an international context• The current approval process of fees provides little incentive to

further lower fees for AFORE with charges already below the average

Fees Charged Have Declined But Remain High in an International Context

0.00

0.50

1.00

1.50

2.00

2.50

3.00

29

• Only 68% of accounts are registered• Same fees charged to assigned workers

even though they may not be able to make use of all services

• Transfers between AFORE are allowed once a year but more than half of the transfers are to AFORE providing lower net returns

• Workers are convinced to switch by a growing number of sales agents

Incentives in the Registration, Assignment and Transfer Processes Are Not Enough to Foster Competition

30

• Allow more choice between different investment strategies while keeping default life-cycle investment strategies

• Gradually relax regulatory limits for equity and foreign securities

• Consider structural solutions to reduce fees (e.g. extending the assignment process to new entrants using a tender mechanism)

• Lengthen the period during which people cannot switch between AFORE from one to three years

Proposals to Improve the Design of the Accumulation Phase

31

MAIN FINDINGS AND RECOMMENDATIONS

IMPROVING THE DESIGN OF THE PAY-OUT PHASE

32

• Large pots of assets can be taken as lump sums instead of being used to finance retirement, affecting negatively retirement income adequacy and public pension liabilities

• Partial early withdrawals from the individual retirement account are allowed in case of unemployment and marriage, diverting money from retirement financing

• The incentive to retire early is strong for low-income workers, increasing public pension liabilities related to the payment of the PMG

Pay-out Options at Retirement Do Not Create Appropriate Incentives

33

• The annuity market is small because there is no demand for annuities (demand will increase as the transition period ends)

• Annuity providers are ring-fenced subsidiaries of insurance companies. They cannot diversify risks and are subjected to a more restrictive investment regime

• Insurance companies can only offer one annuity product, the traditional immediate life annuity

• Disability and survivor pensions are funded by IMSS and ISSSTE, but the choice of the annuity provider is done by the worker

• Mortality tables used by annuity providers sufficiently provision for expected mortality improvements for now

Lack of a Thriving Annuity Market

34

• Early use of retirement savings should be avoided

• All the assets accumulated in the pension system should be combined to finance retirement

• Establish a specific regulatory framework to limit pensioners’ choice of the insurance companies providing disability and survivors’ benefits

Optimise the Resources Used to Finance Retirement

35

• Allow additional annuity products that provide different types of guarantees, aligning reserving and capital requirements with the different levels of risk

• Encourage annuitisation as a protection against longevity risk

• Assess the cost and benefits of having annuity providers ring-fenced from their parent insurance company

Improve Prospects for the Annuity Market

36

• Occupational DB pension funds should be subject to minimum mortality requirements and should use mortality tables accounting for future improvements in mortality

• Update regularly mortality tables to ensure that the ones used by the industry remain adequate

• The Mexican regulatory framework should provide incentive to manage and mitigate longevity risk

Improve the Management of Longevity Risk

THANK YOU VERY MUCH!

OECD work on pensionshttp://www.oecd.org/pensions/