The document summarizes the main findings and recommendations from an OECD review of Mexico's pension system. Key findings include that the old public PAYG DB system is very generous given contribution levels, coverage and contribution densities are low, and fees charged by private pension plans remain high. Recommendations focus on increasing contribution rates, improving coordination of safety nets, relaxing investment limits, reducing fees over time, and ensuring savings are used primarily for retirement income.

1. OECD REVIEW OF PENSION
SYSTEMS IN MEXICO
Main findings and
recommendations
Pablo ANTOLIN
Hervé BOULHOL
Stéphanie PAYET
Mexico City
15 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
2

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
3
Purpose

4. THE MEXICAN PENSION
SYSTEM TODAY
4

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
5 Main Components of the Mexican
Pension System

6. 6
DC System: Mexico in the Middle Range
in the OECD, After Only 17 Years
159.3
146.8
125.6
110.0
96.0
85.3
84.2
76.2
68.3
54.9
51.0
50.1
48.6
37.1
30.2
20.0
14.1
11.3
10.6
10.1
9.5
9.2
8.8
8.8
8.0
7.3
6.7
6.6
5.8
5.5
5.1
4.2
4.1
3.2
0.5
0.1
0.0 50.0 100.0 150.0 200.0
Netherlands (1)
Iceland
Switzerland (1)
Australia
United Kingdom (1)
OECD weighted average
United States
Canada
Chile
Israel
Finland
Ireland
Denmark
OECD simple average
Japan
New Zealand
Mexico
Estonia
Slovak Republic
Portugal
Spain
Sweden (1)
Norway
Poland
Czech Republic
Korea
Italy
Germany (1)
Austria (1)
Turkey
Belgium (1)
Slovenia
Hungary
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)
7
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)
8
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.
9
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
10
Transitional Workers: Public-Sector

11. MAIN FINDINGS AND
RECOMMENDATIONS
THE PUBLIC PENSION
SYSTEM
11

12. • Retirement benefits and conditions in the old system are
very generous relative to the level of contributions paid:
12
The Old PAYG DB System Is Heavily
Subsidised
0
20
40
60
80
100
120
0.25 1.00 1.75 2.50
reference wage
(multiple of average earnings)
Replacement rate
for various contribution periods, %
45 years 35 years 25 years

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
13
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 14
Challenges Faced by the Public
Pension System

15. • 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
NewZealand
Denmark
Ireland
Canada
Norway
Luxembourg
Greece
Austria
Netherlands
Australia
Belgium
Iceland
France
SlovakRepublic
Israel
Sweden
UnitedKingdom
Switzerland
Finland
Japan
Spain
Italy
Germany
Slovenia
Portugal
UnitedStates
Poland
Chile
Estonia
CzechRepublic
Hungary
Mexico*
Korea
Turkey
% 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
16
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
17
Improving Financial Sustainability
and Efficiency

18. MAIN FINDINGS AND
RECOMMENDATIONS
ADDRESSING THE
PROBLEM OF THE
TRANSITION PERIOD AND
LOW CONTRIBUTIONS
18

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
19
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
%offinalsalary

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
20
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
21
Contribution Levels Need to Increase

22. 22
Up to What Level?
8.8
9.0
9.5
10.0
10.0
10.0
10.0
10.0
10.3
10.4
12.0
13.3
16.0
16.0
16.4
16.7
16.8
17.9
18.0
18.4
19.6
19.6
19.8
20.0
20.0
20.0
22.0
22.0
22.9
22.9
24.4
28.0
28.3
33.0
34.0
0.0 5.0 10.0 15.0 20.0 25.0 30.0 35.0 40.0
Mexico (IMSS) (2)
Korea
Australia
Dominican Republic
Canada
Chile
Bolivia
Peru
El Salvador
United States
Iceland
Mexico (ISSSTE) (2)
Luxembourg
Colombia
Belgium
France
Japan
Netherlands
Slovak Republic
Sweden
Germany
Poland
Switzerland (1)
Greece
Latvia
Turkey
Israel
Estonia
Austria
Finland
Slovenia
Czech Republic
Spain
Italy
Hungary
Contribution rates in mandatory pension plans

23. 23
Up to What Level?
30 40 50 60 70 80 90 100
50 5.3 7.0 8.8 10.3 12.0 14.0 15.5 17.3
75 7.8 10.5 13.0 15.5 18.0 20.8 23.5 26.0
90 11.0 14.5 18.0 21.8 25.3 28.8 32.3 36.3
95 12.8 17.3 21.8 25.8 30.5 35.0 39.0 43.3
99 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 24
Introduce a Pro-Rata Mechanism to
Smooth-Out the Transition Period
0.0
10.0
20.0
30.0
40.0
50.0
60.0
70.0
80.0
90.0
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
25
Increase Coverage and Densities of
Contributions

26. MAIN FINDINGS AND
RECOMMENDATIONS
IMPROVING THE DESIGN
OF THE ACCUMULATION
PHASE
26

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
27
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
28
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
29
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
30
Proposals to Improve the Design of the
Accumulation Phase

31. MAIN FINDINGS AND
RECOMMENDATIONS
IMPROVING THE DESIGN
OF THE PAY-OUT PHASE
31

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
32
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 33
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
34
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
35
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
36
Improve the Management of Longevity
Risk

37. THANK YOU VERY
MUCH!
OECD work on pensions
http://www.oecd.org/pensions/