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National Commission for the Retirement Savings System www.consar.gob.mx. The Mexican Pension System for Private Sector Workers Adapting India’s Financial Sector to a Globalizing World November 2002. Content. Overview of the Pension System for Private Sector workers

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National commission for the retirement savings system consar gob mx

National Commission for the Retirement Savings System

www.consar.gob.mx

The Mexican Pension System for Private Sector Workers

Adapting India’s Financial Sector to a Globalizing World

November 2002


Content

Content

  • Overview of the Pension System for Private Sector workers

  • Desirable Characteristics of an Individual Capitalization Account System

  • Conclusions


National commission for the retirement savings system consar gob mx

In 1997, Mexico reformed the Private Sector Workers’ Pension System

  • Previous regime was a defined benefits PAYG system.

  • The PAYG system was severely underfunded.

  • The new scheme is an Individual Capitalization Account (ICA).

  • Contributions are made by the worker, the employer and the Federal Government.


By september 2002 the system has affiliated 28 5 million workers

By September 2002, the System has affiliated 28.5 million workers

As of September 2002, 8.5 million accounts of workers who had not chosen a Fund Manager (Afore) were distributed

28.5

30

26.5

  • Active contributors: 43.6%

  • Averagemonthly income: 500 USD

25

20

17.8

15.6

Millions of Affiliates

13.8

15

10

5

0

1998

1999

2000

2001

September 2002

Figures as of December of each year.


National commission for the retirement savings system consar gob mx

10.2

10.0

10.0

9.7

9.8

9.6

Percentage

9.4

9.2

9.0

9.0

8.8

8.6

8.4

Jul-02

Jan-02

Oct-01

Apr-02

Jun-02

Feb-02

Dec-01

Mar-02

Sep-02

Nov-01

Aug-02

May-02

The system has been able to offer high real returns

As of today, annual average compound real return is 9.3%

Real Annual Compound Return

(Last 12 months)


Five years after the inception of the system total assets sum up 59 us billion dollars or 10 of gdp

Five years after the inception of the System, total assets sum up 59 US billion dollars, or 10% of GDP

Retirement Savings as % of GDP

12.0

10.1 %

SAR 92 (Old Regime)

2.1%

8.9 %

10.0

8.0

7.1 %

6.1 %

Percentage of GDP

6.0

Housing

3.0%

4.0

Retirement Funds invested by Pension Funds

5.0%

2.0

-

September

2002

1999

2000

2001

SAR 92

Retirement

Housing

Siefores are expected to receive US$4.0 billion dollars of mandatory contributions in 2002

Figures as of December of each year


Assets under management will reach 50 of gdp

Assets under management will reach 50% of GDP

Pension Funds’ Assets Under Management Estimations

70

60

50

40

Percentage of GDP

30

20

10

0

2002

2005

2008

2011

2014

2017

2020

2023

2026

2029

2032

2035

2038

2041

2044

2047

2050

2053

2056

2059

2062

2065

2068

2071

2074

*Assumptions: 3.5% GDP real annual growth rate, 4.25% real annual return rate and CONAPO’s population growth rates

Source: CONSAR


Content1

Content

  • Overview of the Pension System for Private Sector workers

  • Desirable Characteristics of an Individual Capitalization Account System

  • Conclusions


National commission for the retirement savings system consar gob mx

The ultimate goal of a pension system is to provide adequate replacement rates to the greatest number of workers

To achieve that goal the system should have the following desirable characteristics:

  • Effective checks and balances

  • Sufficient contributions

  • High risk-adjusted returns

  • Low costs

  • Competitive fees

  • Broad coverage or a National Pension System


Content2

Content

  • Overview of the Pension System for Private Sector workers

  • Desirable Characteristics of an Individual Capitalization Account System

    • Effective checks and balances

    • Sufficient contributions

    • High risk-adjusted returns

    • Low costs

    • Competitive fees

    • Broad coverage or a National Pension System

  • Conclusions


National commission for the retirement savings system consar gob mx

Effective checks and balances are a must since any pension system is sensitive to social, political and economic issues...

In Mexico, checks and balances take place at the Regulatory Agency and at the Fund Manager level:

  • Regulatory Agency

    • Board composition:

      • Workers and employers representatives in addition to government officials from the social and the financial sector participate in the governing bodies.

      • Investment and fees regulations are subject to the favorable opinion of the above mentioned representatives.

    • Core activities:

      • A daily automated surveillance of the system’s operational process and compliance with the investment regime is performed.

      • In-site inspections at fund managers’ premises take place on regular basis.


National commission for the retirement savings system consar gob mx

Effective checks and balances are a must since any pension system is sensitive to social, political and economic issues (Cont)

In Mexico, checks and balances take place at the Regulatory Agency and at the Fund Manager level:

  • Fund Manager

    • Independent board member: avoids conflicts of interest in key decisions.

    • Compliance officer: verifies Consar’s and own regulation compliance. It develops self regulation schemes and designs corrective programs.

    • Risk committee: establishes a risk profile of the fund and authorizes limits, models and guidelines.

    • Investments committee: determines the investment strategy and designates the authorized portfolio manager.


Content3

Content

  • Overview of the Pension System for Private Sector workers

  • Desirable Characteristics of an Individual Capitalization Account System

    • Effective checks and balances

    • Sufficient contributions

    • High risk-adjusted returns

    • Low costs

    • Competitive fees

    • Broad coverage or a National Pension System

  • Conclusions


National commission for the retirement savings system consar gob mx

Sufficient contributions are the cornerstone of adequate replacement rates...

  • Target replacement rates should be primarily a function of contributions

  • Reliance on high expected returns is not advisable

  • In Mexico, the Government participates in the new system in two ways:

    • Contributing periodically to each worker’s account. A fixed amount has redistributive effects.

    • Guaranteeing a minimum pension.


National commission for the retirement savings system consar gob mx

Sufficient contributions are the cornerstone of adequate replacement rates (Cont)

  • A special voluntary savings account with favorable tax treatment is highly desirable:

    • In October, Mexican Congress reformed the Law governing our system. One of the new features was the creation of a Retirement Complementary Contributions account.

    • Last December, Congress approved some changes to the tax code that will allow workers to deduct voluntary contributions to a pension plan.

    • These two reforms are key building blocks to create a US-type 401-K scheme.


Pensions in developed countries depend heavily on voluntary savings

Pensions in developed countries depend heavily on voluntary savings

Replacement Rates in Developed Countries

80

70

68

68

70

60

60

Voluntary System

25

28

13

35

50

Replacement Rate (%)

40

Mandatory System

30

40

47

43

20

35

10

0

Japan

United States

UK

Canada

Source: OCDE, The Macroeconomics of Ageing, Pensions and Savings (Khol y O’Brien 1998)


Content4

Content

  • Overview of the Pension System for Private Sector workers

  • Desirable Characteristics of an Individual Capitalization Account System

    • Effective checks and balances

    • Sufficient contributions

    • High risk-adjusted returns

    • Low costs

    • Competitive fees

    • Broad coverage or a National Pension System

  • Conclusions


An investment regime is necessary given the characteristics of the system

An investment regime is necessary given the characteristics of the system

  • Mandatory contributions

  • Sole financial asset for most participants

  • Socially and politically sensitive scheme

  • Governmental minimum pension guarantee

Need to avoid excessive risk


National commission for the retirement savings system consar gob mx

The investment regime should allow the greatest diversification in order to maximize returns at each risk level

However, according to our vision, a comprehensive risk limit is granted given the system’s characteristics

Return

Risk

maximum level


National commission for the retirement savings system consar gob mx

The risk limit can be expanded as asset managers build up the necessary skills

Mexico’s skills-build-up path

Return

  • Independent Risk Committee that establishes internal limits, methodologies and policies

  • Risk Management Unit that carries on a daily basis the Risk Committee’s guidelines

  • ISO-9000 for the investment strategy process

  • Compliance with international “best practices” for operational risks

  • 1

  • 0

Risk


National commission for the retirement savings system consar gob mx

Given fund managers’ increasingly comprehensive set of skills, Consar’s Board recently approved two important changes to the investment regime

  • Operations with derivatives of underlying securities permitted in the investment regime will be allowed. Fund Managers will have to comply first with strict regulations of risk management prudential rules and operative requirements.

  • A VaR limit that will substitute actual duration-type parameter will come into effect by December 2002.


Content5

Content

  • Overview of the Pension System for Private Sector workers

  • Desirable Characteristics of an Individual Capitalization Account System

    • Effective checks and balances

    • Sufficient contributions

    • High risk-adjusted returns

    • Low costs

    • Competitive fees

    • Broad coverage or a National Pension System

  • Conclusions


National commission for the retirement savings system consar gob mx

A cost effective ICA industry should capture available economies of scale

To accomplish it, some core processes can be centralized:

  • Contributions’ collection

  • Workers database (Name, Social Security Number, Fund Manager)

  • Contributions and returns’ recordkeeping

In Mexico, Fund Managers take care of the third process


National commission for the retirement savings system consar gob mx

A key feature of the Mexican Pension system is the design of its mandatory contributions collection process

The Social Security Institution and the National Data Base play a key role in this process

Social Security Institute

1 a. Sends a bill of due contributions

1 b. Audits companies’ correct and prompt payments

4. Sends information on received payments

National Data Base

Fund Manager

3 a. Sends information on received payments

Collector Bank

6. Delivers contributions

Employer

3 b. Sends contributions

Clearance Bank

2. Pays contributions

Central Bank

5. Sends contributions


Content6

Content

  • Overview of the Pension System for Private Sector workers

  • Desirable Characteristics of an Individual Capitalization Account System

    • Effective checks and balances

    • Sufficient contributions

    • High risk-adjusted returns

    • Low costs

    • Competitive fees

    • Broad coverage or a National Pension System

  • Conclusions


National commission for the retirement savings system consar gob mx

Competitive fees are the result of the interaction of three key elements

  • Simple products:

    • Few and homogeneous options.

    • A fee structure that is easy to understand and to compare.

  • Adequate incentives:

    • Key decisions for the worker’s pension should be made by the most financial-literate and price sensitive person.

    • Costs of those decisions should be born by the decision maker in order to align interests.

  • Relevant and readily available information:

    • Specially, one that highlights the impact of fees and returns differences in the worker’s pension.

    • Easy to access through different channels.


National commission for the retirement savings system consar gob mx

+ 35.9%

60,000

50,000

40,000

US Dollars

30,000

20,000

10,000

0

XXI

ING

Allianz

Inbursa

Banorte

Tepeyac

Principal

Banamex

Profuturo

Bancomer

Santander

Relevant and readily available information...

Fees differentials might have a significant impact on pensions

Final Balance of the Retirement Savings

Source: Consar. Estimates with an affiliate who earns three minimum wages (constant salary), initial balance of $20,973.26 Pesos, a term of 40 years, and the current fee structure. Balance invested at a real annual rate of 5% for every Afore.


National commission for the retirement savings system consar gob mx

Relevant and readily available information (Cont)

An example is our internet-based pension’s calculator

INPUT DATA

  • Actual Fund Manager (Afore)

  • Nominal monthly salary

  • Last pension fund balance

  • Number of expected additional working years

  • Expected annual wage increase

  • Expected rate of return


Content7

Content

  • Overview of the Pension System for Private Sector workers

  • Desirable Characteristics of an Individual Capitalization Account System

    • Effective checks and balances

    • Sufficient contributions

    • High risk-adjusted returns

    • Low costs

    • Competitive fees

    • Broad coverage or a National Pension System

  • Conclusions


National commission for the retirement savings system consar gob mx

The system should aim to achieve the broadest possible coverage

A broad coverage:

  • Reduces the number of non-contributing workers that can become a dead weight cost to the system and thus an obstacle for decreases in fees.

  • Diminishes the fragmentation of rights when workers change of employment.


Unfortunately in mexico 60 of the employed labour force does not have a formal pension plan

Unfortunately, in Mexico 60% of the Employed Labour Force does not have a formal pension plan

The other 40% has a pension plan but within unrelated systems

45

40.7

12.5

40

35

2.4

30

1.0

0.6

24.2

Millions of inhabitants

25

20

15

10

5

0

ELF1

IMSS 2

ISSSTE 3

STATE

INSTITUTIONS 4

OTHERS 5

NOT COVERED

1. Employed Labour Force.

2. IMSS (private sector employees). July 2002

3. ISSSTE (Federal Government employees). May 2002

4. Ham Chande, Roberto; “The Future of the Pensions”. UNAM

5. Includes: ISSFAM, PEMEX, CFE, LFC, Universities (80).

Sources: INEGI 2000 Census, Social Security Institutions and First Governmental Address to the Nation


National commission for the retirement savings system consar gob mx

To increase Pension Coverage, the System will be opened to the rest of the population on a voluntary basis

Individual accounts will be available to:

  • State workers who want to transfer their complementary pension savings to an Afore.

  • Independent workers who want to make voluntary savings for retirement.

  • Private, State, Municipal and Public Agency's workers who want to make retirement complementary contributions in the Afore who manages their employer’s Pension Plan based on individual accounts.


National commission for the retirement savings system consar gob mx

The coexistence of different pension schemes calls for the creation of a National Pension System (NPS)

Pension System for Private Sector Workers

The main goal of a NPS is the preservation of pension rights among different employers regardless of the full completion of pension prerequisites

Pension System for State Service Workers

Pension Plans for Public Entities, Municipalities, and States

Universities Pension Plans

Occupational Pension Plans


National commission for the retirement savings system consar gob mx

The financial feasibility and the portability are key elements in the construction of a National Pension System

Element

Implication

Importance

  • Financial feasibility

  • Portability

Matches the benefits, contributions, and requirements

Recognition, preservation and transfer of rights when the worker switches pension plan

Gives certainty to the worker and avoids fiscal contingencies for an actuarial imbalance

Does not allow the loss of rights because of being affiliated to different plans through worklife


Content8

Content

  • Overview of the Pension System for Private Sector workers

  • Desirable Characteristics of an Individual Capitalization Account System

  • Conclusions


Conclusions

Conclusions

  • ICA are, in our opinion, the best option to reform a pension system

  • The outcome depends on the specific design of some key elements

  • Desirable characteristics include:

    • Effective checks and balances

    • Sufficient contributions

    • High risk-adjusted returns

    • Low costs

    • Competitive fees

    • Broad coverage or a National Pension System


National commission for the retirement savings system consar gob mx

National Commission for the Retirement Savings System

www.consar.gob.mx

The Mexican Pension System for Private Sector Workers

Adapting India’s Financial Sector to a Globalizing World

November 2002


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