Toward the Strengthening of the Pension Systems in Mexico: Vision and Reform Proposals Pension Studies Adolfo Albo Fernando Gonzalez Ociel Hernandez Carlos A. Herrera Angel Muñoz Toward the Strengthening of the Pension Systems in Mexico Vision and Reform Proposals First English Edition, 2008 Translated from the original Spanish Edition under the title “Hacia el Fortalecimiento de los Sistemas de Pensiones en Mexico: Vision y Propuestas de Reforma, 2007”. In case of any difference in meaning between the Spanish and English editions will prevail the original meaning in Spanish. “Toward the Strengthening of the Pension Systems in Mexico: Vision and Reform Proposals” Sponsored by: BBVA’s departments of Economic Research and Pensions & Insurance America (Pensiones y Seguros America) Copyright © BBVA Bancomer, S.A. Av. Universidad 1200, Col. Xoco Mexico, D.F. 03339 All Rights Reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, without the prior permission in writing of BBVA Bancomer, S.A. ISBN 978-968-5947-02-2 Made in Mexico Toward the Strengthening of the Pension Systems in Mexico: Vision and Reform Proposals Executive Summary Contents Foreword 5 Executive Summary 7 Introduction 19 I. Vision of the Study 22 II. Demographic Evolution 2005-2050 24 1. Total population............................................................................................... 24 2. Structure by age............................................................................................. 24 3. Dependence ratio............................................................................................ 25 4. Economically active population....................................................................... 26 III. Economic Panorama 2005-2050 29 1. Base scenario: partial progress in reforms...................................................... 31 2. Long-term growth and relevant variables........................................................ 34 IV. Pension Systems in Mexico 37 Box: Social security and well-being................................................................. 37 Box: Brief historical review of social security in Mexico and pension plans... 40 1. Coverage......................................................................................................... 42 2. Most public pension plans have a defi ned-benefi t scheme............................ 46 Box: The ISSSTE pension system: 1950-2007............................................... 48 3. Advances toward a new pension system....................................................... 50 a) Reforms in the IMSS pension system................................................. 50 Box: Reforms in the IMSS pension system: main motivations...................... 51 Box: Reforms to the pension systems in Latin America................................. 54 b) Reforms in the ISSSTE pension system.............................................. 55 Box: ISSSTE pension bonds........................................................................ 57 4. Pensions under the retirement savings mechanisms..................................... 59 a) Individual account................................................................................. 60 b) Siefore and Afore................................................................................ 64 Box: Regulation and competition in the Afore industry................................. 68 c) Pensions: scheduled withdrawals and life annuity.............................. 73 d) Requirements to obtain a pension....................................................... 74 e) Other individual account withdrawals................................................. 76 V. Interrelation between the Economy and the Pension Systems 77 1. Effects of the pension systems on the economy........................................... 77 a) Labor market........................................................................................ 77 b) Financial markets................................................................................. 79 c) Savings and economic growth............................................................ 84 Box: Savings, fi nancial system and economic growth.................................... 87 2. Limitations of the economy on the pension systems..................................... 88 a) Coverage............................................................................................. 89 b) Income replacement at retirement...................................................... 90 Box: Informal employment in Mexico............................................................. 93 Economic Research Department 3 VI. A Projection of the IMSS Defi ned-contribution Pension Scheme 95 1. Macro-actuarial model...................................................................................... 95 a) Startup scenario.................................................................................... 96 b) Hypothesis of the model....................................................................... 98 2. Main results..................................................................................................... 102 a) Coverage.............................................................................................. 103 b) Pension levels and replacement rates.................................................. 106 Box: Coverage of the guaranteed pension....................................................... 112 c) Long-term savings................................................................................. 114 d) Fiscal costs: IMSS and ISSSTE............................................................. 114 Box: ISSSTE pension bonds and public debt................................................... 122 3. Sensitivity of results to key assumptions......................................................... 127 a) Mandatory contribution rates............................................................... 127 b) Real wage growth rate......................................................................... 128 c) Widowhood benefi t rates..................................................................... 130 d) Interest rate on the retirement funds................................................... 131 e) Other sensitivity exercises.................................................................... 132 VII. Diagnosis 133 1. Coverage.......................................................................................................... 133 2. Pension levels and replacement rates............................................................. 134 3. Fiscal costs...................................................................................................... 136 4. Other considerations....................................................................................... 137 a) Macroeconomic-fi scal........................................................................... 138 b) Microeconomic-social........................................................................... 140 VIII. Proposals 142 1. Proposals......................................................................................................... 142 a) Establishing a national pension system................................................ 142 b) Increasing contributions in the IMSS defi ned-contribution scheme..... 145 c) Increasing the initial amount for pension in the IMSS.......................... 147 defi ned-contribution scheme d) Further strengthening the risk-return options in the Siefore................ 148 e) Targeting the support of the “social quota”......................................... 155 f) Strengthening the pillar of support in the defi ned-contribution scheme. 156 g) Establishing a program of government co-fi nancing............................. 158 h) Increasing the productive capacities of informal workers.................... 160 i) Strengthening the fi nancial culture and a pension education in the country 161 2. The effect of applying a series of proposals..................................................... 162 a) Base economic scenario: partial progress in reforms........................... 163 b) Alternative economic scenario: effi ciency in reforms........................... 164 3. Fiscal viability................................................................................................... 165 Box: Primary balance and public debt evolution............................................... 168 Conclusions 171 Bibliographic References 173 Appendixes 178 4 Pensions and Insurance America Toward the Strengthening of the Pension Systems in Mexico: Vision and Reform Proposals Executive Summary Foreword BBVA is a multinational fi nancial services group and an important pension fund manager in Latin America, and in accordance with its corporate vision of working for a better future for people, it seeks to contribute to the strengthening of the region’s pension systems through analysis and diffusion on their overall situation. Within the framework of the aforementioned vision, BBVA’s departments of Economic Research and Pensions & Insurance America (Pensiones y Seguros America) started in 2004, a joint research project that made it possible to identify an agenda of adjustments to be introduced into the pension systems in Latin America. The results of the study “Road Map for the Reform of the Pension Systems in Latin America” were presented by David Taguas Coejo and Agustin Vidal-Aragon de Olives