Pension Trends in Mexico

Pension Trends in Mexico
Eric H. Anderson, CFA
General Manager, IIM Mexico
October 2006
Macroeconomic Indicators
Indicator
Mexico
Brazil
2006E US$ GDP &
US $845 bn
US$996 bn
2006E GDP Growth
Population
3.6%
105.3 million
3.5%
186.4 million
Inflation (2006E)
3.8%
4.0%
Current Accout Balance
(2006E)
Interest Rate ST
-1.1%
0.7%
7.0%
14.0%
International Reserves
US$ 70 billion
US$ 45 billion
-0.2%
-3.4%
S&P Rating
BBB
BB
Total Public Debt / GDP
25%
51%
Fiscal Balance (% GDP)
Source: ING, Morgan Stanley, Goldman Sachs
Today’s Discussion
1) Mexico’s Privatized Pension System
2) Private Pension Funds
The US Private Pension Fund Experience
Mexican Private Pension Fund Industry
Mexico’s Pension Reform
In 1997 the old pay-as-you-go plan was replaced with a
system of personal accounts (AFORE) modeled after the
Chilean system
All private sector workers were mandatority switched to
the AFORE system while public sector workers remained
in the old social security system
A unique feature of the reform is that workers that were
in the system prior to 1997 can choose between their
AFORE balance or their benefit under the old system
when they retire.
Mexico’s Pension Reform
Workers who pay into the system for 1,250 weeks and reach
age 65 are entitled to a guaranteed minium pension
Fiscal cost to Mexican government for transition is estimated
at 83% of GDP a large savings over the 141% of GDP the
previous system would have demanded
Total contribution per average worker is 8.5% (employee puts
in 1.125%, employer 5.15% and government 2.225%)
Commission charged on contributions, over AUM or some
combination of the two
Initial investment regime was very restrictive
Mexico’s Pension Reform Evolution
Growth in number of accounts
Evolution in accounts
(millions of accounts)
40
30
20
10
0
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
Annual Average Growth: 15.7%
Source: CONSAR
Mexico’s Pension Reform Evolution
Growth in assets under management
Assets Under Management
$70,000
million USD
$60,000
$50,000
$40,000
$30,000
$20,000
$10,000
$0
Dec Dec Dec Dec Dec Dec Dec Dec Dec Aug1997 1998 1999 2000 2001 2002 2003 2004 2005 06
Source: CONSAR
Mexico’s Pension Reform Evolution
Division of Assets by Afore (as of August 2006)
Principal
5%
HSBC
4%
Others
6%
Banamex
19%
XXI
6%
Banorte Generali
7%
Bancomer
17%
Santander Mexicano
7%
ING
7%
Profuturo GNP
10%
Source: Consar
Inbursa
12%
Banamex
Bancomer
Inbursa
Profuturo GNP
ING
Santander Mexicano
Banorte Generali
XXI
Principal
HSBC
Others
Mexico’s Pension Reform Evolution
Changes in the Investment Regime 2002 - 2006
NEW
ISSUERS
LESS
RESTRICTIVE
LIMITS BY
ISSUER
NEW
CURRENCIES
Government Institutions, municipalities,
state-owned companies, corporates, MBS
Limits by issuer based on credit quality
GOB
MXN
MXN
US
US
Yen
Euro
NEW
MECHANISM
FOR RISK
CONTROL
Source: CONSAR
Corp
Yen
Euro
Derivatives Introduced - (Listed, OTC)
Risk Control – VaR limits increased
Mexico’s Pension Reform Evolution
Changes in the Investment Regime 2002 - 2006
EQUITY
INTERNATIONAL
MARKETS
FAMILY OF
PENSION
FUNDS
Source: CONSAR
Equity Indices and ETF’s
(indexed strategies only)
Porfolio Diversification (maximum 20%)
Siefore 2
15% Index Equity
Siefore 1
No Equity, 56 years or more
Siefore
Voluntary Contributions
Mexico’s Pension Reform
Positives and Weaknesses
Positives:
Reduced fiscal burden
Improved capital formation (LT
yield curve, equity market)
Government financing source
(reduced FX exposure, lower
rates)
Discourages quitting labor force
early by requiring 25 years of
contributions
Weaknesses:
Over 50% of workers in the
informal sector do not have a
pension
Public sector remains in the old
social security system which
continues to generate deficits
Lack of choice by affiliates
Contribution rate too low to
ensure adequate replacement
rate
Latin Pension Industry Growth Forecasts
Estimated Growth Pension Systems in Latin America
Country
2000
Argentina
Bolivia
Chile
Colombia
Mexico
Perú
Uruguay
Source: CONSAR
AUM
AUM
(billion USD)
(% GNP USD)
2015
20.4
2.4
35.9
3.6
16.7
2.8
0.8
57
5.9
95.3
26.8
169.2
26.8
1.9
Annual Average
growth (%)
7.1
6.2
6.7
14.4
16.7
16.4
6
2000
2015
7.2
24.8
48.5
4.3
3.1
5.1
3.7
30.9
43.5
89.7
24.7
17.7
28.1
13.3
Three promises that must
be provided for a
successful pension plan:
• Savings will be
protected
• Savings will be invested
wisely
• The money you save
will be there when you
retire
Private Pension Plans
The US 401K plan experience
1. Shift from DB to DC Plans
2.
401K Performance and the introduction of Lifecycle Funds
3.
Solutions to increase employee participation
Active Decision
Automatic Enrollment
Accelerating Shift from DB to DC Plans
The responsibility for making savings and portfolio allocation
decisions is increasingly falling on individuals
Defined Contributions
Defined Benefit
Defined
Contribution
Porcentage
The US 401K Experience
Performance
Performance History:
Over the 20 year period from 1985 to 2004 the average 401K
account return was 3.7%, only slightly above the 3% average inflation
rate. This was in spite of the 13.2% annualized return in the S&P 500.
Invest with emotion – Buy high; Sell low
Lack of Plan Knowledge – Remain invested in
default money market option or sub-optimal asset
allocation
Neglect – Don’t rebalance
Lack of confidence or competing financial
demands – don’t participate at all
The US 401K Experience
The Introduction of “Target Date” Lifecycle Funds
$
#
"
Employees leave the
selecting and monitoring
to the ING professionals
$
!
Employees select,
manage and monitor
their own portfolio
starting with an
allocation you help select
using the Allocation
Mentor Tool – Define
your investment profile
$
Employees select,
manage and monitor
their own portfolio using
ING’s Model Portfolio
Asset Allocations
Employees select,
manage and monitor a
portfolio of securities of
their own choice (i.e.,
funds, stocks, etc.)
Life Cycle “Target Date” Funds
One And Done
$-12 3
4
5
Value-Add for Participants
%
Simplified investment process
Professional ongoing portfolio
monitoring:
&
0
/
'(+, %
'()* '(+(
'(), %
'('* '()(
'(', %
'(** '('(
'(*, %
-
$
'(*(
– Diversification
– Rebalancing
– Systematic adjustments
/
'(+(6
&
"
(more conservative as
goal year approaches)
– Reduces temptation to time
the market
Value-Add for Sponsors
%
.
More choice for participants
Potential for ↑ plan participation
Reduced fiduciary liability
Fewer educational needs
Why Life Cycle Funds?
Simple on the outside
Managed by professionals
Evolves over time – well-designed
Sophisticated on the inside
Optimized portfolios
Disciplined and cost-effective rebalancing
Exploit market trends/anomalies in “real time”
Active risk management
Solutions to Increase Employee Participation
The power of deadlines: Active decisions
Active decision mechanisms require employees to make an
active choice about 401(k) participation.
Welcome to the company
You are required to submit this form within 30 days of hire,
regardless of your 401(k) participation choice
If you don’t want to participate, indicate that decision
If you want to participate, indicate your contribution rate
and asset allocation
Being passive is not an option
401(k) participation increases under active decisions
Fraction of employees ever
participated
401(k) participation by tenure: Company E
100%
80%
60%
40%
20%
0%
0
6
12
18
24
30
36
42
Tenure at company (months)
Active decision cohort
Source: Madrian and Shea (2001)
Choi, Laibson, Madrian, Metrick (2004)
Standard enrollment cohort
48
54
Solutions to Increase Employee Participation
Automatic Enrollment
Welcome to the company
If you don’t do anything
–You are automatically enrolled in the 401(k)
–You save 2% of your pay
–Your contributions go into a money market fund
Call this phone number to opt out of enrollment or
change your investment allocations
401(k) participation increases under
Automoatic Enrollment
401(k) participation by tenure at firm
Fraction of employees ever
participated
100%
80%
60%
40%
20%
0%
0
6
12
18
24
30
36
42
Tenure at company (months)
Hired before automatic enrollment
Hired after automatic enrollment ended
Source: Madrian and Shea (2001)
Choi, Laibson, Madrian, Metrick (2004)
Hired during automatic enrollment
48
Mexico Private Pension Market
Clearly following US Trends
Shift from DB to DC
Life cycle funds recently rolled out by IIM Mexico
Looking at how to increase employee participation
(examining fiduciary impact of automatic
enrollment and Active decision policies)