Document of THE WORLD BANK For Official Use Only Report No. P 7018 -ME REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN OF US$400 MILLION TO BANCO NACIONAL DE OBRAS Y SERVICIOS PUBLICOS, S.N.C. (BANOBRAS) WITH THE GUARANTEE OF THE UNITED MEXICAN STATES FOR A CONTRACTUAL SAVINGS DEVELOPMENT PROGRAM November 13, 1996 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. CURRENCY EQUIVALENTS Currcncv l nit = New Peso (NP) US$It)= NP$7.5 (December 22, 1995) FISCAL YEAR January I - December 31 ABBREVIATIONS AND ACRONYMS AFP Administradoros de 1;ondos de Pensiones (Pension FLnd Administrator - Chile) AFORE Admnirnstradora de Fondos para el Retiro. (Pension Fund Administrator) BANOBRAS Banco Nacional de Ohras y Servicios ji blicos, S. X C. CNBV Comision iVacional Bancaria v de Valores. (National Banking and Securities Commission) CNSF Comision Nacional cle Seguros y Fianzas. (National Insurance and Bonding Commission) CONSAR Comision Nacional del Sistensa de Ahorro para el Retiro. (National Commission of the Retirement Savings System) FAMV Fondo de Apoyo al Mercado de Valores (Securities Market Support Fund) FOBAPROA Fondo Bancario de Proteccion al Ahorro (Bank Fund for Savings Protection) FOVI Fondo de Operacion y Financiamiento Bancarto a la Vivienda. (Housing Financing Trust Fund) FOVISSSTE Fondo para la Vzvienda de los Trabajadores del ISSSTE. (Government Workers' Housing Fund) FSRL Financial Sector Restructuring Loan. FSRP Financial Sector Restructuring Program. FTAL Financial Sector Technical Assistance Loan IMSS Inst7tuto Mexicano del Seguro Social. (Mexican Social Security Institute) INFONAVIT Instituto del Fondo Nacional de la Vivienda de los Trobajadores. (National Workers' Housing Fund Institute) ISSSTE Instutwo de Seguridad y Servicios Sociales de los Trabajadores del Estado. (Institute of Security and Social Services for Government Workers) IV Seguiro de Invalide-y Vida (Disability and Life Lnsurance) IVCM Invalidez, Yejez, Cesantia en Fdad Avanzada, y Muerte (Disability, Old age. Severance, and Death Insurance Coverages) RCV Seguro de Retiro. Cesantia en Edad Avonzada, y Vejez (Old Age and Severance) MPG Minimum Pension Guarantee NAFTA North American Free Trade Agreement PROCAPTE Programa de Capitalizacion Temporal (Temporarv Capitalization Program) SAR Sistema de Ahorro para el Retiro (Retirement Savings System) SHCP Secretaria de Haciendtay Credito Piiblico. (Ministry of Finance and Public Credit) SIEFORE Sociedad de Inversiones Especializadas de Fondos Para el Retiro (Specialized Pension Fund). Conversions in thn te bi rep rvnn rc sdon NP$, 5 US dollar. Vice President Shahid Javed Burki Director Olivier Lafourcade (LAMXC) Manager Sri-Ram Aiyer (Director, LATDR- Team Leader) IBRD team Join Stein and Gloria Grandolini (LASLG - Deputy Team Leaders), Mike Lubrano (LASLG), Tom Glaessner (EAICO), Richard Clifford (LAMIXI),; Zia Qureshi (LAMXC), R. van Puymbroeck (LEGLA); Ross Levine (PRDFP); Donald Mclsaac (FSD), and LUlpiano Ayala (Consultant). Jorge Serraino assisted in the processing of the report. IDB team Ezequiel Machado, Liliana Rojas, Stephen Weisbrod; Hans U. Schulz; Kim Staking; Esperanza Lasagabaster. Peer reviewers Estelle James (PRDPH). Dimitri Vittas (FSD), and Olivia Mitchell (outside peer reviewer The Wharton School. Univ. of Pennsylvania). FOR OFFICLAL USE ONLY MEXICO CONTRACTUAL SAVINGS DEVELOPMENT PROGRAM TABLE OF CONTENTS Page No. LOAN AND PROGRAM SUMMARY ........................... iii I. MACROECONOMIC CONTEXT AND EXTERNAL FINANCING REQUIREMENTS .1 II. THE GOVERNMENT'S CONTRACTUAL SAVINGS DEVELOPMENT PROGRAM .3 A. The Current State of Mexico's Old Age Social Insurance System and the Need for Reform .3 Background .3 The Need for Reform .5 B. Old Age Insurance Reform: Timing, Objectives, and Principles of Reform .6 Timing of the Reform .6 Objectives of the Reform .8 Principles of Reform .8 C. The Key Features of the Reform and Comparison with Other Reforms .8 Old Age and Severance Reforms .9 Disability and Life Insurance Reforms .12 Occupational Risk Insurance .12 Comparison with Other Reforms .12 D. Issues and Government Strategy .14 Pension System Reform .15 Complementary Financial Market Reforms .26 lII. BANK ASSISTANCE STRATEGY .............................. 29 A. Overall Assistance Strategy .............................. 29 B. IFC .............................. 30 C. Coordination with the IMF .............................. 30 D. Coordination with the IDB .............................. 31 IV. THE PROPOSED LOAN .............................. 31 A. Origin .31 B. Loan Size and Proposed Tranche Conditionality .31 C. Technical Assistance .33 D. Disbursements .33 E. Accounts and Audit .33 F. Monitoring and Reporting .33 G. Benefits and Risks .33 H. Environmental Impact .36 V. RECOMMENDATION .36 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. -ii- ANNEXES I. Government Letter of Sector Policy for Contractual Savings Development II. Matrix of Policy Actions III. Matrix of Technical Assistance Needs IV. Pension Reform and its Impact on the Development of Mexican Financial Markets V. Estimated Fiscal Costs of Pension Reform VI. Current Pension System VII. INFONAVIT VIII. Economic Indicators IX. Balance of Payments X. External Capital and Debt XI. Status of Bank Group Operations in Mexico XII. Supplementary Data Sheet XIII. Mexico at a Glance Vice President Shahid Javed Burki Director Olivier Lafourcade Manager Sri-Ram Aiyer (Director, LAT, Team Leader) Staff Members John Stein, Gloria Grandolini (LASLG - Deputy Team Leaders) and Mike Lubrano (LASLG) MEXICO CONTRACTUAL SAVINGS DEVELOPMENT PROGRAM PROPOSED LOAN AND PROGRAM SUMMARY BORROWER: Banco Nacional de Obras y Servicios Publicos, SNC (BANOBRAS). GUARANTOR: United Mexican States. AMOUNT: US$400 million TERMS: The loan is proposed to be a fixed rate single currency loan in US dollars, with a maturity of up to fifteen years. OBJECTIVES: The proposed loan would support the first phase of the Government's Contractual Savings Development Program (CSDP), which is designed to: (a) increase the equity, efficiency, and sustainability of the old age security system and gradually lead to greater effective coverage; (b) establish a financially viable pension system; (c) limit the fiscal impact of the current pension system; (d) raise the level of institutional savings and improve the allocative efficiency of domestic savings; and (e) enhance capital market development by stimulating greater private financial intermediation. DESCRIPTION: The first phase of the reform focused on the establishment of the legal, regulatory, and institutional framework for the reform of the country's old age security system. The second phase will concentrate on the actual implementation of the reformed pension system. Specifically, the first phase of the CSDP supported by the proposed loan, included: (a) introducing the legal and regulatory framework to establish the new pension system and tc regulate and supervise pension fund administrators; (b) designing and issuing the investment management regime; (c) assessing fiscal transition costs; (d) initiating improvements in INFONAVIT's performance; (e) individualizing accounts and strengthening IMSS capacity to manage the operational scheme of the new pension system; and (f) encouraging public confidence through education. In parallel, to ensure the success of the pension reform and recognizing its linkages with the rest of the financial sector, the Government implemented complementary financial market reforms, aimed at: (a) deepening financial sector reforms through continued bank restructuring; (b) modernizing the regulatory and supervisory framework for mutual funds and voluntary pension plans; and (c) deepening the insurance market for the provision of life and disability coverage and annuities. BENEFITS: Overall, the program will lay the basis for a marked increase in the volume of institutional savings and provide the institutional basis through which domestic savings can be channeled to productive investment. It will also lead to the creation of a new class of institutional investors and a new set of longer-term instruments. Pension and social security reform will move -iv- the actuarially bankrupt defined-benefit system to a fully funded defined contribution scheme. Public confidence will be strengthened as workers will no longer view their contributions as a tax to provide benefits to current pensioners; instead, they will view these contributions as a means to build personal wealth. The separation of the pension and health sector schemes will result in pressure for greater efficiency in the delivery of public health benefits. Reforms in the insurance industry will create a larger class of insurance products such as annuities, life and disability and pre-paid medical insurance. Reforms to improve Mexico's legal framework for mutual funds, secured lending and asset backed securities will deepen the capital market over time and broaden the base for domestic savings. In addition, over the longer term, as pension funds increase their equity fund investments, they will become major catalysts for improved corporate governance. RISKS: The reform could lead to major fiscal risks if the savings generated from defined wage contributions do not earn an adequate real rate of return. These fiscal risks arise from the Government's continued guarantee of a minimum pension benefit to everyone participating in the social security system at the time of retirement. Without the housing fund component earning a positive real rate of return, these risks are high. Given the legal limitation on investment in foreign securities, the success of domestic capital market reforms are also crucial to the success of the pension reform especially because of the weakened state of the banking system, which is currently the only major private source of financial assets. Low real rates of return on the average pension fund's assets are also likely to increase the moral hazard associated with providing a minimum pension guarantee by encouraging contributor preference for high risk pension investments. To make success more likely, the Government gave itself a full year to prepare for the transition to the new pension scheme and during this time called on outside technical advisors to improve its supervisory institutions. The risks of political pressures to reverse fiscal management policies will always exist but are mitigated by both Mexico's growth potential over the medium term and the significant amount of time remaining in the term of the current administration which is strongly committed to these reforms. On the banking side, specific programs are in place to increase the capitalization of the banking system while the overall level of supervision has improved markedly. All the above factors will be important for improving the likelihood that pension funds will earn reasonable real rates of return, thus reducing moral hazard concerns. POVERTY CATEGORY: Not Applicable. ESTIMATED DISBURSEMENT: The proposed loan will be disbursed in a single tranche of US$400 million upon loan effectiveness (February 1997). REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO BANOBRAS WITH THE GUARANTEE OF THE UNITED MEXICAN STATES 1.1 I submit for your approval the following report and recommendation on a proposed Loan to the Banco Nacional de Obras y Servicios Pblicos, SNC (BANOBRAS) with the guarantee of the United Mexican States, in the amount of US$400 million to support the first phase of the Government's Contractual Savings Development Program which includes the establishment of the legal, regulatory, and institutional framework for the reform of the country's old age security system. The loan would be a fixed rate single currency loan in US dollars, with a maturity of up to 15 years, and would be disbursed in a single tranche of US$400 million. The Inter-American Development Bank (IDB) is supporting the program with a Sector Adjustment Loan of US$300 million, which would be disbursed in two equal tranches. I. MACROECONOMIC CONTEXT AND EXTERNAL FINANCING REQUIREMENTS 1.2 This section provides a summary assessment of recent economic developments in Mexico and of the economy's short to medium-term outlook. More details on key economic indicators, information on the balance of payments and financing requirements are given in Annexes VIII, IX and X. Further discussion of the economic outlook and country assistance strategy is provided in the Mexico CAS that was issued to the Executive Directors on October 15, 1996. 1.3 Progress on Adjustment. Mexico has responded with a strong adjustment program to deal with the financial crisis that erupted in December 1994. The Government's program has comprised: a substantial tightening of monetary and fiscal policies; a large exchange rate adjustment through moving to a floating exchange rate regime; steps to deal with the severe distress in the banking system; and initiation of further structural reforms--privatization, deregulation. The program includes measures to strengthen the social safety net. The Government's program has been supported by a large international financial package. 1.4 As a result of this effort, Mexico has achieved substantial progress in its adjustment objectives. The current account improved from a deficit of about 8 percent of GDP in 1994 to near balance in 1995, thanks to a 31 percent rise in exports (in dollar terms) fueled by the large peso depreciation. Inflation has been reduced from a peak of 8 percent a month in April to an average of around 1.5 percent in recent months. Helped by the external assistance package, Mexico has rebuilt its depleted reserves, improved its external debt profile, and regained a measure of access to international capital markets. 1.5 But the economy has also experienced a severe recession. GDP fell by 6.9 percent in 1995 and fixed domestic investment by about 30 percent. Also, while the progress on adjustment has helped investor confidence to recover, it remains fragile, as underscored by a new bout of financial market turbulence that emerged in the last quarter of 1995. The turbulence has since subsided, but the continuing fragility of market sentiment remains an important source of uncertainty for the short-term economic outlook. 2 PRESIDENT'SREPORT 1.6 Prospects. The central challenge that Mexico now faces is to foster a return to economic growth while consolidating the gains in macroeconomic stability and restoration of investor confidence. The current year represents an important period in that transition. An economic recovery is now underway. But growth initially will be moderate, with GDP likely to rise by about 3 percent in 1996. Much of this growth derives from the external sector based on the strength of exports. Inflation is projected to fall to around 27 percent in 1996, from 52 percent in 1995, allowing a further moderation of interest rates from the high levels seen in 1995. Provided Mexico perseveres with policies conducive to macroeconomic stability, and continues to deepen and extend structural reforms, it can lay the basis for stronger growth in 1997 and subsequent years. 1.7 If the competitive advantage conferred by the real depreciation of the peso is not allowed to be eroded, Mexico can maintain the new dynamism of its exports, with average real growth in exports of 9-10 percent annually. As growth recovers, so will imports, which contracted sharply in 1995. The rise in imports will tend to widen the current account deficit, but if the projected export growth is realized, the deficit should remain within limits consistent with a continued improvement in Mexico's external debt position. For the next few years, the current account deficit is likely to range from 1 to 2 percent of GDP. As investor confidence returns, private capital flows are expected to recover, but this will be a gradual process. With the retirement of a large part of its short-term debt in 1995, Mexico's external financing requirements will decline but Mexico will face an increase in debt service during 1988-99 on account of repayments due under the 1995 emergency financial assistance package. For a couple of years, before a fuller recovery in private flows occurs, some quick-disbursing official assistance would remain desirable, to support the reserve position as the current account deficit widens and the debt service remains high and to allow a further improvement in the debt profile. Given Mexico's recent experience, the still fragile state of investor confidence, and the economy's continuing vulnerability to a shift in market sentiment, maintaining a strong reserve position will be particularly important. 1.8 The foregoing outlook is subject to two important risks: the weakness in the banking system; and the vulnerability of the Government's macroeconomic program to social and political pressures arising from the deep recession. The various bank support schemes that the Government has put into operation have contained the scope of the banking system crisis. The economic recovery and reduction in interest rates would further help in alleviating banking system problems, and also help ease socio-political pressures. Nonetheless, the banking system remains fragile, and the costs associated with the Government's bank support schemes will be a source of pressure on the fiscal position over the next several years. An additional source of pressure on the fiscal position will be the transitional fiscal costs of social security reform (para. 2.36-2.45). The Government will need to continue to show firmness in resisting pressures for a premature relaxation of policies. 1.9 Restoring stronger growth in the economy in the medium term will require a recovery in investment from the plunge occurring in 1995. The bulk of the rise in investment will need to be supported by an increase in domestic saving, if Mexico is to avoid a reemergence of unsustainably large external deficits - an important underlying cause of the 1994 financial crisis. The rise in Mexico's current account deficit prior to the crisis reflected a large drop in its saving rate. Mexico's national saving rate fell from about 22 percent in the mid-1980s to 16 percent in 1994, and is low by international standards (Table 1). MErco - CoN TRAcTuAL S4vlNGsDEJEopmENT PRoGRAV 3 | Country/Region 91 92 93 |MEXICO 20.3 19.0 19.0 CHILE 24.5 26.8 28.8 LACAVERAGE 19.0 20.0 20.1 EAST ASIA AND PACIFIC 33.8 33.1 34.7 AVERAGE DEV. COUNTRIES Middle Income Economies 26.7 25.6 24.2 WORLD 22.5 21.9 21.6 LAC VRAGE 19.0 20. 2. .A 2. .... ...- =9 o Source: The World Bank- World Tables 1995 1.10 Raising domestic saving and deploying them more efficiently will be a fundamental condition for Mexico to attain strong and sustainable growth. Reforming the pension system and developing the contractual savings industry is one of the most important changes the Government can implement to promote domestic savings and develop the financial and capital markets to make more effective use of these savings. II. THE GOVERNMENT'S CONTRACTUAL SAVINGS DEVELOPMENT PROGRAM 2.1 The Government of Mexico has embarked on a major and important reform of the old age security system which should prove beneficial both to individuals, through the opportunity to obtain increased retirement income, and to Mexico's economic growth prospects over the medium and long term. This reform will avoid the certain deleterious effects on public finances that would have inevitably occurred if the current public, defined-benefit scheme had been left in place. It will also lead to greater private intermediation of domestic savings and to the establishment of the institutions and instruments needed to absorb and allocate savings more efficiently in the future. 2.2 Section II of this report summarizes the current state of Mexico's old age security system and the need for reform of the contractual savings sector. It also describes the objectives and key features of the Government's reform program, and analyzes the main issues to be tackled and the Government's strategy for contractual savings development. A. The Current State of Mexico's Old Age Social Insurance System and the Need for Reform Background 2.3 Mexico's old age security system consists of three pillars. The first pillar is a publicly managed, pay-as-you-go (PAYG), defined-benefits plan. The second consists of individual retirement accounts set up through the commercial banking system, with deposited funds managed by the Central Bank. The third comprises voluntary occupational pension plans. 2.4 The First Pillar: Public PAYG Pension Plans. The Mexican social security system as it evolved for almost fifty years through 1992 consists essentially of two elements of old age support: 4 PRESIDN TSEPORT retirement, pensioners' health benefits, and disability pensions' based on payroll contributions of 8.5 percent of wages for formal private sector workers admninistered by the Mexican Social Security Institute (Instituto Mexicano del Seguro Social - IMSS) and 7 percent of wages for public sector workers administered by the Institute for Security and Social Services for Government Workers (Instituto de Seguridad y Servicios Sociales de los Trabajadores del Estado - ISSSTE); and * additional retirement income from contributions to two specialized housing funds based on an employer-paid contribution of 5 percent of wages for private sector employees administered by the National Workers Housing Fund Institute (Instituto del Fondo Nacional de la Vivienda de los Trabajadores - INFONAVIT) or 6 percent of wages for public sector workers administered by the Government Workers Housing Fund (Fondo para la Vivienda de los Trabajadores del ISSSTE - FOVISSSTE). 2.5 IMSS also provides private sector workers with health care coverage under its own hospital system based on a contribution of 12.5 percent of wages (9.5 percent of wages for public workers in ISSSTE). 2.6 The Second Pillar: The 1992 Reform and the Introduction of Individual Retirement Accounts (SAR). In a partial effort to address growing deficiencies in the pension system, the Government introduced the Retirement Savings System (SAR) in May 1992 which consisted of two sub-accounts: * a new mandatory 2 percent employer contribution to private and public sector employees channeled into individual retirement sub-accounts. These funds are collected by employers and channeled to the Central Bank through the commercial banking system. The Central Bank guarantees a real rate of return of 2 percent on these retirement sub-accounts which by end-1995 totaled NP$22.3 billion. Account registrations have become highly concentrated in the commercial banking system with the two largest banks (BANAMEX and BANCOMNER) handling more than seventy five percent of the total; and * a specialized housing sub-account managed by INFONAVIT. Although the contribution remained at 5 percent of wages, INFONAVIT's benefit provision was changed to accumulated balances (i.e., accumulated contributions plus a real return on these) as opposed to only nominal accumulated contributions. 2.7 The Third Pillar: Voluntary Occupational Pension Plans. By domestic financial market standards, voluntary occupational plans are quite large (about US$8 billion in total assets or 5 percent of GDP as of 1993) and cover about 20 percent of Mexico's labor force. While there are as many as 8,000 such voluntary plans, most of these funds are concentrated in 30 to 35 enterprises - foreign multinationals and the large parastatals - and combine a severance payment obligation (defined under Labor Law Article 165 as 90 days of minimum daily salary for each year of service) with either defined-benefit or defined-contribution schemes. Referred to in this report as IVCM (Invalidez, Vejez, Cesantia en Edad Avanzada, y Muerte), the Spanish acronym for disability, old age, severance, and life insurance. MEaco - CoNTRAcTuAL SAVINGS DE-ELoPMENTPROGRAM 5 The Needfor Reform 2.8 The Zedillo administration has recognized that Mexico's current contractual savings system suffers from several weaknesses. These have significant economic consequences that limit the viability of the social insurance system, impede development of the country's financial sector, and limit prospects for sustainable economic growth. The three key weaknesses are: * Severe Financial Disequilibrium. Based on various measurement methods, the overall financial condition of the pension system to private sector workers provided by IMSS (representing about 80 percent of the total working population) will increasingly place a serious strain on public finances. In addition to IMSS' growing actuarial deficits - due in part to the rapidly increasing dependency ratio, as shown in Table 2 below, - the commingling of funds within IMSS for the different coverages which it provides has permitted the pension system's surpluses to be used to meet cash deficits in certain IMSS insurance programs, most notably health. According to Government calculations, IMSS' actuarial deficit (141 percent of 1994 GDP) is expected to result in a cash deficit by the year 2007, requiring either a trebling of contributions or an increase in Government contributions amounting to I percent of GDP in the year 2000 and 3.75 percent of GDP in the year 2030. * Low Population Coverage. The IMSS-managed retirement and disability system (IVCM) covers about 10 million contributors. Other publicly provided pension schemes cover 1.5 million public sector workers in ISSSTE, about 0.5 million workers in the state-owned petroleum company (Petr6leos Mexicanos - PEMEX), and 0.3 million military personnel, resulting in coverage of about 40 percent of Mexico's active labor force. The remaining 4.5 million self-employed workers, mostly agricultural, and 9.8 million underemployed or unemployed workers are not covered by the formal social security system. Table 2 Mexican Social Security Institute (IMSS) Pension Actuarial Balances as of 12/31/94 1994 NP$1000 million ASET LIABILIT:S.... ............ :: ::~~~~~S :.--:--.-: . -.... .. .... J W . : 9 ^ . .... fi - .- .- - -. - . - . . .. . ..... . ..... . . . .. . . . ......... . . .. Reserves 3.25 Present value of old pensions 96.93 Present value of future 683.67 Present value of future 2390.61 contributions liabilities Actual affiliates 179.74 This generation 1017.40 Future generations 503.93 Future generations 1373.21 TOTAL ASSETS 683.92 TOTAL LIABILITIES 2487.54 DEFICIT 1800.62 (141.5 % of GDP) Source: IMSS and Bank staff estimates. Figure 1 below shows the estimated trends of contributions and pensions of the current IVCM system without reform as Mexico's demographic structure moves towards that of the developed countries (see para. 2.9). 6 PREsIDEN TSREPORT NS2,500,000 - -- - N$2,000,000 N$1,500,000 .... Pensions N$1,000,000 3 XX -X- Contributions NS500,000- .... N v~ 00 - N 0 O+ I .. . . O| 0 0 0x - - - N m N N m m m MS - -l _N_ _ N Ns N es N N N N N N N NCe High Evasion. Evasion has been associated with two main factors: high inflation and short vesting periods. Past high inflation has reduced the real value of pensions. In most cases, this has reduced pensions to the guaranteed minimum benefit, which is equivalent to the minimum wage. In addition, given the short time period in which a worker becomes vested (10 years), nearly 80 percent of IMSS pensioners currently receive the guaranteed minimum wage benefit. Not surprisingly, workers have perceived the pension scheme as a payroll tax. This situation has created strong incentives for both employers and employees to avoid affiliation and under-report earnings to qualify, and over-report them to receive benefits. It has also acted as a deterrent to attract informal sector workers, who comprise mainly the poor. Without broader participation in the reformed pension system, extreme poverty in old age will be an increasing burden on society. B. Old Age Insurance Reform: Timing, Objectives, and Principles of Reform Timing of the Reform 2.9 Across a wide range of countries, both developed and developing, old age security systems are faltering primarily because current revenues are being used to pay for an ever- growing proportion of an aging population. Mexico, like many developing countries has the distinct advantage of initiating reform at a time when its demographic profile is relatively young, making reform more affordable. The timing of the Mexican reform is particularly advantageous given the following four demographic trends (Figure 2): * the majority of the Mexican population is still young - in 1990 only 6.4 percent of the population was above 65 (Figure 2a); MExco - CONT2AC7UAL SAVINGS DEvELOPMENTPROGRAM 7 * rapid growth in aging as a result of lower fertility rates and improvements in life expectancy (Figure 2b) which will result in 10.4 percent of the population above 65 years of age by 2020; * a sharp increase in the dependency ratio: in 1960 there were four pensioners per one hundred contributors, by 1994 this ratio increased to 12.5 per one hundred pensioners (Figure 2c); and * Mexico's current demographic structure limits the fiscal costs of pension reform. In 1994 almost 50 percent of IMSS contributors were between 15 and 30 years old, while the peak of the average wage distribution is reached at around age 40 (Figure 2d); this implies that wages for the 15 to 30 year old population will increase in time enabling them to acquire a pension higher than the minimum. Age Age Rate per 1000 72 7 81 85 70 6 . -7 5 _ ! r..... 71 ....5.. 6165 -1990 68 66 .:0gX 1990 2000 2010 2020 203 190 4 : 1 5 3 5 5 5 7 51::: 64~~~~~~~~~~~~~~~~ 41 45 623 31 35 20 21 25 58 1 :.: S1:.:::.:.:11:.:.:.56 1970 1975 1980 1985 1990 1993 0% 2% 4% 6% 8% 10% 12% 14% 16% 18%/ ieEpcac FriiyRt -- -Mortality Rate U 160000 -- -16 ~D ttw 14 140000 --14 4-. ~120000 --12=, 3.5 8.10000 8.15 0 8 0000 7 8 ~~~~40000 *~~~~~~~~~~~~~~~~~~~~ 4 * 1~~~~~~~~~~~~~~.51 X ~~~~~~~~~~~~~~2.0~ ~ ~ ~ ~~~~~~~. 20000 2 0 5 0.5 0 0 ~~~~~~~~~~~~~~~~~0.0 0.0 1990 2000 2010 2020 230 15 25 35 45 55 65 75 85 Total Population Pop:ulation Over6 ~Elderly Dependency Ratio - Wage IMSS Distribution 8 PRESIDENT'SREPORT Objectives of the Reform 2.10 The reform of contractual savings and the complementary development of financial markets are two of the key goals contained in the Government's National Development Plan for 1995-2000. The Government's strategy aims at: * increasing the equity, efficiency, and sustainability of the old age security system and gradually lead to greater effective coverage; * establishing a financially viable pension system; limiting the fiscal impact of the current pension system and ensure transparency of the fiscal costs of transition; * enhancing financial market development and reducing volatility by stimulating greater private financial intermediation and increasing the array of financial instruments and contracts available; and * contributing to enhance the allocative efficiency of domestic and, in the longer-term, to raising aggregate savings. Principles of Reform 2.11 There are a number of important principles that must be embraced if a sound old age security system is to be put into place. Mexico, like several other Latin American countries, has taken up the challenge of moving towards a multi-pillar, fully funded, defined-contribution old age security system. In addition to ensuring an enabling macroeconomic environment, the key issues it will face are: * introducing the regulatory and supervisory framework to protect the pension rights of participants in the mandatory system; c recognizing, to the fullest extent possible, the fiscal costs of transition and identifying financing sources to turn its implicit social security debt into an explicit debt; * reforming the public pillar by shifting to individual retirement accounts and to private management of pension funds. Meeting these requirements entails reforming IMSS, ensuring real rates of return from the INFONAVIT sub-account, and developing the disability and life insurance market; * setting up the regulatory and institutional framework for personal savings and occupationalpension plans, providing additional protection on a voluntary basis; * building public support and confidence in the new pension system so as to attract informal workers and avoid evasion; and * implementing parallel financial sector reforms to ensure an adequate supply of quality financial assets available for pension fund investment. 2.12 To achieve these objectives, the Government has embarked upon a series of major policy initiatives that have been grouped together under the broad title of "Mexico - Contractual Savings Development Program (CSDP)." C. The Key Features of the Reform and Comparison with Other Reforms 2.13 In December 1995 the Mexican Congress approved legislation (the new Social Security Law - Ley del Seguro Social) to reform the existing social security system to restructure the MA&co - CONT.ACTUALSAyNMSDEvLOPMENTPRoGRAm 9 pension system for workers in the formal private sector from the PAYG, defined-benefit system to a privately managed, defined-contribution system. Modeled on the system in place in Chile, the reformed pension system: eliminates the old PAYG scheme; provides current IMSS affiliates with a choice at retirement between the benefits under the old system or their accumulated balances under the new system; and provides a government-guaranteed minimum pension equal to the indexed minimum wage for those low-income workers whose savings are insufficient to provide a post retirement income at that level. A second legislative package on the implementation of the reforms (the Pension Systems Law - Ley de los Sistemas de Ahorro para el Retiro) was approved by Congress in April 1996. 2.14 The current IVCM system for private sector employees (para. 2.4) is separated under the reform into Old Age and Severance (RCV - Seguro de Retiro, Cesantia en Edad Avanzada, y Vejez) and Disability and Life Insurance (IV - Seguro de Invalidez y Vida), including provision of health benefits to pensioners. Annex VI provides a more detailed discussion of the existing IVCM system. Due to political constraints, the current reform did not contemplate changes to the ISSSTE, PEMEX, other parastatals, armed forces, and the state pension plans. Hence, the portability constraint across private and public sector workers' pension plans will remain for now an issue along with the financial disequilibrium to be faced in the future by these pension funds. However, the introduction of the defined contribution scheme for private sector employees, if successful, is likely to push all the unfunded state employee pension plans in the same direction. The reform is scheduled to be initiated on January 1, 1997, although the administration of pension funds by private managers will not become fully operational until mid-19972. The main legislative and administrative elements of the reform are described in the following sections. Table 3 summarizes the main differences between the old IVCM system and the new reformed system Old Age and Severance Reforms 2.15 The backbone of the new fully-funded pension system is constituted by individual retirement funds (SIEFORES - Sociedades de Inversi6n Especializadas en Fondos para el Retiro). The SIEFORES will be managed by investment management firms (AFORES - Administradores de Fondos de Ahorro para el Retiro) to be established by the private sector (domestic and foreign), IMSS, and trade unions. In addition to the option for IMSS to establish a single AFORE, it will continue to have a role as: (i) the legal enforcer of all contribution collections; (ii) the provider of benefits to all existing pensioners; (iii) the entity responsible for delivering benefits to those transition workers choosing the old PAYG system at retirement; and (iv) the provider of the minimum pension guarantee to all private sector workers. 2.16 Coverage and eligibility. Contributions to the new system will be compulsory for all private sector workers beginning on January 1, 1997. The retirement age remains at 65 years. 2 On October 28, 1996 the Mexican authorities presented draft legislation to Congress to delay the implementation of the social security reform from January 1, 1997 to July 1, 1997. Nevertheless, even though contributions to the SIEFOREs will begin on July 1, 1997, workers' affiliation will proceed as planned, beginning on January 1, 1997. AFOREs are expected to be already authorized and operating by then. The reform was postponed for two main reasons: (a) the GoveTnment was not fully ready with the unique identification system, which is essential to avoid evasion, ghosting etc; and (b) the Govermnent was not ready with systems for collection of contributions by IMSS and their transfer to the AFORES. The Mexican authorities decided that prior to the actual initiation of the reform it was necessary to install a more powerful system for individualization of accounts and to move towards a centralized and more reliable and accountable computer-oriented scheme for the payment of contributions. In terms of account individualization, it was decided to add to the IMSS number and the fiscal identification number (RFC) a more reliable identification number entitled Clave Unica de Registro de Poblacion (CURP). These actions will improve the overall design of the system. |0 PRESIDENT SREPORT The years of contributions required for eligibility for the minimum pension guarantee (MPG) are raised from 10 to 25 years, defined as 12503 weeks. 2.17 Contributions. Beginning on January 1, 1997, each worker's individual retirement account will be composed of two compulsory sub-accounts, the RCV retirement sub-account managed by the AFORES, and the INFONAVIT sub-account. Workers can also open a third sub-account for voluntary contributions. Workers' contributions will be automatically passed on to the designated AFORES. 2.18 Under the reform, contributions to old age and severance in the AFORES' individual accounts will equal 6.5 percent of a worker's wage (the current 4.5 percent for old age and severance plus the current 2 percent contribution in the retirement sub-account in the Central Bank) and a Government contribution of NP$ 1 per day, known as the social quota (see Table 3). The social quota will equal between I and 5.5 percent of the worker's wage depending on the level of each workers' wage and will be indexed to the December 31, 1996 CPI. On average it will be equivalent to 2.2 percent of wages. It will be transferred to each worker's account to which active contributions are being made. Transition workers have the right to transfer their past retirement sub-account contributions (para. 2.6) made to the Central Bank between 1993 and 1996 into their new AFORES accounts. Contributions to the INFONAVIT sub-account, equal to 5 percent of a worker's salary, will continue to be invested in INFONAVIT housing. Total contributions for retirement, therefore, amount to between 12.5 and 17 percent of a worker's wage. 2.19 Benefits. Benefits under the new system fall into two groups: benefits to new workers and benefits to transition workers. New workers are defined as those beginning their contributions to the system after January 1, 1997. The first cohort of retirees fully under the new system is expected in approximately 25 years. Benefits will consist of the accumulated balances in their individual retirement accounts (AFORES plus INFONAVIT accounts) or the MPG under the new system. The MPG will be equal to the minimum wage in Mexico City as of December 31, 1996, indexed to the Consumer Price Index (CPI). At retirement, workers will choose between a gradual withdrawal option or buying an annuity from an insurance company. 2.20 Transition workers are defined as those currently contributing to the PAYG system. Although these workers will begin contributing to their new individual retirement accounts after January 1, 1997, they will retain the right to the benefits of the old system. A lifetime switch option allows transition generation workers to choose at retirement the higher of the acquired benefits under the current system and the accumulated balances in their individual retirement accounts under the new system. More specifically, transition workers' benefits under the old system would be: (i) benefits accrued under PAYG system equal to a percentage of the average of their last five years nominal wage or an MPG equal to the minimum wage in effect at the time of retirement, indexed to changes in the minimum wage; (ii) accumulated balances in the INFONAVIT sub-account (from 5/1992 onwards); and (iii) accumulated 5/1992-96 balances in the retirement sub-account (para. 2.6). These benefits would be compared to the accumulated balances in their individual retirement accounts (AFORES plus INFONAVIT accounts) plus accumulated 5/1992-96 balances in the retirement sub-account (Table 3). 3 One contribution week equals 7 contributing days. MExco - CONTPACTuAL SA vNGS DEwPoMENTPROGRAm 11 Table 3: Mexico - Comparison of Current and Reformed Old Age Security Systems OldAge and Severance (RCV) IMSS * Contributions to chosen pension fund administrator (AFORE) l Benefits provided by AFORES if new system, or IMSS if old PAYG system ............................................................ chosen at retirem ent .... ........................ ...................................................... .............................. ................................................................................................... .chsna e Disability and Life Insurance (IV) 1MSS iMSS ... CONTRWUI'JONS ,% ~*w)~ 15.5 163-21.0............ is............. I6.S - 2L0 Old age and severance (RC') 12.5 - 170 (= L5 + NPSI per day) dli..f lrI#fff 4.0 Di~~~~~~~~~~ ........................i.,.f,,... ................................................ ........... Detailed breakdown: IVCM (to IMSS): 8.5 RCV Individual Accounts: Old age and severance 3.0 to AFORES: 6.5b+NP$1 Disability and death 3.0 Old age and severance 4.5 Reserves for pensioners' health 1.5 Retirement sub-account 2.0 Administration expenses 0.6 Social quota (per day) NP$1I Social Assistance 0.4 to INFONAVIT: 5.0 SAR-Retirement (to Central Bank): 2.0 IV to IMSS: 4.0 SAR Housing (to 1NFONAVIT): 5.0 Disability and life 2.5 Reserves for pensioners' health 1.5 ["C.'.Fw_'.'2' Er%ThILW l OldAge (minimum pension) 500 weeks (10 years) and 65 years old 1,250 weeks (25 years) and 65 years old Severance 150 weeks, inability to earn 50% of salary 250 weeks Disability Insurance 150 weeks 250 weeks Life Insurance . . . ... .-. ....... -............. ' "'"''..l Old Age: Amount of pension (i) benefits accrued under PAYG system New workers: accumulated balances in (a % of the average wage of last 5 years in individual accounts (AFORES + INFONAV1T) nominal terms plus a fraction for each year in since 1/1/1997; excess of 10, with a maximum of 10 minimum Transition workers: at retirement choose wages - Art. 167 old Social Security Law) + highest between: (i) current benefits (see (ii) accumulated INFONAVIT contributions previous column) and (ii) accumulated (iii) retirement sub-account balances 5/92-96 balances in individual accounts (AFORES + 11lNFONAVIT) since 1/1/1997 + retirement sub-account accumulated balances 5/92-96 (if ............................... ...........I................................................ ................................. | .................................... Old Age: Withdrawals d . * Gradual withdrawals from individual account; e or * Annuity bought from an insurance _ company Disability Insurance 50% of the average wage during last 150 35% of average wage for the last 500 weeks weeks of contribution of contributions ................... ................................................................ ................ ............................................ .............................. ................. ............................................... Life Insurance Widow: 90% of disability pensiow, Same as before Dependents: 20% of disability pension, or 30% if both parents deceased H Minimum Pension Guarantee (MPG) Equivalent to one Mexico City minimum Equivalent to one Mexico City minimum wage wage level indexed to actual minimum wage I on 12/31/96 indexed to the CPI f a. Under IVCM, contributions could not exceed 10 times the minimum wage and under the new system it is 25 times. b. Plus the accumulated balances in the retirement sub-account (from 1993 to 1996) if the worker so wishes. c. Government contribution of NP$1 per day is indexed to the consumer price level and estimated to be between I and 5.5 percent depending on worker's income. The maximum of 5.5 percent is for workers earning I minimum wage and the average is about 2.2 percent of wages. d. Lump withdrawal at retirement permitted only for balances in excess of 130 percent of MPG. e. Workers taking gradual withdrawals must take out annuity insurance to cover probability that they live longer than expected and outlast savings. f. Currently average wage for IMSS affiliates is 2.6 minimum wages, thus MPG is approximately 38 percent of average wage. 12 PRESIDENT'SREPORT 2.21 The MPG, to both transition and new workers, is provided by the Government in the event that the value of the worker's accumulated savings in all retirement accounts is inadequate to provide for the minimum pension. The Government contribution will only be equal to the difference between the MPG and funds available in the individual retirement accounts. For transition workers opting for benefits under the old IVCM system, IMSS will pay benefits first from the worker's accumulated balances in the individual retirement account, and when these funds are exhausted, from Government resources. Disability and Life Insurance Reforms. 2.22 The reform separates disability and life insurance coverages from the other lines of insurance which IMSS continues to manage. As a result, funds can no longer be commingled. Total contributions for disability and life insurance are 4 percent of wages since they include 1.5 percent for reserves for pensioners' health expenses. Eligibility requirements were increased from 150 weeks to 250 weeks and disability pensions were reduced from 50 percent of the average wage in the last 150 weeks to 35 percent of average wage for the last 500 weeks. IMSS will retain responsibility over the management of this line of insurance, but private insurance companies will provide benefits through annuities. Occupational Risk Insurance 2.23 Occupational risk insurance will also be separated from other lines of insurance which IMSS continues to manage. Premiums will become firm-specific in contrast to the current system where specific premiums are established for each economic sector. Hence, the reform will create greater incentives for firms to reduce work-related injuries and should result in a decline in the average work-related risk insurance premium. Benefits under this line of insurance, however, remain largely unchanged with the reform. For permanent disability injuries, pension benefits equivalent to 70 percent of the average wage of the last 5 years will continue to be provided. As in the case of life and disability insurance, private insurance companies will provide benefits through annuities. Comparison with Other Reforms 2.24 Table 4 below summarizes key comparisons between Mexico and three other countries in the region that have recently carried out pension reform. The reforms being carried out in Mexico, while broadly similar to those adopted in other Latin American countries, differ in several significant ways: * Eligibility requirements. The number of years of contributions to be eligible for the benefits of the new system are higher for Mexico (at 25 years) than in other recent reforms. In addition, Mexico has defined a week as equal to seven working days, which, in practice, extends the eligibility period. This high eligibility requirement reduces both the risk of evasion and the need for the Government minimum pension guarantee. * Demise of contributions to PAYG system and lifetime switch option. Unlike the new pension systems in Chile, Argentina and Colombia, the option to continue to contribute to a PAYG old age and severance insurance plan has been completely eliminated under the new Mexican system, even for transition workers. New workers, as in the case of Chile, will be totally integrated in the new system. Transition workers will have a choice on the benefit side at the time of retirement, but not on the contribution side. Thus, a larger volume of funds will be intermediated by the private sector than in the case of these other reforms. This is also an MAxCO - CONMTACTUL SAVJNGSDEVELOPMENTPROGRAW 13 TABLE 4. PENSION REFORMS IN LATIN AMERICA .. e ,.M - -- -,, ,, ..~~~~~~~~.... . - l- ,:. . M . . ~~~~~. g' .,.. .. - ........ .. ..... .. a* . . Nature of the reform Public defined Public split into Public PAYG Public defined benefit benefit (PAYG) public PAYG and changed to changed to private changed to private private defined choice between defined contribution defined contribution public PAYG (for private sector contribution (all and private workers only) workers) defined contribution Transition arrangements Phased out Continues with Continues with Eliminated' What happens to old system? changes changes Is current labor force allowed to remain Yes Yes Yes Noa in old scheme? _ _ Is new system mandatory for new labor Yes No No Yes force entrants? Can workers switch back to public No No Yes, every Noa system after entering AFP? three years. Recognition bonds Yes Yesb Yes' Nod Profile of new pension scheme What role Minimum pension Flat and minimum Minimum Minimum for public pillar? guarantee pension pension pension guarantee Social assistance guarantee Social assistance Social _ assistance Total contribution rate for new system: available for old age annuity 10 8 10 6.5 + 5.0 + 2.2' disability/survivorsladministrative 3 3 3.5 4.0 public pillar and social assistance _General revenues 16 I General revenues Total contribution rate: before reform 19 27 8 15.5 after reform 13 27 13.5-14.5g 16.5 - 21.0 Maximum percentage of portfolio allowed in: Domestic equities 30 50 to be decided 0 Foreign securities 10 10 to be decided 0 Governnent bonds in 1994 45 50 50 100 (in 1997) a. Contributions to the old system cease on December 31, 1996. Transition workers can choose at retirement the higher of the benefits available under the old PAYG scheme or the new defined contribution plan. b. "Compensatory pension" is paid upon retirement, not as a bond. The value is based on years of contribution and last ten years' eamings. c. Workers with fewer than 15 0 weeks of contributions are not eligible for a recognition bond. d. Disclosure of expected current and fuiture fiscal costs would be made on an annual basis. e. This is paid by the employer. f. Government contribution ofNPS 1 per day is indexed to the consumer price level and estimated to be between I and 5.5 percent depending on worker's income and on average equivalent to 2.2 percent of wages. g. The rate shown is for 1996 and following years. The contribution rate will increase gradually between 1994 and 1996. Source: "Averting the Old Age Crisis" World Bank, 1994 (page 277) and World Bank intemal documents. improvement over the Colombian reform which allows continuous switching by new entrants between the two systems (every three years), raising administrative costs and increasing volatility in the privately-managed funds. Alternative to issuance of recognition bonds and implications for fiscal costs of transition. Mexico's pension reform also differs in that the Government will not issue recognition bonds (as in Chile) or compensatory pensions (as in Argentina) to explicitly value current workers' 14 PRESIDENT 'SREPORT past pension contributions. The Mexican Government could not issue recognition bonds or compensatory pensions because of the legal treatment of acquired rights. These acquired rights make it difficult to explicitly attach a value to a worker's acquired benefits under the old PAYG system up until the time of the reform. On the fiscal side, the Mexican plan is more risky because the Government's liability is uncertain. However, the Government's contribution of NP$1 per day partially recognizes the Government's potential liability. In addition, the magnitude of the fiscal obligation will depend on the real return on transition workers' post 1997 contributions. Its potential advantage is that it does not lock the Government into fixed fiscal costs. Should real returns be higher than expected, more transition workers will take their benefits under the new program, thereby reducing fiscal costs. In terms of choice to transition workers, Mexico's scheme offers an improvement over the Chilean system. In Chile, transition workers were asked to choose at the start whether to stay with the old system or accept a recognition bond and join the new system. Given that the system was new and the uncertainty of future returns, this was a difficult, if not an arbitrary choice to make. In the Mexico scheme, workers can compare the benefits of the two systems at retirement and choose the higher of the two. Moral hazard risks associated with the incentive for workers and AFORES to invest in high risk securities and to evade contributions given the expectation to retire with the old PAYG benefits are mitigated by two factors: (i) the majority of transition workers (65 percent) are under 32 years of age; and (b) workers will have their own individual retirement accounts as opposed to a hypothetical Government guarantee. M Minimum Pension Guarantee. In terms of the minimum pension guarantee, it is lower in Mexico than the other countries, equivalent at present to approximately 40 percent of average wage, a figure which is expected to decline to 25 percent of the average wage by the time the first cohort of new workers retires (about 2025) as real wages increase. Taking advantage of a historically low minimum wage in real terms and favorable demographics, Mexico's potential fiscal costs are likely to be significantly lower than those of other reforms in the region. In addition, from the incentive point of view, the lower the guarantee the less relevant it becomes and the greater the incentive workers and AFORES will have to earn a high rate of return. 2.25 The Mexican reform follows the Chilean model as well as adds some innovative elements. Like in Chile, all vestiges of the old PAYG system will disappear with the last cohort of transition workers around 2025. The authorities have worked closely with Chilean counterparts as well as authorities of the U.S. Securities and Exchange Commission since the AFORE systems builds on Chile's AFP experience and on the US mutual fund experience. The success of the reform and the minimization of fiscal costs will depend on careful implementation and strong supervision. The Government has allowed itself until the beginning of 1997 to put in place the necessary institutional infrastructure. Moreover, the Government will strengthen the role of the regulatory body both through new legislative and regulatory powers and through cooperative exchanges with Chile and the U.S. D. Issues and Government Strategy 2.26 Contractual savings reform in Mexico provides the first real opportunity to shift the old PAYG pension system to a fully-funded, defined-contribution model and expand and deepen Kffxzco - CONTRACTUAL SA vwGGSDEvELOPmENTPROGRAM 15 domestic capital markets. Such reform encompasses both pension reform and complementary financial market actions. To achieve the objectives of the reform (para. 2.10), the Government needs to carry out a number of important actions, including: (a) designing and implementing the legal framework to regulate pension fund administrators and strengthening the monitoring and enforcement of the new scheme; (b) establishing and enforcing an adequate investment management regime; (c) evaluating and ensuring the funding of the fiscal transition costs; (d) improving the financial performance of the INFONAVIT-managed housing fund; (e) strengthening the IMSS in its ability to manage account individualization, the enforcement of billing and collection, and the provision of benefits; and (t) encouraging public confidence through education. In parallel, the Government will implement complementary financial market reforms to facilitate the continued development of the privately-managed pension system. To ensure the success of the pension reform, the Government will carry out these actions in two phases. The first phase focused on the establishment of the legal, regulatory, and institutional framework for the reform of the country's old age security system. The second phase will concentrate on the actual implementation of the reformed pension system. 2.27 Specifically, the first phase of the CSDP program, supported by the proposed loan, included: (a) introducing the legal and regulatory framework to establish the new pension system and to regulate and supervise pension fund administrators; (b) designing and issuing the investment management regime; (c) assessing fiscal transition costs; (d) improving the financial performance of INFONAVIT; (e) individualizing accounts and strengthening IMSS capacity to manage the operational scheme of the new pension system; and (f) encouraging public confidence through education. In parallel, the Government implemented complementary financial market reforms, aimed at: (a) deepening financial sector reforms through continued bank restructuring; (b) modernizing the regulatory and supervisory framework for mutual funds and voluntary pension plans; and (c) deepening the insurance market for the provision of life and disability coverage and annuities. The main issues raised by each of these actions and the Government's response are described below. Pension System Reform (a) Legal, Regulatory, and Supervisory Framework for Fund Administration 2.28 In December 1995, a new Social Security Law (Ley del Seguro Social) was enacted, modifying the current public pay-as-you-go, defined benefits scheme to establish a privately managed, mandatory, defined contributions scheme permitting private management [para. 4.5 (a)]. The new Social Security Law provided that the regulatory and supervisory regime governing the revised pension system would be the subject of subsequent detailed legislation. The Pension Systems Law (Ley de los Sistemas de Ahorro para el Retiro) approved by Congress on April 26, 1996 [para. 4.5 (b)] sets out the structure and powers of CONSAR and provides guiding principles for the establishment, operation and supervision of pension fund administrators (AFOREs) and specialized mutual funds for pensions (SIEFOREs). It also sets out more detailed rules governing conflicts of interest, market share limits, officer and director responsibility and investor protection. Since September 1996, CONSAR has finalized draft regulations covering authorization and capitalization of AFOREs and SIEFOREs, portfolio valuation, commissions and fees charged by AFOREs and promotion and marketing of AFOREs and SIEFOREs to the public [para. 4.5 (b)]. The Ministry of Finance and Public Credit has finalized rules governing the establishment of AFOREs controlled by foreign financial institutions [para. 4.5 (b)]. After discussions with Bank staff, CONSAR has also prepared draft rules governing the investment 16 PRESIDENT'SREPORT regime for SIEFOREs. These drafts are acceptable and are expected to be issued in final form in October/November 1996 [para. 4.6 (a) and (b)]. 2.29 The Pension Systems Law pointedly did not adopt the governance and supervisory framework applicable to Mexico's mutual fund industry. Legislators and the administration felt since a handful of financial groups control the bulk of the Mexican banking, securities and mutual funds industries, the legal/regulatory framework for a mandatory contribution system should impose stricter rules for independent decision-making and avoidance of conflicts of interest. A strong CONSAR with ample authority and human and other resources necessary to supervise and enforce compliance was also essential. 2.30 The law and regulations address these key areas of concern for regulation and supervision of AFOREs and SIEFOREs in the following manner: Nature and Control of AFOREs. Chapter III, Section II of the Pension Systems Law sets out the basic rules for ownership, organization, authorization, capital structure and corporate governance of AFOREs. AFOREs will be single-purpose business corporations with independent capitalization. CONSAR regulations require each AFORE to maintain a minimum paid-in capital of N$25 million and a special reserve (as required by Article 28 of the Pension Systems Law) equal to the greater of $25 million or 1% of the total assets of SIEFOREs under management. The paid in capital and special reserve are required to be invested in shares of the SIEFOREs managed by the AFORE. The capital of an AFORE that is a subsidiary of a financial group will not be available to meet the obligations of other subsidiaries of the group. As an additional safeguard, Article 22 of the Pension Systems Law provides that financial intermediaries (including banks) or financial groups that are not in full compliance with applicable capital standards may not be shareholders of an AFORE. The establishment of AFOREs requires the authorization of CONSAR, which may grant or deny authorization in its own discretion after examining the business plan, shareholding, systems, control and management of the firm. Article 54 of the Pension Systems Law empowers CONSAR to revoke the authorization of an AFORE or SIEFORE that fails to meet the standards set forth in law and regulations. CONSAR regulations require sponsors to provide it with detailed information about the business plan, management, source of capital and controlling shareholders. Under the Pension Systems Law, a shareholder that at any time wishes to acquire more than 10% of the capital stock of an AFORE is required to make detailed financial disclosures to the CONSAR revealing their sources of capital for the preceding five years. Foreign Ownership. Article 21 of the Pension Systems Law provided that the Ministry of Finance and Public Credit may issue, in accordance with international agreements, regulations permitting a class of AFOREs majority-controlled by foreign financial institutions (but not individuals or industrial concerns). In accordance with this provision, the Ministry of Finance and Public Credit has issued a regulation permitting financial institutions from NAFTA MExco - CONTRhACTuAL S4AVYGSDELELOPmENTPROGR4AM 17 countries,4 Colombia, Costa Rica and Venezuela to establish majority-owned AFOREs. Up to 49% of the shares of such foreign-owned AFOREs may be held by other foreign or Mexican shareholders. Foreign-owned AFOREs will receive equal treatment with Mexican-owned AFOREs, will compete head-to-head with them and will not be subject to the types of market share limitations that Mexico enforces against foreign-owned banks and broker/dealers. * Commissions and fee structure. Article 37 of the Pension Systems Law permits AFOREs to charge management fees based on a percentage of assets under management, the flow of contributions, or a combination of both, in accordance with regulations issued by CONSAR. Consistent with Article 37, CONSAR has issued regulations which authorize each AFORE to freely set management fees based on a percentage of contributions (a front end fee), a percentage of assets under management, or some combination of the two. In evaluating the appropriateness of commission structures charged by the various AFOREs, regulators are aware that, from the affiliate's point of view, the most important factor is rate of return net of expenses. Accordingly, CONSAR will issue regulations requiring accurate disclosure of the net rate of return. * Conflicts of Interest. In recognition of the potential for abuse presented by Mexico's interconnected and highly concentrated financial system, Chapter III, Section V of the Pension Systems Law establishes strict limitations on permissible transactions between AFOREs and affiliated financial institutions and issuers. CONSAR recognizes that given that a large percentage of pension contributions may ultimately be managed by AFOREs which are subsidiaries of financial groups and/or affiliated with other financial institutions, strict supervision and enforcement of conflict of interest rules will be required to build public confidence in the system. The Pension Systems Law itself establishes that: * Employees, management and shareholders of an AFORE may not divulge or make personal use of material non-public information. . Employees with responsibility for making and executing investment decisions for AFOREs may not also serve as employees of an affiliated (or unaffiliated) financial institution. Overlap of decision-making personnel between an AFORE and affiliated financial institutions would dilute responsibility and in some cases create incentives to make investment decision that are not in the interests of the AFORE's contributors. * SIEFOREs may not purchase securities in a primary offering if such securities are issued by an affiliated financial or non-financial institution or underwritten by an affiliated financial institution. SIEFOREs may not effect deposits with affiliated financial institutions. * SIEFOREs may invest no more than 5% of their assets in securities issued or guaranteed by shareholders or those exercising management control. 4 U.S. and Canadian subsidiaries or branches of financial institutions from non-NAFTA countries are treated as U.S. or Canadian institutions. Accordingly, European and Japanese financial institutions can gain access to the Mexican market through their U.S. and Canadian Subsidiraries. 18 PRESIDENT'SREPORT * All contracts between an AFORE and affiliated companies must be approved by the compliance officer of the AFORE. CONSAR is empowered to issue regulations further clarifying the conflict of interest rules and establishing requirements for assuring continued compliance and supervision. The regulation governing the investment regime establishes that a SIEFORE may invest no more than 5% of its total assets in securities issued or guaranteed by entities that have a management or shareholding nexus with the SIEFORE. * Market Share Limits. In order to encourage greater competition in the provision of pension fund management, Article 26 of the Pension Systems Law sets a 20% limit on the system assets that may be managed by any single AFORE5. The Consultative and Supervisory Committee of the CONSAR is authorized to set a higher limit only if it determines that it will not prejudice the interests of workers. To assure that no AFORE receives an unfair competitive advantage, CONSAR intends to refrain from authorizing the first AFOREs until it is able to grant simultaneous authorizations to a significant number of competitors. * Responsibility of Officers and Directors. The drafters of the Pensions Systems Law and CONSAR have striven to establish clear rules of responsibility for directors and employees of AFOREs. The Pension Systems Law provides that members of the board of directors, the general director and the compliance officer of each AFORE must be approved by CONSAR on the basis of the moral integrity and technical and management capacity of the nominees.6 Article 52 of the Pension Systems Law authorizes CONSAR to remove any director, officer, compliance officer or other officer found to lack the moral integrity or technical or management capacity required for such position. * Publicity and Marketing. Article 53 of the Pension Systems Law requires that all advertising and marketing be conducted in accordance with regulations prescribed by CONSAR. Article 47 requires that SlEFOREs distribute prospectuses that fairly describe their portfolio and investment policies. All such prospectuses must be reviewed and approved by CONSAR. CONSAR has issued initial regulations covering promotion and marketing of AFOREs and SIEFOREs and is expected to issue more detailed guidelines on the required contents and presentation of prospectuses as practice in this area develops. 5 In addition, Transitory Article seventeen of the pension Systems law provides that for the first four years of operations of the new system, the maximum market share permitted each AFORE will be only 17%. 6 To avoid dilution of responsibility, Article 49 of the Pension Systems Law provides that the members of an AFORE's board of directors must also serve on the boards of each of the SIEFOREs managed by such AFORE. These directors must also be members of the investment committee of each SIEFORE. The board must be composed of at least five directors, and at least two-fifths of the members of the board must be independent directors. In order to qualify as an independent director, a director may not be closely related to or have any employment relationship with the shareholders or principal officers of the AFORE. Directors, including independent directors can be held responsible for any actions taken, or for knowledge of irregularities that may be contrary to the interests of the workers. Each AFORE is required to have a compliance officer responsible for overseeing compliance with the rules established by the Pensions Systems Law and CONSAR as well as internal rules and procedures. The compliance officer is appointed by and directly responsible to the shareholders of the AFORE and may not be removed by management. In addition to overseeing internal compliance and reporting to management and shareholders on the status of compliance, the compliance officer must report to CONSAR on a monthly basis or immediately in the event of the discovery of any irregularity in compliance. The Compliance Officer will be held responsible for failure to execute his responsibilities under the law and is subject to sanctions. MEizco - CONTRACTuAL S4 vnGSDEvELOPmEIVTPROGRAM 19 Investor protection. Article 31 provides that each AFORE must establish a specialized unit to respond to questions and claims from workers and employers. Such unit must include an officer with authority to enter into agreements binding on the AFORE and must report to its board. More importantly for investor security, Articles 109 and I 0 of the Law provide for submission of claims of workers and employees that are not settled by such unit to a system of conciliation and arbitration overseen by CONSAR. . Supervision of the reformed system: strengthened CONSAR. From the outset, the Government has recognized the need for a strong regulatory authority for the pension system, with both the legal authority and the human and other resources required to assure compliance with law and regulations. The Pension Systems Law grants CONSAR broad powers to set and enforce rules and standards for all aspects of operations of the revised pension system. CONSAR has full supervisory authority over AFOREs and SIEFOREs, as well as supervisory authority over other participants in the pension system (such as banks and insurance companies) to the extent the activities of such entities involve the pension system. CONSAR is empowered to issue regulations, conduct examinations, impose fines and sanctions and recommend criminal prosecutions. In the event that irregularities are uncovered in the operations of any entity subject to CONSAR supervision (including AFOREs and SIEFOREs), CONSAR is authorized to effect an administrative or management intervention of such entity. As discussed above, CONSAR may revoke the authorization of any AFORE or SIEFORE found to be out of compliance with the Pension Systems Law or CONSAR regulations. CONSAR has prepared an institutional development plan ("Plan General de Restructuraci6n de CONSAR") to provide itself with resources commensurate with its new responsibilities. The annual budget of the CONSAR is expected to increase substantially by approximately 60%. Over the next eighteen months, the plan envisages the installation of a new computer system (and the hiring of outside contractors), a substantial increase in staff (from 162 to over 250), public education programs, the upgrading of key systems and training of personnel. Two-thirds of the new staff will be mid- and high-level personnel. A portion of the funds necessary for improving systems and developing the capacity of CONSAR staff will be provided through the on-going Bank - financed FTAL. The priorities of the plan in the areas of systems and personnel include: development of actuarial standards and methodologies of analysis; implementation of on-site and off-site supervision programs; drafting of examination manuals and training of examiners; implementation of systems and software to monitor trading activity and detect irregularities; development of methodologies for measuring risk and assessing the effectiveness of private securities ratings; installation of systems and preparation of staff to produce a regularly issued statistical bulletin providing key data on the performance of the pension system. (b) Investment Management Regime: Classes of Funds and Portfolio Composition 2.31 Article 43 of the Pension Systems Law authorizes CONSAR to establish and enforce rules of general application for the composition of the portfolios of SIEFOREs. In preparing these regulations, CONSAR has been especially sensitive to issues relating to: (i) the prudent balance between investing in government bonds, private equity and debt instruments and bank obligations; (ii) investor options among portfolios with different investment policies; and (iii) valuation of 20 PREzIDENT'sREPoRr portfolio securities. The draft investment management regime reviewed by Bank staff [para. 4.5 (b)] is expected to be issued before the end of 1996 [para. 4.6 (b)]. 2.32 Initially Single Class of SIEFOREs. Article 47 of Pension Systems Law authorizes CONSAR to permit each AFORE to manage and offer to its customers a variety of SIEFOREs with different portfolio compositions, provided that each AFORE offers at least one SIEFORE the portfolio of which is composed "fundamentally" of securities whose returns are indexed to the Mexican CPI. Mexican legislators felt that to assure public confidence in the system, participants need to be provided with the option of investing in instruments offering a real rate of return. 2.33 At the outset CONSAR will allow each AFORE to establish only a single SIEFORE, "fundamentally" invested in indexed instruments. CONSAR intends eventually (perhaps beginning in 1998) to permit each AFORE to offer customers a variety of equity and debt funds with distinct investment policies. This decision to restrict each AFORE to only a single debt fund at the outset reflects the government's desire to simplify supervision in the first year of pension fund operations, reduce potential confusion among the public and build public support by avoiding volatility. Article 4 of the draft investment regime regulations interprets the term "fundamentally" to require that at least 51% of the assets of the initial SIEFOREs be represented by debt instruments indexed to consumer inflation. I M M LI M ITS _ i........................ _. . >.,...............___ _ .................... ........° ffud LJMITS JI5YINSTIIMFWT (~ ~p~n~ktge 9fFw...... (as % of fund) M R......, . ..... Government debt (1j 100 Equity securities 0 Investment grade co_porate -non-bank- debt (2) 20 LElig b e bank deb (i_sued or guaranteeby a commercial bank) (29_3) 10 Total eligible private debt (corporate and commercial bank) and 30 development bank obligations Investment in instruments issued or guaranteed by any single issuer as a 10 Lnercentage of SIEFORE assets Investment in instruments issued or guaranteed by any single issuer, as 10 a percentage of the issuer's securities Investmen_tin_any singe issue as a percentage of such issue 10 Investment in instruments issued or guaranteed by issuers belonging to 15 the same financial, commercial or industrial group, as a percentage of SIEFORE assets Investment in instruments issued or guaranteed by affiliates of the 5 SIEFORE as a percentage of SIEFORE assets _. (1) Development bank obligations are subject to the overall limit of 50% investment for corporate, commercial bank and development bank securities. (2) Short-term obligations (less than one year maturity) must be rated in the top three rating categories by an authorized rating agency; long-term obligations must be rated in the top two categories. CONSAR's Risk Analysis Committee will establish criteria for when a rating from a single agency is inadequate and when commercial banks would be required to secure a rating from an additional agency. (3) The securities of banks that have been intervened by the authorities or whose primary capital (exclusive of subordinated debt) is less than 4% of risk weighted assets are ineligible for investment by SIEFOREs. MA&co- CoN1RAcTuAL SAvwNGSDEvELOPMENTPROGRAm 21 2.34 Portfolio Composition. CONSAR is empowered to establish prudential regulations governing the portfolio composition of SIEFOREs.7 The following chart summarizes the prudential limitations included in the draft investment regime regulation for the initial SIEFOREs. The limitations to be imposed reflect CONSAR's consideration of a number of characteristics of the Mexican securities markets, including: (i) the degree of liquidity of many listed equity securities; (ii) the suitability of certain poorly-rated debt instruments for mandatory pension funds; (iii) the fairly small number of private issuers in the market and the dangers of concentration of investment in related companies; and (iv) concerns about the appropriateness of excessive investment in the banking system, in particular in those institutions that may not be able to comply with capital adequacy standards. 2.35 Complementary Securities Markets Reforms. The Government recognizes that continued development of Mexico's privately-managed mandatory pension system depends on implementation of complementary reforms in the country's securities markets. Accordingly, CONSAR and CNBV are collaborating on a number of financial market modernization efforts, including: improving standards for the existing private rating agency industry; upgrading the regulatory framework and supervision of Mexican securities markets; improving disclosure standards for issuers and intermediaries consistent with international best practice; and strengthening self-regulation by market participants. (c) Fiscal Costs 2.36 The full benefits of the reform will not be felt unless the fiscal costs of the existing unfunded system are made explicit to the extent possible and are funded through a credible financing plan. The Government must also define what combination of additional fiscal savings (higher revenues or lower spending) and borrowing will finance the transition costs. Addressing these issues is critical to fiscal discipline and to the impact of the pension reform on domestic savings. A discussion of the fiscal costs of transition is summarized below. A detailed analysis of these costs, including an explanation of the model as well as sensitivity analyses under various assumptions, is presented in Annex V. 2.37 The reform of the old age security system generates four fiscal consequences: * the cost of providing pensions to existing pensioners (without the income provided by the PAYG defined benefit system); * the costs of providing pension guarantees, including the guarantee of pension benefits under the old PAYG system to transition workers resulting from the lifetime switch option at retirement, and the MPG to new workers; * making explicit the implicit 1992-96 liabilities in the retirement sub-account; and * the costs of the new NP$l per day Government contribution to individual accounts indexed to the CPI (the Social Quota) and Government contribution of 0.425 percent of salary towards workers pension. Such CONSAR regulations are subject to the general requirement of Article 43 that 100% of the portfolio be invested in cash and/or securities and the prohibition against foreign investment included in Transitory Article 38 of the Social Security Law. 22 PRESID 'SREPORT 2.38 In addition, pension contributions can no longer support health insurance. Changes introduced in the social security law which affect health insurance are estimated by the Mexican authorities to increase the cost of health insurance by about 0.5 percent of GDP per year. The Government is still analyzing these fiscal implications of the change to the social security law for health service provision. The World Bank and the IDB are working with the Mexican authorities to finalize estimates of additional costs, and, on health sector reforms. 2.39 Pensions for Existing Retirees. Fiscal costs for providing for existing pensioners and those receiving invalidity payments can be estimated accurately since IMSS knows the number of pensioners receiving benefits and the amount of benefits paid. These costs equal about 0.4 percent of GDP for 1997 and will decline rapidly over time. 2.40 Pension Guarantees. These comprise: (i) the guarantee of pension benefits to transition workers resulting from the lifetime switch option at retirement; and (ii) the MPG to new workers. The Government must fund these two guarantees only to the extent that value of funds in the individual accounts are insufficient to cover them. • Benefits to transition workers: old age and disability. Transition workers will choose the MPG under the present system if the accumulated balances in their individual retirement accounts (in post-1997 AFORES retirement accounts and post-1997 INFONAVIT accounts) and the investment performance of these accounts are inadequate to provide the MPG. The fiscal cost of the MPG, which is the difference between the value of the minimum benefit and the value of a worker's post 1997 individual account at retirement is uncertain. It depends on the contribution rate, the number of years transition workers contribute to the new system, the growth in real wages, and the rate of return achieved on fund investments. Under conservative assumptions (2 percent real wage growth, 3.5 percent real rate of return on AFORES accounts, and non-availability of INFONAVIT account funds to meet the MPG if workers choose benefits under the old system), the fiscal cost accounted for by these transition workers will rise from 0.21 percent of GDP in 1997 to about 0.80 percent of GDP in 2025 (Table 5). Nearly 10% of this cost is due to the cost of providing life/disability and occupational risk insurance to transition workers. * MPG to New Workers. This MPG is linked to the minimum wage of January 1, 1997 indexed to the CPI and not as under the present system to the actual minimum wage prevailing at the time the pension is drawn. This reduces its fiscal cost substantially. Estimates of these costs are dependent on real wage growth and real investment performance as well as the number of workers entering the new system and the rate of inflation. It also depends on the distribution of workers within wage categories. The more workers earning close to the minimum wage, the more costly the guarantee. Currently, about 50 percent of the workers earn wages equal to or less than 2 times the minimum wage. However, if real wages should grow by 2 percent per annum and the MPG to new workers remain unchanged in real terms, the percentage of this MPG to minimum wage will drop to 61 percent in 25 years. Under these and associated assumptions the cost of the MPG to new workers is almost negligible in the earlier years, increasing to about 0.2% of GDP in 2025. 2.41 Transfer of Accumulated Balances in Retirement Sub-accounts. Transition workers have the right to transfer their accumulated contributions in the retirement sub-account made ME=CO- CONTRACTUALA4vNGSDEvELOPMENTPROGRAM 23 between 1993 and 1996 to AFORES which will maintain these in a separate sub-account. They have an acquired right to a 2 percent real rate of return on these funds for the first year if they choose to maintain their balances in the Central Bank. Since these funds are already included as debt of the Federal Government, they are not included as a new fiscal cost but have fiscal consequences in that the Government would have to refinance an estimated US$4 billion of domestic debt within four years. 2.42 Daily Social Quota. The uncertainty in this cost is the number of workers opting for coverage under the reform. If pension funds are perceived as lucrative savings vehicles, many workers now in the informal sector may join the formal sector. The NP$1 contribution, being indexed to the CPI, will decline as a percent of wages through time as real wage growth occurs. It's cost is estimated to equal 0.20 percent of GDP in 2025 assuming a slight increase in coverage (from 28% of economically active population presently to 36% by 2025). 2.43 Estimated Total Fiscal Costs. The sum of the above costs related to pension reform is estimated to be between 1 and 2 percent of GDP during the next 20 years (Table 5). Table 5. Total Estimated Fiscal Cost of Pension Reform in 1997-2025 (percent of GDP) ........ . .. ....2 ..$ ....5 A. Pensions paid to pre 1997 Retirees 0.39 .09 0.03 B. MPG to Transition Workers Without 0.21 0.70 0.80 INFONAVIT (MPG to Transition Workers with (0.05) (0.38) (0.53) INFONAVIT) B. MPG to New Workers 0 0 0.16 C. NP 1$ Per Day (Social Quota) and other Government Contributions 0.33 0.25 0.20 TOTAL (Without INFONAVIT) 0.93 1.04 1.19 TOTAL (With INFONAVIT) (0.77) (0.72) (0.92) Source: Annex V, Scenario 2B and 4B. 2.44 The Government has completed the sensitivity analysis of the fiscal costs of transition and the evaluation of actuarial methodologies and the data base [para. 4.5 (c.i)]. The Government will also publish annually the actuarial income and expenses for IVCM programs to make fiscal transition costs explicit [para. 4.5 (c.ii)], and pension related transition costs for 1997 will be included in the 1997 budget. The Government has also agreed to maintain updated projections of pension related transition costs for later years and make them public. 24 PRES1DENT'SREPORT 2.45 To ensure the smooth transfer of SAR accumulated balances from the Central Bank to AFOREs, the Government has already developed processes establishing the means to authorize transfers and to ensure that contributors are informed about the transfer [para. 4.5 (c.iii)]. (d) INFONA VIT 2.46 Mexico's special housing funds form part of the country's pension and social security system. INFONAVIT, which covers private sector workers, and FOVISSSTE, which covers government workers, provide subsidized mortgages to eligible members. These activities are funded through mandated employer contributions into individual workers' accounts equivalent to 5 percent of a worker's base wage in the case of INFONAVIT (up to 10 minimum salaries). Balances in individual housing accounts augment workers' retirement benefits. 2.47 Both institutions serve as important vehicles for mortgage finance. More specifically, INFONAVIT, which operates as a retail mortgage institution, provides about 20 percent of total housing credit and 45 percent of new housing units. The institution suffers from weak credit management and poor commercial practices. Substantial subsidies (in addition to those contained in contracted interest rates) are being generated by a number of factors, including underwriting standards which grant mortgages whose amortization periods extend beyond a contributor's working life, and fluctuations in the real minimum wage to which mortgage payments are tied. These practices have led to financial problems including negative real rates of return on workers' contributions (-2 percent in 1993 and 1994), and a reduced lending capacity due to capital erosion resulting from poor repayment and collection. 2.48 All this is compounded by extensive evasion or underreporting of contributions by employers. Management changes introduced in 1992 have had a limited effect on operations. 2.49 Under the reform, contributions to INFONAVIT will represent between 30 and 40 percent of total contributions to pension accounts. The ramifications of INFONAVIT not earning positive real rates of return include: (i) higher fiscal costs as a poor financial performance by INFONAVIT lowers total returns on individual accounts and increases the probability that younger transition workers will choose the old PAYG over the new system or that the Government will have to provide for a MPG for new workers; and (ii) the loss of potential retirement income by workers just entering the new system which could lead to continued evasion. The burden of poor performance of INFONAVIT on new workers will be aggravated as the MPG falls relative to average wages. In addition, the Government recognizes that a modern housing finance system will require significant improvements in INFONAVIT's financial performance. 2.50 The Government has agreed to initiate measures to ensure that INFONAVIT earns a positive real rate of return and that the accumulated benefits of this housing contribution are added to the wage contribution in AFORES accounts (6.5 percent plus the daily "Social Quota" NP$1 per day) assuring better pension benefits for workers and reducing the fiscal costs of the reform. Among other actions, the reforms will ensure that, for the first time, there is proper disclosure to contributors and the general public on INFONAVIT's operations and performance, establishing the basis for improved accountability. Hence, the reforms should lead to improved performance by INFONAVIT or trigger a reaction, which could lead to further Government actions. MF.tco - ComcAcTvuL SA vNs DEraoPmEzTPROGRAm 25 2.51 Based on the results of a special evaluation of INFONAVIT's operations, several measures are being implemented to improve financial performance which will include [para. 4.5 (d)]: * initiating a regular supervisory process by the National Banking and Securities Commission "Comisi6n Nacional Bancariay de Valores (CNBV)"; and * publication in CONSAR's bulletin, at least twice a year, of the results of INFONAVIT's financial operations. (e) Account Individualization and Strengthening of the IMSS 2.52 As mentioned earlier (para. 2.15), IMSS retains an important role in the reformed old age security system, inter alia, the enforcement of billing and collection of contributions to the system, and continued payments to current pensioners and to transition workers choosing the old benefit scheme at retirement. Given the severe problem that arose in the existing SAR system with multiple accounts and account admninistration and the high levels of evasion to the system, the IMS S' greatest challenge at the outset of the reform will be to ensure the implementation of the operational scheme of the new pension system, particularly with the collecting and channeling of contributions to AFOREs. 2.53 To avoid the aforementioned problem with multiple accounts, the new legislation specifically requires individuals to have unique accounts. The law also establishes that the IMSS is to assign a new account number to each contributor to the system. Transfers of accounts will be permitted when changes of employment occur, preventing one of the main problems that resulted in the emergence of multiple accounts per contributor. Avoiding multiple accounts will be particularly important given the government contribution of NP$1/day and the tax benefits for employers associated with these accounts. 2.54 Since late 1995, CONSAR has been adopting a series of regulations to initiate a process of consolidation of SAR accounts. As part of this process, CONSAR signed agreements (convenios) with IMSS, and INFONAVIT to use one number (that of IMSS) to uniquely identify retirement accounts and to interchange and reconcile account information for each contributor [para. 4.5 (e.i)]8. The regulations issued by CONSAR also supported the creation of a privately owned and managed entity to process account information and effect transfers of accounts (PROCESAR), and to establish a national data base for retirement accounts (BDNSAR) [para. 4.5 (e.ii)]. 2.55 In addition, a special agreement was signed between CONSAR/SHCP and IMSS to strengthen its capacity to manage the implementation of the new operational scheme [para. 4.5 (e.iii)]. This agreement includes actions to ensure: the updating of the IMSS data base; the issuance of the social security number of the IMSS; the integration of the new IMSS data base to BNDSAR; and the appropriate functioning of billing and collection of contributions. All these tasks will be performed according to a time-bound working plan outlined in the agreement to be signed between CONSAR and the IMSS. The working plan not only includes the modernization of the IMSS computer systems but also of its operational procedures. (I) Public Confidence and Education 2.56 The lack of public confidence and the low level of financial sophistication across a broad spectrum of the population are key factors hindering the growth of institutional savings. This See footnote 2 in page 9. 26 PRESIDENT 'SREPORT stems from a public perception that government management of funds or provision of services has been both inefficient and often corrupt. The public is skeptical that contributions to government and private savings schemes will result in later benefits to them. Instead the public fears that contributions will be used for excessive public expenditures rather than for investment in economically viable and desirable public projects. In addition, government or private savings schemes have often not defined individual accounts clearly, and the quality of information disclosed to individual savers has been poor, thus further reducing confidence. 2.57 The Government has already initiated a public awareness campaign to bolster support for the reform and to encourage participation in the new pension system. This program will inform workers about how the new system will benefit them and how it makes them responsible for managing their own retirement account. In the case of Mexico, initial diversification will be limited. Complementary Financial Market Reforms9 2.58 The Government recognizes that continued successful development of Mexico's privately- managed mandatory pension system is linked to the implementation of complementary financial market reforms. Inter alia, reforms to facilitate the development of an adequate supply of quality financial assets for pension funds to invest in. Accordingly, as part of the CSDP, the Government has initiated a number of financial market modernization reforms, including: (i) efforts to strengthen the banking system; (ii) actions to address deficiencies in the regulatory and supervisory framework for mutual funds and voluntary pension plans; and (iii) actions to facilitate the deepening of the insurance market for the provision of life and disability insurance coverage and annuities. (a) Banking System 2.59 For the foreseeable future, Mexico's privately-managed pension funds will operate within a financial system overwhelmingly dominated by commercial banks and their financial holding companies. The health of the Mexican financial system as a whole depends importantly on the effective resolution of the banking crisis that followed the 1994 devaluation of the peso and restoration of the health of Mexico's commercial banks. 2.60 In the aftermath of the devaluation, the Mexican financial sector authorities focused their efforts on the immediate problems. The initial steps taken included: holding actions to avoid systemic collapse; loosening of foreign investment restrictions; incentives to encourage recapitalization of banks by shareholders; and intervention of the most troubled banks in the system. As the situation has stabilized, the emphasis is on putting in place the prerequisites for a more consolidated, well capitalized, competitive and efficient commercial banking system. This stage involves: a more selective bank-by-bank approach to resolutions; implementation of revised prudential regulations and accounting standards; reexamination of the bank liability insurance scheme; stepped-up supervision; acceleration of the final disposition of intervened banks and assets; and modernization of the legal/regulatory framework for banking and finance. 9 The Government's actions in this area will be monitored as part of the overall program implementation. MfExrco - CONrTRACTUAL SAvrNGSDEtELOPMAEATPROGRA4 27 (b) Mutual Funds. 2.61 Mexico's mutual funds fall into four general categories, stock funds (which may also invest a share of their assets in debt instruments), debt funds for individuals, debt funds for corporations, and venture capital funds. Each type of fund is governed by a different set of regulations covering asset diversification, valuation and other aspects of fund operation. Since the enactment of the current Mutual Funds Law (Ley de Sociedades de Inversi6n) in 1987, Mexico's mutual fund industry has been characterized by: (i) fairly wide variations in the volume of assets under management; (ii) a steady decline in the number of accounts, especially those held by individual investors; (iii) a high degree of concentration, especially for equity fund management; and (iv) management by banks and other financial group subsidiaries, who often have incentives to steer customer and mutual fund investments into direct obligations of affiliated banks. Performance records have been spotty. In general, debt funds have performed similarly to money market instruments. This is not surprising, since the shortage of long-term debt instruments and the need to maintain liquidity to provide for often dramatic unexpected redemptions has caused most debt funds to invest principally in short-term government and bank obligations. 2.62 At the end of 1995, Mexican mutual funds assets amounted to approximately N$50 billion (3 percent of GDP), down from a high of N$100 billion in May 1992, in little more than 260 thousand accounts. More than three quarters of mutual fund assets are in debt funds invested overwhelmingly in short-term instruments. Since the commercial bank privatizations of 1992, the percentage of debt fund portfolios invested in obligations of banks has increased dramatically, by April 1995 reaching almost 72%. The failure of the Mexican mutual fund industry to develop as an attractive alternative to competing short-term bank instruments and the continued concentration of management of mutual funds by financial groups with a strong presence in banking had already prompted the Government to reexamine current laws and regulations in this area before the enactment of the pension system reform. The reform reinforced the need for such reexamination. The number of fund managers is expected to grow as financial groups take advantage of synergies between operating an AFORE and a mutual fund manager. More importantly, a larger and better managed mutual fund industry could provide an important complement to SIEFOREs, by contributing to deeper long-term debt and equity markets and providing institutional demand for riskier securities in which pension fund investment will be limited. 2.63 As noted above under "Regulatory and Supervisory Framework for Fund Administration", the legal/regulatory regime for AFOREs and SEEFOREs is tighter than that for mutual funds, especially in the areas of corporate governance and conflicts of interest. The Government, through CNBV and CONSAR, is reviewing the experience of the mutual fund industry over the past nine years, focusing on issues of portfolio valuation, related-party transactions and the relationship between fund managers and the fund. The results will provide a basis for changes in mutual fund regulation, including: (i) greater voting rights for shareholders, (ii) a more important role for independent directors on the boards of investment companies, (iii) requirements for independent director approval of affiliate transactions; (iv) valuation of portfolio securities by unaffiliated parties; (v) steps to encourage the development of an independent mutual fund management industry; and (vi) more effective supervision by the CNBV. 28 PRESIDE:T 'SREPORT (c) Voluntary Pension Plans 2.64 A number of private companies in Mexico have established voluntary pension plans for the benefit of their workers (para. 2.7). Most such schemes provide for employee contributions of between 2 and 6 percent of annual wages, with the assets of the plan managed by a bank or brokerage firm. Although these plans are subject to certain portfolio requirements established by SHCP, they operate entirely outside the current IMSS and ISSSTE systems and are essentially unsupervised. It is expected that voluntary private pension plans will grow in importance given the public visibility of the pension reform and possible revisions of the tax code currently under study that would provide greater incentives for employer and employee contributions to such plans. 2.65 The new Social Security Law and the Pension Systems Law represent an important first step towards introducing a regulatory and supervisory regime for Mexico's private voluntary pension plans. Article 82 of the Pension Systems Law provides for the registration of qualifying voluntary pension plans with the CONSAR in accordance with rules and procedures to be established by CONSAR. Registered plans must be certified as actuarially sound to the satisfaction of the CONSAR and will be subject to full CONSAR regulation and supervision. Registration of a plan with CONSAR permits a worker's retirement account at an AFORE to be transferred to such worker or the voluntary pension plan's administrator when such worker retires under the terms of the voluntary plan. Since voluntary plans often permit workers to receive a pension at an earlier age than under the Social Security Law, participation in a registered plan will be attractive to workers in that it will give them earlier access to accumulations in their AFORE retirement account. Future tax incentives for voluntary retirement plans will also likely be available only for plans registered with CONSAR. (d) Development of Disability and Life Insurance 2.66 Under its retained role in disability and life coverage, the IMSS is required to provide specific benefits within a budget of 2.5 percent of wages for life and disability insurance. The most feasible way to provide efficient insurance coverage will be to purchase insurance plans from private carriers. However, the private insurance market is currently underdeveloped; its development is a medium-term objective of the Government. Evidence suggests that privatization of these insurance coverages could substantially reduce the number of people on the disability rolls through tightening of disability standards and reduce the premiums for both these types of insurance combined to less than 2 percent of wages. 2.67 To make progress in the development of the private insurance industry, the Government through the National Insurance Commnission "Comisi6n Nacional de Seguros y Fianzas (CNSF)" and the SHCP will initiate a study to review existing regulations for provision of life and disability by insurance companies. Terms of reference for the study have already been agreed to with CNSF and consultants have been contracted. The study's recommendations will provide the basis to initiate a plan to modernize the existing legal and regulatory framework for life and disability insurance (e) Development of Annuities Market 2.68 Under the reform workers have the option of purchase an annuity with the fund in 'their' SIEFORES accounts in retirement. In addition, transition workers have the option of taking lump sum payouts at retirement from the retirement sub-accounts established between May 1992 and ME;xco - CoNTRACTuAL SA vGs DEEL oPMENT PRoGRAM 29 1996 and from their INFONAVIT accounts. Currently the annuities market in Mexico is almost non-existent. 2.69 On April 26, 1996 , the Ley General de Instituciones y Sociedades Mutualistas de Seguros was amended to establish the legal framework for the development and supervision of the annuities market. In addition, through the National Insurance Commission (Comisi6n Nacional de Seguros y Fianzas - CNSF), a study will be carried out to identify the changes needed to the regulatory framework for annuities, including types of annuity products, reporting requirements, pricing guidelines, actuarial disclosures, and regulation of insurance brokers' commissions. Terms of reference for the study have already been agreed to with CNSF. Based on the results of the study, regulations will be issued complementing the requirements of the amended law. III. BANK ASSISTANCE STRATEGY A. Overall Assistance Strategy 3.1 Past Lending. The Bank vigorously supported Mexico's economic adjustment and debt reduction programs during the FY86-91 period, with loans totaling almost US$11.4 billion (reaching a peak of US$2.6 billion in FY90), more than half of which were quick disbursing sector adjustment and interest support loans. This led to a rise in Bank exposure in Mexico, from 8.8 percent of the Bank's total portfolio in 1989, to about 12 percent currently. Between FY92- 94, annual lending averaged US$1.4 billion, with no adjustment loans, and the focus of operations shifted to poverty reduction, human resource development and the environment, while maintaining a strong program in infrastructure. The Bank supported Mexico following the crisis of December 1994 with two operations: (i) a US$1 billion quick disbursing Financial Sector Restructuring Loan (FSRL I) to assist in efforts to rescue Mexico's banking system which had come under severe stress as a result of the exchange rate crisis, and consequent inflation and recession; and (ii) a US$500 million Essential Social Services Loan. These two operations, together with investment lending, increased total lending in FY95 to US$2.4 billion. 3.2 Future Lending. As indicated in the CAS recently submitted to the Board, future Bank lending is expected to incorporate baseline lending of US$1.5 billion per annum for the next three years focused on investment lending, with adjustment lending totaling US$1.25 billion, viz (i) the proposed Contractual Savings Development Program; (ii) a second follow-up Financial Sector Restructuring Loan (FSRL II); and (iii) a Second Contractual Savings operation. The proposed lending program supports government plans to implement far reaching structural measures covering: * Measures to raise domestic savings, including effective pension reform (moving to a fully-funded, defined contribution, privately-managed, scheme); continued restructuring of the banking system; a further shift to consumption-based (rather than income-based) taxes; and further capital market development (including development of long-term savings instruments). * Private sector development and modernization of social services, including modernization of the public health delivery system through joint public/private provision by sub-contracting to private providers of medical services. * Provision of adequate and cost-effective infrastructure services, through a program of infrastructure privatization and development of second-tier mortgage 30 PRESIDENT 'sREPORT lending institutions and the creation of a market in mortgage asset-backed securities. B. IFC 3.3 As of June 30, 1996, IFC's portfolio in Mexico involved 40 clients and stood at US$652 million, including US$582 million (89 percent) in loan investments and US$70 million (11 percent) in equity participations. IFC's Mexican exposure amounted then to 7.6 percent and 6.6 percent of total investments disbursed and held, respectively, by the Corporation world-wide. The Bank and IFC have been cooperating closely in response to the crisis and its aftermath and in preparing the first joint Bank Group CAS in 1996 for Mexico. IFC staff have been members of the Bank teams responsible for the development of the Financial Sector Restructuring Loan as well as the Infrastructure Privatization Technical Assistance Loan. IFC has also been working closely with the Bank on the formulation of a possible fund for private infrastructure financing and in the Southern State Initiative, Taking into account the emerging needs of the private sector and the development agenda proposed in the CAS, IFC intends to significantly increase its investment activities and portfolio exposure in Mexico in the coming years. Reflecting the sizeable long-term financing needs of the corporate sector, IFC anticipates that through FY99 its activities could increase from 10 to 14 projects per year while estimated gross approvals could reach US$700-800 million annually, including US$300-350 million for IFC's own account. Such a program would result in the processing of 40-44 projects involving estimated gross commitments of US$2.2 billion through FY99, of which about US$1 billion would be for IFC's own account. Over 50% of the program would go to financial market development and general manufacturing, and the balance to infrastructure, petrochemicals and agribusiness. The share of infrastructure could increase substantially with a comprehensive privatization program in this sector. C. Coordination with the IMF 3.4 The Bank has been working closely with the IMF in monitoring the macroeconomic situation in Mexico and advising the Government in this area. Given the IMF's direct role in financing the stabilization program through the ongoing stand-by arrangement, its team has led the dialogue on macroeconomic stabilization measures, exchange rate policy, and liability management issues. In fiscal policy, the IMF has concentrated on developing macro targets, while the Bank's sectoral background has enabled us to advise on sector policies. In the financial sector, the Bank has a lead role, due to our prior experience in preparing both last year's Financial Technical Assistance Loan and the Financial Sector Restructuring Loan. At the same time, the IMF and the Bank have coordinated especially closely in implementing the Financial Sector Restructuring Loan, because of the inter-dependence of financial sector and macroeconomic stability. The impact of macroeconomic adjustment on social programs is of concern to both institutions, and the Bank is sharing with the IMF its analysis in this area during the course of the stabilization program. Finally, macroeconomic stability will depend critically on Mexico's ability to increase domestic savings and productivity; the Bank's ongoing analytical work in these areas is being shared with the IMF, so that it can feed into the evolving macroeconomic framework. The Fund is discussing with the Government a three-year extended arrangement to succeed the current stand-by which, following its recent six-month extension, expires in February 1997. AMI=co - CONTRACTUAL SA VGsDLopmENTPRoGR,4 31 D. Coordination with the IIDB 3.5 Given the current economic situation, the IDB strategy for Mexico is divided into short- and longer-term components. The IDB's short-term objective is to support Government efforts to reestablish macroeconomic stability through (i) program lending aimed at assuring the solvency of the financial sector and (ii) helping finance the basic needs of those most affected by the crisis. To these ends, the IDB has cofinanced both of the World Bank's large crisis-related operations: the Financial Sector Restructuring Loan and the Essential Social Services Loan. It is also expected to cofinance the present proposed loan in support of the Contractual Savings Development Program. 3.6 The IDB's longer-term objectives are to support Government efforts to: (i) achieve sustained economic growth, via infrastructure investments aimed at private sector development, agricultural productivity growth, and human resources development; (ii) promote equitable growth, through programs to reduce poverty and to improve the provision of social services (education, nutrition, and health) --relying on and reinforcing the capacity of states and municipalities and of the private sector; and (iii) achieve environmentally sustainable growth, through programs geared to protect the environment and natural resources. IV. THE PROPOSED LOAN A. Origin 4.1 The proposed loan would support the first phase of the reform of the Mexican social insurance system. The Bank's involvement in the area of contractual savings in Mexico began in 1990 with the preparation of an economic report which provided a detailed analysis of contractual savings issues. A number of the report's recommendations were taken up in reforms, including in January 1993 when the concept of the individual retirement account was introduced as part of the SAR. The proposed loan is the outcome of a close dialogue between the Bank and the Government on the development of Mexico's financial sector and the need to improve the allocation of financial resources and set the basis for the effective channeling of domestic savings. 4.2 The Bank's involvement during the first half of 1994 included the provision of advice and technical support in the area of pension and social security reform and in other capital market development areas. This involvement culminated in the preparation of a pension reform and financial sector policy option papers for the new administration and Bank financing of technical assistance to the financial sector. The Government's initial request for Bank financial support for the proposed operation was made in September 1995. The Government legislation reforming the pension system was enacted on December 15, 1995 and April 26, 1996. B. Loan Size and Proposed Tranche Conditionality 4.3 Loan Size. A single tranche loan of US$400 million is proposed to be made available upon loan effectiveness, anticipated for February 1997. The loan closing date would be June 30, 1997. 4.4 Proposed Tranche Conditionality. The conditions below have been selected based on their importance in the setting up of the new pension system. Although the process of private pension fund management is at an early stage, by the time of tranche disbursement the legal, regulatory and institutional framework for the new pension system will be in place. In addition to 32 PRESZDENT'SREPORT the specific actions listed below, tranche release would be contingent upon: (a) maintenance of an appropriate macroeconomic framework; and (b) satisfactory progress in the implementation of the overall Contractual Savings Development Program which is outlined in the Government's Letter of Sector Policy (Annex I). 4.5 The following policy actions were taken prior to Board Presentation: (a) Reform of Old Age Insurance System: Congress approved reforms to the Social Security Law to reform IMSS and move to a defined contribution scheme for private sector workers (para. 2.13-2.14); (b) Regulation of pension fund administrators and supervision of the reformed system: enacted the Ley de Coordinaci6n de Fondos de Ahorro para el Retiro containing guiding principles acceptable to the Bank (para. 2.28-2.29); finalized draft key regulations on fund administration and the investment management regime containing guiding principles acceptable to the Bank (para. 2.31); (c) Fiscal transition costs: (i) completed sensitivity analysis and satisfactory evaluation of actuarial methodologies and data base (para. 2.46); (ii) agreed to publish annually the actuarial income and expenses for IVCM programs to make fiscal transition costs explicit (para. 2.46) (iii) adopted transfer arrangements for accumulated SAR balances (5/1992-1996) from the central bank to AFOREs over a period of four years (para. 2.47); (d) INFONAVIT: initiated measures to improve financial performance including: (i) initiation of a regular supervisory process by CNBV (para. 2.53); and (ii) establishment of disclosure requirements for the returns obtained by INFONAVIT (para. 2.53); and (e) Account individualization and strengthening of IMSS: (i) CONSAR signed agreements with IMSS, ISSSTE, and fNFONAVIT to use one number to uniquely identify SAR and SIEFORE accounts and to interchange and reconcile account information for each contributor (para. 2.56); (ii) CONSAR issued circulars providing rules for identification of accounts and account transfers and to individualize aggregated contributions of multiple contributors (para. 2.56); and (iii) a special agreement was signed between CONSAR/SHCP and IMSS to strengthen its capacity to manage the implementation of the new operational scheme (para. 2.57). 4.6 The following policy actions would be taken prior to effectiveness: (a) Regulation of pension fund administrators and supervision of the reformed system: issuance by CONSAR of key regulations containing guiding principles acceptable to the Bank (para. 2.28); and (b) Investment management rules: issuance by CONSAR of key regulations containing a series of general principles governing investment management rules and principles acceptable to the Bank (para. 2.31). 4.7 The second phase of the reform program would focus on the implementation of the new pension system. This second phase is expected to be supported by a proposed second Contractual Savings Development Program Loan to be presented to the Board towards late- 1997. Mkuco - CONTRACTUAL SA viNGS DFEwPmENTPRoGRAm 33 C. Technical Assistance 4.8 The technical assistance requirements of this operation will be financed through the Financial Technical Assistance Loan (FTAL) associated with FSRL I. In addition, a Policy and Human Resources Development Fund (PHRD) in the amount of US$975,000 was approved on July 26, 1996 to support the preparation of the second phase of the Contractual Savings Development Program. A matrix detailing the technical assistance to be provided is attached as Annex III. D. Disbursements 4.9 BANOBRAS the borrower and financial agent for the Loan would be responsible for submitting withdrawal applications and would maintain separate records and accounts for all transactions under the Loan. The Borrower will open an account in the central bank. Upon Bank notification of tranche release, the proceeds of the loan will be deposited by the Bank in this account at the request of the Borrower. If after deposit in this account, the proceeds of the loan are used for ineligible purposes (e.g., to finance items imported from non-member countries, or goods or services in the standard negative list), the Bank will require the Borrower to either: (i) return that amount to the account for use for eligible purposes; or (b) refund the amount directly to the Bank, in which case the Bank will cancel an equivalent undisbursed amount of the loan. E. Accounts and Audit 4. 1 0 BANOBRAS will maintain separate records for all transactions under the Loan. Upon the Bank's request the Borrower shall have the deposit account audited in accordance with standard Bank requirements. F. Monitoring and Reporting 4.11 Monitoring and reporting will be facilitated through the close coordination of activities and implementation agencies supported by the FTAL and direct technical assistance from the Bank. Under the FTAL, technical assistance is being provided to assist the Government in implementation of the overall program through the CONSAR, CNSF and SHCP. G. Benefits and Risks 4.12 Benefits. The Government's contractual savings development program will result in a number of important benefits: a. The change from an actuarially bankrupt defined/benefit system to a fully funded defined-contribution scheme will increase public savings in the longer term. If the current system were maintained, eventually the actuarial deficit would have to be met with a subsidy from the fiscal account, an increase in contributions, or a decrease in benefits. b. The separation of the pension and health sector schemes will result in greater pressure to improve efficiency in the delivery of public health services. Currently, these services are subsidized with funds from the pension system. The efficiency of heaith services delivery must improve to avoid an increase in contributions or a cut in benefits. 34 PRESIDENT 'SREPORT c. The reform will create a new class of institutional investors (AFORES) and an increased volume of institutionalized saving. As institutional investors gain expertise in managing pension funds, the allocative efficiency of domestic savings will increase. In addition, institutional investor demand for long-term assets permits the possibility of the development of markets for long-termn financial instruments. d. To the extent that institutional investors hold bank-related financial paper, a likely outcome in the near term, these investors can play an important role in monitoring and controlling bank risk by avoiding the paper of risky banks. 4.13 The pension reform is expected to have a positive social impact. Low income formal sector workers rely heavily on publicly-provided pensions for sustainable post-retirement income generally due to an insufficient accumulation of other savings. The establishment of SAR accounts in the first phase of reforms in May 1992 provided many individuals with their first account with a commercial bank. The Government's reform program will expand access to financial services to a broader base of the population and at the same time provide greater incentives for informal workers to join the formal economy. Specifically, the reforms supported by the proposed operation will allow individuals to accumulate personal wealth, benefiting from higher real rates of return in a broader range of investment vehicles improving post-retirement living standards. The public information campaign to be carried out will gradually increase awareness of the benefits of the new pension scheme and change current perception so that contributions are perceived to be linked to benefits and an accumulation of wealth rather than as a tax. 4.14 As workers retire under the reformed system they will buy annuities to convert the assets accumulated in their pension accounts to yearly income to provide for retirement, which will require the development of a regulatory framework for a private annuity market. In turn, the creation of this market will spur the development of an insurance industry, both for the efficient provision of annuity products and for the development of a wider range of insurance products, such as life and disability insurance. Furthermore, the growth of a private insurance industry will create a broader institutional investor base, which will support development of capital markets. 4.15 Risks. There are several major risks which could limit the effectiveness and impede the success of the proposed pension reform program: a. slippages or inadequate supervision of private pension fund managers, leading to low returns, regulatory non-compliance and even fraud; b. the weakening of the banking system adversely affecting the reformed pension system, resulting from: (i) AFORES being established by financial groups which are also owners of banks; and (ii) investments by AFORES in commercial bank liabilities; c. difficulties in establishing unique identification numbers for contributors10 and in reconciling multiple accounts which would delay the implementation of the pension reform. d. inadequate improvements in INFONAVIT's financial performance; '1 See footnote 2 in page 9. MExico - CONTRACTUAL SA7NGSDEw-LOPmENTPROGRAM 35 e. slower-than-expected development of a long-term securities market which would reduce the investment options of pension funds, potentially constraining their returns; and f. lack of sufficient fiscal discipline necessary to maintain a favorable macroeconomic environment to ensure that (a) pension funds' securities investments yield a positive rate of return, and (b) the government has sufficient resources to provide benefits promised to transition workers. 4.16 To address and reduce the first risk, the Government allowed itself a full year to prepare for the implementation of the new pension scheme. In addition, pension fund assets are likely to be very small at the beginning of the reform and invested in a narrow range of financial instruments. New supervisory and enforcement powers for CONSAR have been included in the Ley de Sistemas de Ahorro para el Retiro approved in April 1996. In parallel, the FTAL has supported the Government in the development of policies and regulations in a broad range of areas including the investment regime, capital regulation, and fee structure of privately-managed pension funds. In addition, CONSAR is arranging cooperative relationships for training and technical support from the U.S. Securities and Exchange Commission and Chile's Superintendency of Pension Fund Administrators. 4.17 To prevent the weaknesses of the banking system from adversely affecting the reformed pension system, the Government's CSDP includes specific safeguards with respect to the investment by AFORES in commercial bank liabilities. However, actual compliance with these provisions will depend on the perceived power and technical capabilities of the supervisory body, CONSAR. In addition, the Government has initiated a second stage of banking reforms to ensure the restoration of the health of the banking system. 4.18 To preserve competition and reduce extreme reliance on financial conglomerates, the Government has tried to facilitate broad entry and limit regulatory barriers in the establishment of pension fund operators to stimulate competition. Limits included on foreign participation in pension fund operators are only partial. In addition, these limits do not apply to a number of countries with whom Mexico has reached agreements, including the U.S. and Canada under North American Free Trade Agreement (NAFTA). Of particular importance have been Government actions to permit each investment fund account administrator to sub-contract services freely in such areas as collections and account processing. 4.19 The Government has developed a plan to tackle the challenges for instituting a unique identification number for each account holder and reconciling accounts for approximately 10 million contributors. CONSAR will contract the services of an experienced and well-qualified specialized firm to assist in this task. The Bank has also reviewed and assessed this plan to ensure that it is feasible and can be successfully implemented prior to the initiation of the new pension system in 1997. 4.20 The Government recognizes the importance of improving INFONAVIT's performance to ensure better returns for workers and minimize fiscal costs resulting from the minimum pension guarantee. Measures being implemented, including proper disclosure of its operational results, should lead to improved performance by INFONAVIT or trigger a public reaction, which could lead to further Government actions. 36 PRESiDENT 'SREPORT 4.21 The risk of a slower-than-expected supply response for a variety of long-term securities is being mitigated by: (i) reasonable prospects for macro-economic and monetary stability; and (ii) improvements in the legal/regulatory framework for securities markets and mutual funds. 4.22 Finally, the potential for weakening of fiscal discipline will persist but is mitigated by both Mexico's growth potential over the medium term and the significant amount of time remaining in the term of the current administration which is strongly committed to these reforms. In addition, the cost of the pension reform at between I and 2 percent of GDP has been adequately estimated and is manageable. The low overall level of pensions and the favorable demographic structure in Mexico are important factors which are helping to minimize the fiscal costs of the transition compared with other countries in the region. Sensitivity studies using different rates of return and actuarial estimates indicate that the range of costs fall within the scope of recent fiscal efforts and are achievable both in the short and long term. H. Environmental Impact 4.23 There are no negative environmental impacts associated with this loan, which therefore, has an environmental rating of"C". V. RECOMMENDATION 5.1 I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank, and recommend that the Executive Directors approve it. James D. Wolfensohn President By: Caio Koch-Weser AN]VEX I Page 1 of 5 MEXCO CONTRACTUAL SAVINGS DEVELOPMENT PROGRAM GOVERNMENTLETTER OFSECTORPOLICYFOR CONTRACTUAL SAVINGS DEVELOPMENT' Mr. James D. Wolfensohn President International Bank for Reconstruction and Development 1818 H Street, N.W. Washington, D.C. 20433 USA Dear Mr. Wolfensohn: One of the key objectives of the economic strategy adopted by the present Government is to lay the foundations for sustainable growth of the productive apparatus. Given Mexico's present population dynamics, this is the only way to generate the sources of well-paid employment required to raise the general standard of living. With a view to achievement of this goal, the 1995-2000 National Development Plan highlights the need to increase domestic saving, and it is in this context that a contractual savings program takes on particular importance. By means of this Letter of Development Policy, we are requesting World Bank (and Inter-American Development Bank) financial support for implementation of the Pension System Reform now under way in Mexico. The success of this Reform will depend not only on the actual operating mechanisms introduced but also on establishment of a climate of economic growth with price stability. It is in this context that the following description of the key economic policy guidelines this Government has been applying since it took office should be viewed. In response to the conditions stemming from the financial crisis that overtook the country in late 1994, and with the aim of laying firn foundations for sound and sustainable growth, Mexico's economic policy has focused on three interlocking objectives. First, a contingency strategy was followed to rectify the major macroeconomic imbalances that had been at the root of the financial crisis. Second, measures have been introduced to mitigate the effects of the crisis on the standard of living of broad segments of the population, and to create development opportunities for the most vulnerable social groups. Third, steps have been taken to extend and expand the work of structural change so as to raise the productivity of the Mexican economy and thereby enable it to join in the globalization process successfully. Over the short term, the series of actions taken in the fiscal, monetary and exchange arenas made it possible not only to cope with the abrupt suspension of capital inflows from the exterior but also to avoid hyperinflation resulting from depreciation of the currency. Steps were also taken to ensure ongoing normal operation of the financial system. This program required establishment of an Exchange Stabilization Fund, which materialized thanks to support from the major international financial institutions and the financial authorities of the US and Canada. The Mexican economy went through its severest contraction since the era of the Great Depression, with GDP falling by 6,9 percent in real terms in 1995. On the other hand, the trade balance showed a surplus of US$7 billion, which made it possible to rectify the balance of payments current account. Contrary to what occurred during earlier crises, correction of the country's external accounts was possible on this occasion mainly because 1 Unofficial translation from the original Spanish text. ANNEX I CONTRACIUAL SAVINGS DEVELOPMENT PROGRAM Page 2 of 5 of an expansion in exports, itself a result of advances in the modernization of the country's productive apparatus in the years just prior to the crisis. It is important to point out that the economic contraction occurred during the first part of the year, and that by the fourth quarter of 1995 a change in trend was observable. For instance, GDP was higher in the fourth quarter than in the third. Preliminary information indicates that this trend continued during the first quarter of 1996. Changes in the National Consumer Price Index bear witness to a significant abatement of inflation. Whereas the annualized inflation rate reached 52 percent by the end of 1995, in April this year it was at 37 percent, a trend expected to continue over the coming months. As for the key financial sector indicators, the drop in inflation has resulted not only in lower interest rates but also reduced exchange market volatility. I For its part, the fiscal adjustment program helped increase savings in this sector consistent with the objective of imnproving domestic saving performance. Results for the 1996 first quarter indicate that the goal of a balanced budget will be achieved at the end of the year. (Please note that the targets agreed under the program negotiated with the International Monetary Fund have been satisfactorily reached.) Mexico's social policy strategy has focused on decentralizing federal public expenditure. The transfer of resources to state and local government hands has improved not only the efficiency with which they are administered but also the mechanisms of response to social requirements. For one thing, this program has contributed to the promotion of rural and urban infrastructure, to the advantage of low-income groups. At the federal level, increased resources are being allocated to sustaining subsidies on certain goods and services, while the subsidies themselves are being channeled more effectively to the neediest groups. At the same time, increasing support has been made available for human resources training - through programs designed to broaden education and improve the quality of instruction, raise nutritional levels, and strengthen health services. In the case of structural adjustment strategy, the main focus has been on raising the productivity and efficiency of the economy, the former being regarded as the best means of increasing employment and strengthening wage-earners' purchasing power. In this context, the authorities have concentrated on promoting competition, expanding the deregulation process, and eliminating distortions and privileges, particularly where they derive from a monopolistic market structure. These obstacles occasion higher costs, which work to the detriment of the final consumer and undermine the competitiveness of Mexican exports. At the same time, steps have been taken to strengthen governmental regulatory capacity to protect consumer interests, in particular in such sectors as ports, airports, telecommunications, rail transportation, and distribution of natural gas. In the interests of greater social security, increased domestic saving, and more effective employment support, the present Government has focused particular attention on reforming the pension system, a move which demonstrates its determination to extend and expand structural change and ensure its sustainability. The financial and production crisis precipitated in late 1994 revealed the vulnerability of the Mexican economy in terms of the lack of widespread, ongoing domestic saving. Although domestic saving had reached 22 percent of the national product in 1988, it declined subsequently, failing below 16 percent in 1994. This led to growing dependency on short-term capital flows to finance the expansion of internal aggregate demand. In these circumstances, productive investment, particularly for the long term, lacked the dynamism required for sound expansion of the productive apparatus, which in its turn meant that when the crisis erupted there were serious consequences for welfare levels throughout the population, and on employment wages. CONTRACTUAL SAVINGS DEVELOPMENT PROGRAM ANNEX I Page 3 of 5 In order to rectify the causes of the crisis, expand employment, and provide foundations for sustainable groNvth, the Federal Government instituted a comprehensive strategy consisting of both contingency measures and structural reforms - a strategy incorporated in the 1995-2000 National Development Plan. This Plan recognizes that a sustained annual rate of economic growth in excess of five percent will require total annual investment equivalent to 24 percent of GDP. Financing this level of investment so that external saving become a healthy supplement to, and not a substitute for, domestic saving means that the latter must increase progressively to at least 22 percent of GDP by the end of the century. The investment process can go ahead only if the resources to finance it are available. In this regard, the Government is aware that the goal of increasing investment has to be accompanied by development of adequate, stable sources of savings. Bearing this in mind, and also the need of the population for well-paid jobs and rising welfare levels, the Federal Governfnent has adopted the basic principle that domestic saving must become the fundamental source of financing for national development, with external saving playing only a supplementary role. In providing for this principle to be put into effect, the Government has determined that domestic saving can best be increased through: - greater public sector saving, achievable if govermment finances are kept on a sound footing by ensuring that both current and capital spending conform to criteria of social efficiency; - fiscal and taxation reforms that promote saving as opposed to consumption; - creation of financial instruments that afford savers both security and competitive retums; - strengthening of social security system funding mechanisms, and in particular, in the case of the pension system, replacement of the pay-as-go scheme with individual capitalization. Given the rapid transformation of Mexico's demographic profile, which signals a growing presence in the population of those aged 65 years and over, reinforcement of the funding mechanisms supporting the social security system takes on special importance as an effective means of stimulating domestic saving. Although young people -36.2 percent at aged 14 years or under, according to the 1990 census - constitute a major segment in the country's population pyramid, the ratio of retirees to the working population has grown steadily and will continue to do so in the coming years. While there were four retirees for every 100 members of the work force in 1960, by 1994 the ratio was 12.5 per 100. IMSS, the Mexican Social Security Institute, projects future annual growth rates of 2.5 percent in number of contributors and 5.8 percent in number of retirees. While the group of those over age 65 made up 5.7 percent of the total population in 1990, it is expected to grow at annual rates around 3.6 percent up until the year 2050. This aging of the population is one of the most salient aspects of anticipated demographic change, and poses a major threat to the solvency of the present pension system. The legislative and regulatory framework for IMSS operations did not allow an adequate response to the challenges posed by such demographic change. As became apparent from its actuarial balances, there was an actuarial deficit which, if allowed to go unchecked, would within just a few years prevent the Institute from covering its pension system obligations. Among other factors contributing to the deteriorating financial position of the pension system was the fact that system participants tend to regard their contributions as taxes rather than as authentic financial assets with a savings purpose. This occurs because their IVCM* contributions go into a general fund and benefits paid are not. commensurate with total contributions. As a result, there is a high incidence of evasion, which weakens the system. Another problem is that individuals who reach retirement age without ever having qualified in the system, or who build up some senioritv but not sufficient to qualify, lose all rights in respect of their contributions. Because the system is collective, under the present rules the longer workers are qualified in the system and the more they have paid into it the smaller their pensions are compared to their total contributions. The almost IVCM = invalidez, vejez, cesantia en edad avanzada, y muerte (i.e. disability, old age, severance and death). ANNEX I CONTRACIUAL SAVINGS DEVELOPMENT PROGRAM Page 4 of S complete lack of a proportional relationship between contributions paid in and individual benefits obtainable both encourages evasion and penalizes major groups of workers, thereby undermining the concept of household saving. In order to resolve this series of problems, draft legislation modifying the orientation and operation of the social security system was submitted to Congress in November 1995, being enacted and put into effect the following month. These events reflect the Government's determination both to raise standards of living and promote pnvate savings. The new pension system gives a central role to the worker, who will participate in decisions affecting both system asset management and system supervision. Creation of entities with specialized expertise in asset management should improve worker benefits, while an increased contribution from the Governmuent will ensure that the new model is financially viable. The regulatory and supervisory authorities concerned are also to be vested with new powers which will improve their capacity to oversee the system. In all, the new framework within which the pension system is now to operate will give workers the benefit of greater transparency and predictability. Pension system reform will make a very important contribution to the development and modernization of Mexico's financial system, while simultaneously the success of the reform will depend on the solidity of that same financial system. The reform is thus closely linked with the financial strategy the Government has been following. The capital development scheme under which worker contributions are to be invested will give greater depth to the financial intermediation sector, while the resulting focus on long-term saving will create a market for instruments with longer maturity dates. In order to ensure that the greatest volume of resources is channeled efficiently toward the most productive sectors of the economy, the participation of the country's other financial intermediaries and its regulatory and supervisory authorities will be vitally important. Accordingly, it is essential that steps be taken to strengthen existing institutions and orchestrate a regulatory framework that provides adequate incentives to reconcile maximization of yields on savings with assurances of security for savers. Since it is clear that one of the essential pension system financing sources will be contributions to INFONAVIT (Instituto del Fondo Nacional para la Vivienda de los Trabajadores), a central component of the Government's strategy is to upgrade that agency's operating efficiency. As part of the process, steps will be taken to promote greater transparency and predictability in this sector, and at the same time to increase the returns workers obtain on their contributions in respect of housing. The material now following provides further detail on the Contractual Saving Development Program, or CSDP: CSDP objectives The key objectives of the Program are to: - establish a financially viable pension system; - promote transparency and predictability in the pension system; - ensure that the new system operates with greater efficiency; - ensure the equity of the system; - enhance the socially cooperative nature of the system by increasing the Government's contribution; - ensure that workers' vested rights are guaranteed in the process of transition to the new system; - promote long-term domestic saving; and - support financial market development. CONnRACruAL SAVINGS DEVELOPMENr PROGRAM ANNEX I Page 5 of 5 CSDP orinciples The basic principles underlying the reform are: management of individual accounts by specialized institutions; recognition of the fiscal cost of the transition; definition of a regulatory framework and supervision procedures to protect the rights of system participants; and introduction of a regulatory and institutional framework for employee savings and pension plans. CSDP-related activities The Federal Government is also committed to carrying out the actions enumerated in Annex II. These policy measures will help extend and expand the transformation of pension contribution systems. Finally, actions connected with the capital market development required to guarantee the success of the Contractual Savings Development Plan are also set out in Annex II. Lic. Guillermo Ortiz Minister of Finance and Public Credit MATRIx OFPOLICYACTIONS (Actions in italics are included in Letter of Sector Policy only, to be monitored as part of the overall program implementation) '.',.-.,.'.,;'.~~i'" ''" '' 9 ''- '.'''':'"''''. " '''"' ' ' :a:-:~ ~ ~ ~ ~ ~~~~~~~~7 777;--~ .....- - .. ' ' -...: ''' '''',-: .-; C:V.: R. ' -.-: :,- : 7:-' 77':--- : : ' ':; , . b Maintenance of a supportive * Maintenance of a sound macroeconomic framework Afantenance of a sound macroeconomicframework macroeconomic program. consistent with the policy objectives and program described consistent with the policy objectives and program in the Letter of Sector Policy. described in the Letter of Sector Policy. 3: ''A F . .-- ...... ,.- ,. -...... :,: :.M Reform of the Old Age Insurance On December 11, 1995, a new Social Security Law was enacted System Reform the public PAYG pillar to move from a Govermment pay-as-you-go, defined benefits and shift toward private management of scheme to a mandatory, defined contributions scheme pension funds. permitting private management. The new system will be implemented beginning on January 1, 1997. The key legislative changes are, inter alia: * dividing the amounts currently collected for IVCM' into two parts: (i) disability and life coverage (2.5% of base salary) and (ii) retirement, severance, and old age (RCV) amounting to 4.5%, which together with the contributions to the SARW account of 2% of base salary and the "Social Quota", will be transferred to individual accounts for each worker (invested in shares of a SIEFORE). In addition, a mandatory contribution of 5% of base salary will go into a housing sub-account (INFONAVIT) and a tripartite quota of 1 5% (employers, employees and the State) will be allocated to a fund for health expenses of pensioners; * inclusion of transitory provisions including protection of rights of existing affiliates; * explicit separation of accounts for health versus pension services; * funding partially the minimum pension guarantee by a new Govermnent contribution (Social Quota); * redefining the minimum pension (change indexation to _ IVCM means coverage for disability, old age, severance and life insurance currently provided by IMSS. - 2 SAR means the Retirement Savings System. MA TRIX OFPOLICYACTIONS (Actions in italics are included in Letter of Sector Policy only, to be monitored as part of the overall program implementation) ~~~~~.. dH. .,,.,.............. -...... ............ ............ ''''"'''"-"'"''"''''"''''"l-"'..........''"5"'''. ,..., . ! l... ........N.... OA TO S XECEDDE N . .... ......... .......0.....l ......TIO THESEONDPHSOFTEPOW M CPI and eligibility from 500 to 1,250 work weeks); * imposition of new ceiling for retirement sub-account N contributions; and * introducing private competition for provision of annuities under life and disability coverage and for old age under new system. . . B B . .. . - . 3 ............................................ .... : X.: g .: X. . . . . . . _ . . . D~RGLATORY RGIMt ORT ADMJNSTAIONAND INVERSTMNTO ?ZSJN.FP 1. Regulation of Pension Fund * On April 26, 1996, the Ley de los Sistemas de Ahorro para e Satisfactory implementation of regulations (circulars) Administrators (AFOREs) el Retiro was enacted and includes, inter alia, general to make the new pension system operational principles related to: Introduce the legal and regulatory => entry and exit procedures for AFOREs, including framework for AFOREs and SIEFOREs special authorization rules for financial groups to make the new pension system with banks to establish an AFORE; operational. z disclosure requirements; = conflict of interest; and => AFOREs' and SIEFOREs' operating rules. * Draft regulations satisfactory to the Bank presented: (a) by CONSAR relating to: => eligibility requirements to establish AFOREs; => commission and fee structure; - => capitalization; => marketing; and => transfer of funds by account administrators and investment management entities. (b) by SHCP relating to: => authorization of foreign ownership of AFOREs. PR...R TO.E.FECTW.NES. Issuance of above regulations. .__ _ _ _ _ _ __ _ _ _ _ _ _ .._ _ _ _ _ _ _ _ _ _ __ _ _ _ _ _ _ _ _ _ _ ._ _ _ _ _ _ _ _ _ _ __ _ _ _ _ _ _ _ _ _ MATRIx oFPOICi ACTIONS m (Actions in italics are included in Letter of Sector Policy only, to be monitored as part of the overall program implementation) ,, ,-.,--- . ,--- - - . - .- .- .... ..... ~~~~~~~~~~~~~. .- . . . ... . -.... -- . . . .-CYN -HS OF TIl. .....A 2. Investment Management Rules * On April 26, 1996 the Ley de los Sistemas de Ahorro para * Satisfactory implemtientation of r egulations on the t el Retiro was enacted. including inter alia general investment managetmient regime | Establish a sound regulatory system for principles related to the investment management regime. the investment of pension funds. * .Aidvance in the implementation oJ'actions to improve * Satisfactory draft regulations prepared by CONSAR financial sector infrastructure, including: governing the investment management regime, including. => asset allocation rules; > Jurther developing the credit rating industry => permissible investment strategies for families of and other financial information services; and funds, including inter alia: => upgrading the regulatory and supervisory Se I. prohibiting investments in banks intervened by policy framework ofAfexico 's securities FOBAPROA; and markets. 2. establishing specific restrictions limiting investments in debt instruments of commercial banks to 10% of total SIEFORE portfolio. * Finalized rules satisfactory to the Bank establishing disclosure requirements, including: (i) formal provision, at least once a year, of individual account statements to contributors on the performance of their share in the SIEFOREs and INFONA VTsubaccounts indicating the balance offunds and rate of return: (ii) automatic provision to contributors upon their request of the information outlined on item (i); (iii) publication by CONS.4R, at least twice a year, of a bulletin stating the performance of individual SIEFOREs including asset allocation, balance sheet, and income statement and INFONA VIT rate of return compared to the SIEFOREs. AC W.S1' TO, T. "'N * Issuance of regulations governing the investment management regime. -, MA4TRIX OFPOLICYACTIONS (Actions in italics are included in Letter of Sector Policy only, to be monitored as part of the overall program implementation) ... ..... :~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~. . .... SuPERVISION OF THE BEEOI~~MEI) SYSTEM . .....................-...IA. Strengthen CONSAR to ensure effective * On April 26, 1996 the Ley de los Sistemas de Ahorro para * Sati.actory implementation of the time-bound capacity and of the regulations relating to > establishment of improved supervision scheme for surveillance and inspection CONSAR; => strengthening of its enforcement powers; and > strengthening of CONSAR's governance through a reexamination of the Board's composition. * Finalized draft regulations by CONSAR relating to surveillance and inspection procedures. * Agreed upon and initiated implementation of a time-bound business program to strengthen CONSAR's supervisory capacity, including: r developing methodology and supervision systems (operating systems and software) for valuation of eligible financial instruments; N ' drafting of manuals describing responsibilities for inspectors;- => developing and testing of a customized software to detect trading irregularities; => developing and initiating training programs in the areas of on-site inspections and off-site surveillance systems; > implementing new operational scheme in conjunction with IMSS;- > designing and implementing focused training programs to upgrade capacity; and > preparing a statistical bulletin. , . |~~~~~~~~~~~~~~~~~~~~~~~~~ MATRIX OFPoLIcyACTIONS n (Actions in italics are included in Letter of Sector Policy only, to be monitored as part of the overall program implementation) OJW~~CT1VE ACTIONS TAKRNfl~~I.R........... . .. .........1RIN .^^S:... BOARI) '1z,N, AT= . SECOND XJLE ' ROA. _______ ___________It ..~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~..... * ,,, CA ,c,, TRANS ITION' 't. . ....:.--'.::':.'-''..''''.:''': Evaluate and ensure the transparency of * Completed sensitivity analysis and satisfactory evaluation * Include in the 1997 Budget allfiscal costs associated the fiscal cost of reforms. of actuarial methodologies and data base; and with the reform of the social security system; Agreed to publish annually the actuarial income and * Publish updated projectionsfor later years; and expenses for IVCM programs to make fiscal transition costs explicit. Transfer of retirement sub-accounts from * Having adopted transfer arrangements for accumulated * Actual migration of accounts out of Central Bank of Central Bank to private investment SAR balances (5/1992-96) from Central Bank to AFOREs workers' having instructed the Central Bank to do so. managers. over a period of four years. - .J A ::: . .. .......: - - . Minimize the fiscal cost and ensure Initiated measures to improve the financial performance of * Improvement in the financial performance of workers an adequate pension, by INFONAVIT, including: INFOV4 T'IT assuring that funds invested in * initiation of a regular supervisory process by CNBV under INFONAVIT achieve market rates of procedures applicable to similar financial institutions; and return, and the interest revenues are * publication by CONSAR, at least twice a year, on the credited to workers' pension accounts. performance of individual SIEFOREs and INFONAVIT. ,. STRENGTIENWNG 0 T IMSS: $ 'TS',AM ..Y T ,N:E . 'RAI:A'' 'FOR T'' W ES' ' ' ':. Strengthen IMSS in its ability to manage * Legal and regulatory framework established for CONSAR, account individualization, the IMSS and INFONAVIT to use one number (that of IMSS) enforcement of billing and collection to to unify past SAR accounts and SIEFORE accounts and to avoid evasioni, and provision of benefits. interchange and reconcile account information for each contributor; * CONSAR developed and issued circulars providing rules - for identification of accounts and account transfers to eliminate multiple accounts for individual contiibutors, to individualize aggregated contributions of multiple .ontnbutors. and to improkc transparenc- of the wi ,m. . MATRIX OFPOLICYACTIONS (Actions in italics are included in Letter of Sector Policy only, to be monitored as part of the overall program implementation) ...... .. ... ....TJ~PR0T .ClO~XET, * Agreement signed between CONSARJSHCP and IMSS on an action to improve the efficiency of the IMSS to ensure overall implementation of the new operational scheme including: (i) updating IMSS database, and (ii) strengthening the individualization of accounts. Conduct public awareness campaign to * Initiated a public awareness campaign. Continue to develop materials and promotional efforts bolster support for the reform and to to reach and explain to the average worker the encourage participation in the new advantages ofproviding for his/her own retirement. pension system. L1~~~~ QMPZ TAR flM~~~~~~~~... ......4. .. ....... .. ..... S McW Rk~~~~~~~~*M ...1.I.. . Recapitalize the Banking System * Continued progress in the implementation of measures to accelerate the restoration of the soundness of the Restore the Health of the Banking banking system. System. Reform of Savings Protection Scheme * Completed study to evaluate the current liability * Agreement on a plan to proceed with the phasing out protection system and propose alternative more rational of the savings protection scheme according to the Reduce moral hazardfrom the current schemes which would lessened the moral hazard effect. study 's recommendations. comprehensive liability protection. MATRIX OFPOLICYACTIONS (Actions in italics are included in Letter of Sector Policy only, to be monitored as part of the overall program implementation) 2 gg BB "' ' ' V' "S 'M ?$ I T ..'": 6 'BB... j. AC,.-,. ~XFTJ., 61 -~ . , L 6 ~ . , . , : ::,-6 . . . .... . . _ _ _ _ _ _ _ _ _ _ _ _ _ _ __.... . Intprove the transparency of mutual * CNBV and CONSAR initiated review of the experience of Develop a program aimed at modernizing existing mutual funds operations and assure consistency the mutualfunds industry over the past ten years, focusing fund legislation and regulation, reflecting the review of of regulation of mutualfunds with in particular on issues of: past experience and consistencv with AFORE/SIEFORE SIEFORES. => valuation of portfolio securities; regulation, including: * a more important role for independent directors on the = related-party transactions; and boards of investment companies, =corporate governance. * requirements for independent director approval of affiliate transactions; * valuation of portfolio securities by unaffiliated parties; * steps to encourage the development of an independent mutualfund management industry; and * more intensive supervision by the CNBV 6 -. - :: ' N ' ' ' ' B L A N -,. 6 . . .:_ 6 _ - _ : _ - _, _ 6 _ - _ ._.. ... . . . .. - . Establish supervisory authority for * On April 26, 1996 the Ley de Sistemas de Ahorro para el voluntary pension funds which Retiro was enacted providing for CONSAR to oversee complement mandatory system voluntary pension funds choosing to register with CONSAR Deepen the insurance market for * Terms of reference agreed with CNSF and consultant * Complete studies provision of annuities andfor life and contracted to undertake study to review existing * Put in place the regulatory framework to modernize disability coverages regulations and policies for provision of life and disability existing regulations and policies for insurance by insurance companies. companies . X , .. ' 6'.,-MRKE .' :'-'. '''..'.-.'.:.:. > Deepen the insurance market for * On April 26, 1996 the Ley General de Institucionesy a Complete study and issue complementary regulations provision of annuities. Sociedades Mutualistas de Seguros was enacted laying the to meet the requirements of the amended law. framework for the development and supervision of the annuities market. * Terms of reference agreed with CNSF to carry out a study of changes needed to the regulatory framework. I TEcHNICAL ASSiSTANcE NEEDS, TIAIET.IBLE, ,4ND SOURCES OF FINANCING t g Mt . ... ... . t .. . w , , ---- g~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~. . . . . . . Implementation of of presentations relating to pension reform and -Oct 96 WB- campaign relating to social security 2. Design of media and dissemination campaign, including workshops reform and information sessions for affiliates Oct 96-Dec 97 Japan PHRD fund Improvement of IMSS service delivery Strengthening of IMSS to improve its efficiency in delivering the Jan 96-Dec 98 IMSS own resources services which remain under its responsibility, partictularly: supervision i of account transfers to AFORES; delivery of pensions to transitioni generation opting for PAYG; delivery of disability and life insurance,M and delivery of health services Addressing fiscal costs and fiscal I. Validation of actuarial methodologies and of data base Jan-Feb 96- WB Loan preparation funds transparency of reforms o 2. Estimation of fiscal costs and proposal to ensure fiscal transparency Jan-Apr 96 WB Loan preparation funds I Development of legal and regulatory 1. General support for the drafting of: Jan-Mar 96 WB Loan preparation funds framework for Investment Management a. the draft Ley de Coordinacion de Fondos de Ahorro para el Retiro of Pension Contributions (particularly in the areas of disclosure requirements and AFOREs operating systems), WB-FTAL b. related regulations and circulares Apr-Dec 96 2. Regulations governing AFORE's commissions level and structure Jan-Mar 96 WB-FTAL 3. Regulations governing AFOREs' comercializaci6n (e.g., regulations Jan-Mar 96 WB-FTAL on sales agents, etc.) Strengthening of CONSAR to ensure 1. Development of methodology and supervision systems (operating Apr-Dec 96 WB-FTAL adequate account supervision systems and software) for valuation of eligible financial instruments 2. Drafting of manuals describing responsibilities for inspectors June- Oct 96 WB-FTAL 3. Design, develop, and implement customized software to detect Apr-Dec 96 WB-FTAL trading irregularities and audit trails relating to transactions undertaken by investment management companies on behalf of affiliates (to be coordinated with CNBV) 4. Training programs in the areas of on-site inspections and off-site Apr-Oct 96 WB-FTAL surveillance systems 5. Development of actuarial standards and models to be used as well as Apr-Oct 96 WB-FTAL supervision techniques for actuarial work related to coverage offered through the AFORES in coordination with IMSS and ISSSTE .._.._..__ 6. Overall CONSAR human resource development through focused Jan 96-Dec 98 WB-FTAL training programs to upgrade capacity in the areas of financial analysis, Japan PHIRD Fund actuarial techniques, and special technical areas _ _ TECHNICAL ASSISTANCE NEEDS, TIMETABLE, AND SOURCES OF FINANCINGC 7. Setting up regional CONSAR offices Apr-Dec 96 WB-FTAL & CONSAR own resources 8. Develop capabilities and training programs to perform credit ratings June 96-June 97 WB-FTAL of issuers of securities bought by AFOREs and to rate banks o Improve institutional capacity to 1. Evaluate experiences from different OECD and LA countries with Jan - June 97 Japan PHRD Fund increase regulation and supervision of the reform of their pension systems. private fund management 2. Draft recommendations on how to better implement the reform and create a financially viable pension system. Modernize the legal and regulatory 1. Drafting of new investment regulations for VPFs Apr-Oct 96 WB-FTAL framework for Voluntary Pension Funds 2. Design of new auditing guidelines for internal/external actuarial and financial audits 3. Drafting of regulations for disclosure requirements Prepare a quarterly statistical and 1. Design and produce the first version of the quarterly bulletin Oct 96-Apr 97 Japan PHRD Fund information bulletin summarizing the new regulatory regime, initial list of AFORES, capitalization levels, composition of pension funds and other financial information. ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~Xx,.. ...,... ,. .. ...-......, '.- Development of legal framework for 1. Finalize a study of changes needed in the legal framework for Apr-June 96 WB-FTAL annuities market annuities and Apr-Oct 96 2. prepare draft regulations Development of legal framework for CNSF needs to provide details By Oct 96 WB-FTAL pre-paid medical insurance plans __ Modernization of Insurance Regulations CNSF needs to provide details By Oct 96 WB-FTAL and Supervision i .-. TUA J i S .......: : ...... Improve the transparency of mutual 1. Review lessons learned By Oct 96 Own resources (CONSAR- funds operations and Assure consistency 2. Draft legislative changes to the Mutual Funds Law CNBV) of regulation of mutual funds with AFORE's funds Development of domestic market in Prepare an action program based on the results of the FSRL I study By mid-96 WB-FTAL asset-backed securities identifying regulatory obstacles and legal impediments to asset 1 securitization . fECIINIC4LAS511s'ANCE NEEDS, TIMET,4BLE, ANDSSOuI?cEs oF FIN4NNCfAIG Arealdti vi L fd(an iwri rr i ni' .ADITJQNAL ?IN A A77 TROMINTS - . : . : C Strengthening of domestic securities 1. Evaluate and upgrade the regulatory and supervisory policy Jan 96-.. WB-FTAL markets framework of Mexico's securities markets 2. Improve disclosure standards and ensure consistency with E. international best practices, 3. Strengthen self-regulation by market participants Strengthening of the credit rating I. Evaluate anid improve credit scoring and disclosure niles. June 96-... WB-FTAL industry m Deepening of domestic financial I. Prepare studies on the role of financial and insurance markets in the Sep 96-Dec. 97 Japan PHRD Fund markets and development of the success of the reform effort. insurance market 2 Evaluate and upgrade the necessary regulation based on the studies recommendations. =~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~IA ANNEX IV Page I of 8 MEXICO CONTRACTUAL SAVINGS DEVELOPMENT PROGRAM PENSIONREFORMAND ITS IMPACT ON THE DEvELoPMENT OF MEXICAN FINANCLiL MARKETS Introduction A major justification for developing a fully funded pension system in Mexico is that it will contribute significantly to the development of the domestic financial system, which will increase the efficiency of the allocation of savings, both those generated domestically and those resulting from capital inflows. There are two aspects to financial system development. The first is increasing the diversity of financial institutions operating in the market, and the second is deepening the market for financial securities. This annex describes the current state of both elements of Mexican financial markets. The evidence shows that Mexico has relatively developed markets for government securities, but that its institutional structure is, like most other major markets in Latin America, bank dominated. It can be expected that pension reform will ultimately lead to a much more diverse financial structure, which, in turn, will lead to a deepening of financial markets. Evidence presented in this annex suggests that this outcome can be realized if the Mexican government implements legal and regulatory reforms suggested in the loan agreement. However, establishment of sound rules and regulations in themselves will not create deep financial markets. Investor confidence in the legal and regulatory structure can only be built from practical experience of operating in the markets under a variety of economic circumstances. This reform will get this process under way. To discuss the impact of the introduction of pension funds on Mexican financial system development, the annex reviews the relationship between institutional diversity and securities market development in Chile, Germany, Japan, and the United States. The experiences of these countries indicate that an increase in institutional diversity translates into securities market development only in those cases where a significant portion of institutional investors are mutual funds and trust funds. Moreover, for financial markets to flourish, markets need to have sufficient scale to provide liquidity for the securities held by institutional investors. Large pools of investible funds do not automatically translate into large scale markets because achieving market scale also requires a sufficient number of investors with diverse interests to maintain markets in securities under a wide range of economic circumstances. This implies that the Mexican strategy of creating mutual funds to manage pension contributions is a necessary first step in developing broad markets for financial securities because these institutional investors will potentially be active traders of securities. The market also is of sufficient size to generate liquidity. The remnaining challenge is to provide adequate incentives for the development of a diverse investor base for securities. This includes clarification of the legal standing of investors during borrower restructurings. In addition, investors must gain confidence that the accounts provided by issuers are sufficiently transparent to permit a meaningfuil evaluation of their financial prospects. Recognizing the importance of account transparency, the new Mexican Pension System Law allows pension funds to invest only in securities rated by well recognized private rating agencies and under the approval of the regulatory authority for the pension system (CONSAR). This would provide incentives for borrowers wishing to access resources from pension funds to improve their accounting and disclosure standards. The investment rules for pension funds currently prohibit investments in equities because the authorities do not believe that there is insufficient market depth in most listed stocks. However, the presence of a pool of institutional investment funds should provide impetus to improve the quality of the equity market so that prohibitions can be removed as quickly as possible. The annex is organized as follows. Section I provides an overview of the institutional structure of the Mexican market compared to several industrial and other Latin American countries and of the depth of Mexican financial markets. Section II analyzes the relationship between institutional structure and financial market depth in several industrial countries. Section III considers possible investment strategies of Mexican pension fund managers, given the current state of financial market development. It draws on Chilean experience in the 1980s in ANNEX IV CONTRACTUAL SAVINGS DEVELOPMENT PROGRAM Page 2 of 8 reaching conclusions. Section IV discusses how Mexican financial markets are likely to evolve as pension funds become important investors. Section I. Structure of the Mexican Financial System The structure of financial systems can be described from the perspective of institutional development as well as from the perspective of market development. A discussion of institutional development encompasses the number of different types of financial institutions operating in the market, their relative market shares, the types of assets in which they invest, and the market structure within specific subgroups of institutions, such as banks and insurance companies. An analysis of market development includes a description of the markets in which financial instruments trade: the variety of assets traded and the liquidity of these markets as well as the volume of open market securities relative to those intermediated by financial institutions. Table I presents the ratio of liabilities of financial institutions as a percent of GDP for selected industrial and Latin American countries at year end 1994. Depository institutions, defined as banks, savings banks, cooperatives, and postal savings systems, account for most of institutional savings in Argentina and Mexico, compared to Chile, Japan, and the U.S. In addition, the ratio of Mexican financial institution liabilities to GDP is substantially lower than for Chile and the industrial countries but almost twice as high as the ratio for Argentina. C__ ,,Aen -- 4 Mexico 59 12 72 USA 59 64 123 Japan 247 111 359 Germany 231 33 264 Chile 63 32 95 Argentina 28 Source: Comisi6n Nacional Bancaria y de Valores (Mexico), Federal Reserve System, Balance Sheets for the U.S. Economy 1945-94 (US), Bank of Japan, Economic Statistic Monthly (Japan), Superintendencia de Bancos e Instituciones Financieras Chile, Boletin Estadistico Mensual S.A.F.P. (Chile) B.C.R.A., Estados Contables de las Entidades Financieras (Argentina), IMF, International Financial Statistics. Note: Depository Institutions include savings, thriffs and postal savings, and other financial Institutions include trusts, mutual funds, insurance and pension funds. Table 2 presents the structure of financial institutions operating in Mexico. It indicates that the Mexican financial system is domninated by two major groups of institutions: the first is commercial banks, which had 52% of financial assets held by institutions as of September 1995 and development banks, which had 24% of financial assets on that date. The only other major group of institutions is brokerage firms, with 15% of total assets. Institutional investors and fimds managers, including mutual funds and insurance companies, have very small market shares with around 2 percent each. Within the comnmercial bank sector, the two largest banks hold about 40% of banking assets. It is also noteworthy that mutual funds and insurance companies together represented less than 6 percent of financial institution assets in 1994. CoNTRAcTuAL SAVNGS DEVELOPMENT PROGRAM ANNEX IV Page 3 of 8 D*c~ 1993 Det. 194 Sep 199. Banks 556677.9 799880.4 872553.8 % 50% 47% 52% Brokerage Firms 210813.7 399243.736 251656.7 % 19% 24% 15% Development Banks 195424.2 336487.852 409726.516 % 17% 20% 24% Mutual Funds 80481 61234 61611 % 7% 4% 4% Insurance 29650.5 35408 42236.121 % 3% 2% 3% Others 47911.357 61561.128 46072.9631 % 4% 4% 3% Total 1120958.686 1693815.116 1683857.1 % 100% 100% 100% Source: Comision Nacional Bancaria y de Valores. Note: Others include credit unions, factoring companies, warehousing companies, bonding companies, exchange houses, and leasing companies. The relatively large balance sheets of brokers suggests an active market for securities in Mexico. This is confirmed by data in Table 3, which presents an overview of the depth of the market for traded securities on the Bolsa in Mexico. Trading on the Bolsa, which until 1995 had been quite active, is dominated by fixed income securities, and virtually all of these securities are liabilities of the government. The short-term securities are mostly CETES, and the long-term securities are Mexican government development bonds, having maturities of approximately two years. The market for government securities was, until 1995 rather large, with trading volume relative to the size of the banldng system only slightly smaller than this ratio for the U.S. government securities market. . {-, X . . .h ............ ........ Equity total 203756 298646 219410.4 1% 2% 5% Fixed income total 127746617 1266276 2656972 Fixed Government development banks 88% 10% 55% Bonos ajustables del Gobierno Federal 556673 633040 1220651 4% 5% 25% Money market instruments 1481820 11729041 1941269 10% 88% 40% Certificados de la Tesoreria de la Federaci6n 1423428 11559534 1478099 10% 87% 31% Total 14432194 13293963 4817767 100% 100% 100% In contrast, trading on the equity market is relatively thin. Volume is only a fraction of the volume in the government securities market. Also, as indicated in Table 4, only 21 firms have a high degree of liquidity. In addition, the stocks of about 20 Mexican firms are traded through American Depository Receipts in New York, but volume is limited to a few firms. ANNEX IV CONTRAcTuAL SAVINGS DEVELOPMENT PROGRAM Page 4 of 8 -t- :- . . ' - -:. -.'. : '. ' . ! ! .X . '. '.|... . . ''- '' t..'..: Degree of Liquidity Number of Companies High 21 Medium 32 Low 59 Minimum 78 None 101 Intermediate Market 51 Total (Number of Companies Listed) 342 Source: Bcletin Bursatil, December 20, 1995, BMV Note: Degree of liquidity is measured by number of shares traded. As indicated in Table 5, prior to 1995, Mexican private firms issued a substantial amount of medium and long-term paper in the U.S. and Euromarkets. In 1993, these issues equaled 30 percent of the volumne of net new credit provided by the banking system in that year. However, in 1994, new securities issues began to decline, and in 1995, they fell to about 15 percent of their 1993 peak. Bonds 1168 2933 4777 3581 1099 Shares 3580 3472 2307 1422 67 Total (A) 4748 6405 7084 5003 1165 Increases in net credit of financial system (B) 3225 30990 2380 52734 n.a. (A)(B) 2 0.207 0 0.094 0.147 0.298 9 Source: Comisi6n Nacional de Valores, Banco de Mexico. Section II: Institutional diversity and securities market development: Industrial Country Experience An important motivation propelling pension reform in Mexico is that the development of institutional investors will provide an impetus for further development of financial markets. In this context a experience of industrial countries have been very varied. This can be seen by comparing the experience of US and Japan, two countries with much more diversified structures than other industrial countries (like Germany, for example, see table 6). For example, while in the US institutional diversity has been associated with liquid and developed financial markets, in Japan where trust and mutual fund institutional investors as well as large insurance sector are present, money markets are dominated by banks, and there are no asset-backed securities markets or even liquid corporate bond markets. CONTRACTUAL SAVINGS DEVELOPMENT PROGRAM ANNEX IV Page 5 of 8 Table:6. As es. f F.i1cia. nstns: $eeral ndustrial 1nr(1994.- . .;. ......(Percetof Totti Fnaudid.. h. st..itutnas .........i .-:ts _. ~~InsœtitDtfgm$.io:. . Countrie Baing &T s Trustsd - an. ::e-sion .s - .. : _ Mutualud.s .-.e :- -: ml..s Germany 88% --- 12% --- 100 Japan 70% 14% 16% % USA 45% 28% 6% 21% 100 100 s ~~~~~~% Resource: Deutsche Bundesbank, Monthly Report, Bank of Japan, Economic Statistics Monthly, Federal Reserve System, Balance Sheets for the U.S. Economy, 1945-94. Note: Japanese Postal Savings Assets are desegregated into deposits and insurance, and they are accounted for in Banks & Thrifts and Insurance, respectively. Japanese pension funds are included in trust and insurance categones. Limitations of markets for securities in Japan compared to those in the U.S. is reflected in differences in portfolios held by institutional investors across the two markets. As indicated in Table 7. a large portion of the assets managed by institutional investors are loans and mortgages, whereas these instruments make up only a small portion of the assets of U.S. funds managers. Table. 7:. Ins ftitutonal Ptla rs.'Ae .Ja.. & US- 1992 : : -fliuetiia and .oeg p-- - - - - - - - - - - - - - - - - I0 ----------- -25% 0 C') rD 0) Off mA) 0) st - o 0c'))N ItL)0 ~ 0 _ -|-Minimum --- Assumption -Manufacturing * For the minimum wage there are two series of assumptions on their real evolution. We have decided to consider a low inflation environment and a high inflation environment. When inflation is high, minimum wages flll deeply and have a slower recuperation. CoNTRACTuAL SAVINGS DEVELOPME NT PROGRAM ANNEX V Page 7 of 32 . ... ..... ...~ .: -21.05% -21.05% -6.15% -15.86% 99 | g0.. .S t .. : .-3.28% -9.42% -0.86% -3.85% -0.89% -3.25% -0.90% 4.17% 0.0% -3.36% 1.42% -1.71% 1.42% 0.45% *4..::...... Note: These assumptions are for modeling purposes only and can not be taken as official forecasts on the subject Inflation is speciallv important for the old IVCM system, since those pensions were computed taking the average of a worker's nominal wages in the previous 5 years. In a high inflation environment we can expect fiscal costs due to acquired rights recognition to fall. Inflation assumptions are as follows: 52.0% 52.0% 30.0% 45.0% 22.0% 38.0% 1BssB.BB.9R$BBj S in;16.0% 30.0% 12.0% 24.0% 11.0% 20.0% .OO~ 9.0% 19.0% 6.0% 17.0% 6.0% _ _10._0% . S',0.S.Bm"' ':'....... ......... Note: These assumptions are for modeling purposes only and can not be taken as official forecasts on the sumbject. - IMSS data shows contrbution density is in average 0.83 for its affiliates. This means that for each period of time the effective contribution period is only 83% of it. Years of service and contributions are affected in the model by this density factor. * Finally, we have to address the issues of operation costs. The AFORES will be private firms whose only source of income will be commissions charged to their affiliates. Experience from Chile and Peru points out that commissions (excluding disability insurance premiums) can reach 2% of workers wages. Therefore, we have assumed that commissions charged by the AFORES to the workers will be equivalent to 2% of covered wages. This amount will not accumulate in the individual account. A4. GOVERNMENT CONTRIBUTIONS TO THE PENSION SCHEME The rates of contribution the government is required by law to make to the new pensions scheme are as follows: ANNEX V CONTRACTUAL SAVINGS DEVELOPMENT PROGRAM Page 8 of 32 Socia quotas per woMrker:r 5. EOfe I .basic salary of December, 1996, iudexed by INPC.| Proportonal uota: 0.425% of the worker's salary. Proportional quota: 0. 125% of the worker's saliv. * The cost of the prorated contributions the government is required to pay for (a) retirement, age and severance and (b) disability and life insurance is negligible. * The social quota is the largest cost item among government contributions to the new pensions system. Its cost will be close to 0.3% of GDP in 1997 and will remain steady at that level over the first nine years of the reformed system. After that it will decline under the impact of GDP growth, which will predominate over that of growth in number of workers. The following graph depicts how total cost practically coincides with social quota cost owing to the insignificant level of prorated contributions cost. Fiscal Costsas%cfGC Q. Q30 Q5, 1 w S ~ ~ ~ ~~ -- --- -- -- ------------ --------- Qi 0 QOr 7 1 8 SU c'ial Qat;a U Thxxriaoal CctribLii El Tcial CONTRACTUAL SAVINGS DEVELOPMENT PROGRAM ANNEXV Page 9 of 32 A5. TRANSITION The transition group comprises three categories of workers: 1. All workers that at the effective date of the reform (January 1, 1997) were active and therefore acquired rights during the effectiveness of the previous law. 2. Persons that contributed to the IMSS at some time but were not active at the effective date of the reform and may later begin to contribute again. 3. Persons that were receiving an IMSS pension prior to January 1, 1997. When the time comes to take their pension, the persons in categories I and 2 may choose between the pension due to them under the new individual accounts system and applicable to them under the old law. Those for whom the previous system would have been preferable will receive that pension together with the balance on their individual accounts and when this is exhausted the government will provide the necessary sums. In the model, workers compare the net present values of each flow of payments (IVCM v. programmed withdrawals) choosing the highest. Modeling people with acquired rights who currently are not contributing but can return to the systen is an issue lacking of a proper actuarial model in Mexico. The IMSS has no model or estimated probabilities in this area. A6. CURRENT PENSIONS Pensions in course of payment will be deemed to mean those being paid by the IMSS up to December 31, 1996. Beginning when the IMSS's reserves are exhausted, which will happen during the second year, the govermnent will assume responsibility for financing them. The margin of reliability of these estimates is all the greater in that: T his is a closed group, i.e. its population does not grow over time; The number of pensioners and the amount of their pensions at the end of 1995 is known and it is necessary to estimate only the number of persons that will take pension during 1996. By 1995 its cost was close to 0.4% of the GDP; These persons are not affected by the interest rate since they lack individual accounts and their pension is funded entirely out of fiscal resources. The estimates are, however, affected by the real growth in the minimum wage since by law their pensions have to be indexed to that variable. Since this is a closed group with an average age higher than that of categories 1 and 2, their population will disappear after a couple of decades. A7. ROLE OF THE HOUSING SUBACCOUNT (INFONAVIT) Contributions to the Housing Subaccount, 5% of the worker's salary with a ceiling of 10 times the minimum wage, are managed by INFONAVIT. INFONAVIT operates a points systm to determine which contributors are entitled to apply for a housing loan. For loan beneficiaries, the savings on this Subaccount serve as down payment to acquire a dwelling and they will be required to repay the rest of the loan through deduction from their salaries and future employer contributions. This means that there may well be workers who at the time they go on pension have a zero balance on this Subaccount. Moreover, workers who do not receive a loan are entidtled to withdraw the balance of the housing Subaccount at the time they take their pension. Prior to 1992 INFONAVIT paid very negative real rates to these funds; since the 1992 reforms, however, it has been able to offer real rates close to zero. As and when the 1992 reforms bear fruit, the Housing Subaccount resources can be expected to earn positive real interest rates. The decision to finance rights acquired under the old pensions scheme through the housing Subaccowmt is not available since a worker currently receives his or her IVCM (or working risks) pension plus the contributions ANNEX V CONTRACiuAL SAViNGS DEvELPMENT PRoGRAm Page 10 of 32 to INFONAVIT. Nevertheless, the new CONSAR Law contains an article that establishes that contributions to INFONAVIT prior to 1997 must be refunded to the worker, but INFONAVIT contributions from 1997 onwards will be considered part of the individual account and must be surrender to the State if benefits under the old pension system are choosen. In view of all these facts transition costs for the transition population must be computed considering different scenarios (under low and high inflation environments): Scenario 1.- INFONAVIT funds can be used to finance acquired rights. From 1997 to 2004 these funds receive a 0% real return and a 3.5% real return from 2005 to the firture. All other funds receive the interest rate of 3.5% real. Scenario 2.- INFONAVIT funds can be used to finance acquired rights. Nevertheless, these funds receive a 0% real return throughout the projection period. All other funds receive the interest rate of 3.5% real. Scenario 3.- INFONAVIT funds can not be used to finance acquired rights (Congress rejects the article mentioned above). All other funds receive the interest rate of 3.5% real. Since new generations do not have acquired rights on INFONAVIT funds, this scenario does not apply to them. For presentation purposes for them we will include the results from scenario 1 (the MPG) on tables belonging to scenario 3 for transition population. Scenario 4.- INFONAVIT funds can be used to finance acquired rights. Nevertheless, these funds receive a 0% real return between 1997-2004 and 2% after 2004. All other funds receive the interest rate of 2% real. A8. FISCAL COST OF ACQUIRED RIGHTS RECOGNITION Before looking at the estimation results it is convenient to point out that this exercise is not assuming a fixed contribution period for transition workers. The length of the contribution period for a worker depends on the probabilities of pensioning (having an accident or retiring). In consequence, some workers will leave the system earlier if they suffer an accident. When reaching the age of 60, probabilities of retirement become positive, nevertheless there will be workers still active even if they are 65 or more. Today, IMSS pensioners show an average contribution period of 22 years, so, applying current probabilities our transition population will have the same average period of contributions (some under the Old and some under the New Law, depending individual's age). .& RESULTS OF FISCAL COSTESTIATIONS Results are the following for each scenario: * Ongoing pensions (PCP) are very sensitive to the inflation enviromnent assumed and more specifically to minimum wage real increases since these pensions are indexed to it according the old Law. Under low inflation assumptions (Projections Series B), ongoing pensions cost represents 0.39% of 1997 GDP. Afterwards they decline and by 2030 ongoing pensions have a cost of 0.015% of the GDP. * Assumning high inflation (Projections Series A), hence negative real growth i minimum wages, ongoing pensions cost decrease to 0.35% of 1997 GDP. This cost fades out during the projection horizon and by 2030 it represents 0.014% of the GDP. Scenario 1.- acquired rights recognition (DER.ADQ.) are very sensitive to inflation due to two factors. The first, pension amount is computed with the average wage, nominal terms, for the last 5 years of contributions. Second, it is indexed to the minimum wage. Hence, acqtured rights recognition cost in a low inflation environment reaches a peak above 0.2% of the GDP in 2026, while this peak is only of 0.1% in 2022 if inflation is high. For the first 3 years of the new system recognition cost sums 0.05% of the GDP. CONTRACTUAL SAVINGS DEVELOPMENT PROGRAM ANNEX V Page 11 of 32 TRANSITION COST. SCENARIO 1 0.40% 0.35% --- 0 .3 0% -- - -- - - -- - - - - - - - - - 0.30% i--+- DER.ADQ.1B 0.25% ---------------------------________ --PCP lB 0.20% __------------ FDR. ADO. IA 0.15% ----- ----- ------------i-;9-DE.ADQ-1 .. PCPIA 0.05% ' ;--------_ 0.00% - N N N CN N4 a N CN N N Scenario 2.- In this case, INFONAVIT fimds earn a real interest rate of 0% all over the projection horizon, inducing higher a fiscal cost than in the previous scenario. For the high inflation enviromnent, recognition costs have their peak in 2020, reaching 0.34% of the GDP. With low inflation the maximum cost comes by the year 2025, when it is equal to 0.52% of the GDP. For the first 3 years of the new system recognition cost sums 0.05% of the GDP. TRANSITION FISCAL COST. SCENARIO 2 0.600% 0 .5 00% ---------- ---- -- - - - -- - - -.-DER.ADQ. 2B a.-- PCP 28 DER.ADQ.2A .--PCP 2A 0.200% --~-----s'_____ .. ----------2A 0.100% --------------- 0.000% YEA R Scenario 3.- In contrast with the previous scenario, here INFONAVIT resources are not available for finding acquired rights. In consequence, fiscal cost is the highest. For the first 3 years of the new system recognition cost sums around 0.2% of the GDP. With low inflation, fiscal cost reaches its peak by 2026 in 0.80% of the GDP, while a high inflation environment contributes to keep this cost below 0.39% of the GDP in the year 2020 when it is in its maximum. ANNEX V CONRACrUAL SAVINGS DEVELOPMENT PROGRAM Page 12 of 32 TRANSITION COSTS. SCENARIO 3 1.000% ------ 0.800% o 0.600% O-'0 C~ (0 O~ ('.4 L ( V I- 0 S~O 00 40 0% . ;-. i- i. RN - - '--- 0) 0 0 0 0 0 0 0 0 00 a - N N N N' N N N N N N N YEAR --DEP.A DQ. 3B PCR1P3B B D2 ADQ.3A ....* PCP3A Scenario 4.- Here we are assuming that real interest rate is 2% for all funds, except for INFONAVIT in the period 1997-2004 when it is 0% real. For the first 3 years of the new system recognition cost sums almost 0.1% of the GDP. When inflation is high, the peak is reached in 2023 and equals 0.19% of the GDP. With low inflation the cost is higher and its maximum equals % 0.4$ in the year 2027. TRANSITION COST. SCENARIO 4 0.450% - 0.400% a - - - - 0.350% --- - X 0.300% - - --- a 0.250% ---- ;.- --- C 0.200% .-.- -. 0. 150%- 0.100% ------ 0.050% --- --- 0.000% I i i a- O (0 a) (D tl 0 - N 0 a) 0 0 0 0 ' -4'C(N (NN (l) - N N N N N N N C N N N YEAR | +DER. ADQ. 4B- PCPP4B ... DER. ADQ. 4A XPCP 4A C GUARANTEED PENSION The new Social Security Law provides that no pension shall be lower than the guaranteed pension, which has been set at one 1997 minimum wage and thereafter shall be indexed to the NCPI. This section sets forth the fiscal cost of offering this guarantee only to the generations that join the IMSS with effect from January 1, 1997. Fiscal cost for transition workers who take the MPG are included in the Acquired Rights section although we have not separate this particular kind of pension from the IVCM ones. For workers who contribute for the first time from 1997 onward the dropout probabilities were applied and the pensions these workers could achieve with their savings were calculated in order to compare them with the guaranteed pension. For those that do not reach this amount, the government will make up the shortfall. CONTRACTUAL SAVINGs DEVELOPMENT PROGRAM ANNEX V Page 13 of 32 Estimates have been done for scenarios 1, 2, and 4 under high and low inflaion. Scenario 3 does not apply to new generations since they have not acquired rights over the housing sub-account. MPG fiscal cost is negligible for the first 20 years, since during this period no person is eligible for this pension in case of retirement and for other insurances there is an insured sum paid by the IMSS to enable the worker to obtain 35% of his average salary as pension (70% for working risks). Only when this 35% (or 70%) is lower than the MPG the State must make up the shortfall. In consequence, only people with very low wages will need this additional help from the government. MPG fiscal cost became important by the year 2024, when it reaches around 0.10% of the GDP. In the year 2030 fiscal cost for the MPG is 0.29% of GDP for scenario lB and 2B (B meaning low inflation) to 0.34% for scenario 4A (A meaning high inflation). D. SUMA4RY OF FISCAL COSTS ARISING OUT OF REFORM OF THE SOCL4L SECURITYL4 W The fiscal costs of reform of the Social Security Law, for selected years and our 8 scenarios, are summazed in the following graphs. Yearly results and fiscal cost by type of pension can be found at the end of this annex V. TOTAL FISCAL COST. LOW INFLATION SCENARIO 1.40% ------------------------- --------.-- -.. 1.00% -&AA4AAAAAAA 0.80% - - no CZ 0.60%I 0.60% . - - -------- - - --- _ . 0.40% - 0.20% - - - - - - - - - - - - - - - - - - - 0.00% I I I I I I i I I I I 1 1 - i I I I I I I I I I I I i I I I I S O X D C1 b1~ U) a t YEAR -|+ 1B _-*-2B v. 3B 4B ANNEX V CONTRACTUAL SAVINGS DEVELOPMT PROGRAM Page 14 of 32 TOTAL FISCAL COST 1.00% 0.80% L vJA ii ;k--L A AA AA A A- 0. 0.60% -~ 0.40% -- - - - - - - 0.20% _- - - - - - n 0Ono/ I, ,, . , ,1 I I I I I I I I e . v.vv % {w r 1 1 lr r T I r1 r r 7 1 1 7 7! i r ! 1 r- o Cf co am Cj U) X * r-. O 0) 0 0 0 0 T- O- . N N (N C#) ) o 0 0 0 0 0 0 0 0 0D 0 '- N (N (N N N N N N N1 N YEAR +-1A - 2A -A --3A .. 4A A joint group, comprising staff of the World Bank and SHCP, held meetings in Mexico during the second week of April 1996 to analyze the data provided by the SHCP for fiscal costs of the IMSS pension reforn, and to deepen the usefuilness of the actuarial model. The group found that the model captured fiscal costs adequately. On the methodology two fiuther points were noted: (i) The income distibution used in the model might underestimate the proportion of population at the low-end of the distribution, and in tunm, might underestmate fiscal costs. However, further analysis of this point provided by the SHCP, indicates that such underestimation would be no more than 10% of the fiscal cost. (ii) Fiscal costs might be sensitive to the evolution of minimum wages relative to the average wage. Under the projected scenarios minimum wage decrease as a function of the average wage. Should they grow parallel under the projected scenarios fiscal cost would be higher. However, preliminary calculations of this relation provided by the SHCP show that this cost would be at the most 5% of the total fiscal costs. Also, SHCP demonstrated that historically speaktng the Mexican case illustrates that there is a poor correlation between the movement of the minimum wage and the average wage, and that minimum wages have shown a secular decline during the last 25 years. CoNRAiuLSAvNGs DEvELopS5ENrPROGRAM ANNEX V Page 1S of 32 ANNEX V TABLES TOTAL FISCAL COSTS UNDER DIFFERENT SCENARIOS SCENARIO 1B ,.,,2.;;,.. 3 0032 .i% 0.32796 0.000001M 0.771s . . . .a9@l 0.063W 0.3650A 0.327% 0.00000O 0.755a 0.0839q 0.3180A 0.322% 0.000009. 0.7239 gX;%68 0.083z 0.318Cs ~0.318% 0.000009O 0.7069 ~~~~~0.1029q 0.2730,q 0.3149q 0.00o1 9A 0.7688 0.1110s 0.2529 0.309N 0.000029' 0.6729 SX;s88 ~0.119gq 0.232% 0.305% 0.0000394 0.656s . .... ~~0.128N 0.214% 0.300% 0.0000394 0.642-A w 2''g@ 0.13409 0.197% 0.295% 0.000049q 0.626"A ~~~~~0.1 40W 0.1819 0.290% 0.00004N 0.6115 2 2.< .|˘˘˘0.146S .16 0.285% 0.000049 .58 ... 0.1539q 0.1510A 0.281% 0.000049 0.5859A ' 'S88sRo"4g 0.157h 0. 1380h 0.276°h 0.000049I 0.5719 ....... 0.1620S 0.1260h 0.270% 0.00004'M 0.5589 .'. '. .{XN.! 0.166S 0. 1140A 0.265% 0.000004' 0.546N ;; j..$.':2.2.UUi 0.1 71 S 0. 1040% 0.260% 0.00003N 0.535N .:2 2.20",0 0.75T4. 0.094%M 0.255% 0.0000309 0.52494 0.1I79S O.. .05°h 0.250% 0.000039A 0.5140A 0.183N . 0.0760% 0.245% -0.0000309 0.5040A ~~~~~0.1889 0.068%4 0.2409% 0.000030A 0.4960A ,g'22 - ~0.1 91 0,061 OM 0.235 0.000039( 0.4875 .s .m ".M 0.194S 0.054% 0.230% 0.0000394 0.4790A ['.R':;.::''. 0.198%j4 0.049%1 0.225%| 0.000030A 0.4710/ ~~~~~020 04 0.40 .2%0045A0470 A [.,.,',,,3205049 0039 0.2150% 0.023170A 0.4820 ''g@X - ~~0.208% 0.035%A 0.21S 0.060789A 0.514SA ,,.,,: ,g2 7...0.2069% 0.031 OA 0.205S% 0.109649( 0.552% *: . ,,.,20210.206% . 0.028% 0.201%S 0.1572909 0.592 0.208%0.. 0.0250A 0.196% 0.19725SI 0.6259 0.2080% 0..0022%A 0.191S 0.23042S 0.6519 ' R: ':::2'2g 0.2040% 0.019%4 0.187 % 0.25826SI 0.6689 '2''R; '' t@..fi. 0. 1980% 0.017% 0.182% 0.280489 0.6789 . ......... 0,1870% 0.0159% 0.177S% 0.2983094 0.6789 ANNEX V CONTRACTUAL SAvmGS DEVELOPMENT PROGRAM Page 16 of 32 ':::+':s'::~~~~~~~~~~~~~~~~~~~~~~~~~~..i"s :.,'""s '....Q.....'s lg- .0Ps : .1$ 0.051 0.000% 0.002S 0.000% 0.000% 0.053 0.0000 00000 0.0000 0.0000 .I s. i 0.060S 0.000% 0.002S 0.000% 0.001% 0.063 0.0000 A 0.000O0 0.0000 00000 ..... . . |0.070% 0.000% 0.003 0.000% 0.001% 0.073 0.00000A 0.0000 0.0000 0.0000 0.080% 0.000% 0.003N 0.000% 0.001% 0.083/ 0.00000 0.0000 0.0000% 0.00001 ssg .i 0.090% 0.000% 0.002 0.000% 0.001% 0.094 % . 0.0000 0.0000 0.0000 0.0000W 0.098% 0.000% 0.003 0.000% 0.001% 0.102 % 0.0000 0.000 0.0000 0.0000 .s. Ssw0.106% 0.000% 0.003 0.000% 0.001% 0.1110 0.0000 0.0000 0.000000 0.114% 0.000% 0.004 0.000% 0.001% 0.1190 0.00009 0.0000N 0.00009 00000 0.122% 0.000% 0.005 0.000% 0.001% 0.128% 0.0000 0.0000 00000% 0.0000 0.1270 0.001% 0.006% 0.000% 0.001% 0.134 0.0000 0.0000 0.000000 .. . . s ..0.131 0.001% 0.007 0.000% 0.001% 0.140 % 0. 0.0000% 0.0000 0.0000 ..... . ..9 0.136 0.001% 0.008% 0.001% 0.001% 0.146 0.0000 0.0000 0.0000 0.0000W 0.140 0.001% 0.009 0.001% 0.002% 0.153 0.0000 0.00009 0.0000% 0.0000 .;~ . sS 0.144 0.001% 0.009 0.001% 0.002% 0.157% 0.0000N 0.0000N 0.0000% 0.00009 <.s. . .... 0.148 0.001% 0.010% 0.001% 0.002% 0.162% 0.0000 0.0000 0.0000% 0.0000 s . s E 0.152 0.001% 0.010N 0.001% 0.002% 0.166% 4 0.0000 0.0000 0.0000% 0.0000 . 1 01570 0.001% 0.011 s 0.001% 0.002% 0.171 0.0000 0.0000 0.0000 0.0000 . . .s . h 0.160A 0.001% 0.011 M 0.001% 0.002% 0 .175% 0.0000% 0.0000 0.0000 0.0000 .s s sQ1˘ 0.164 0.001% 0.011 N 0.001% 0.002% 0.179T 0.0000 0.0000 0.0000E 0.0000 >:s gns 0.168E 0.001% 0.011 s 0.001% 0.002% 0.183% . 0.0000% 0.0000 0.0000% 0.0000 s S s0 0.172 0.001% 0.012N 0.001% 0.002% 0.1880 0.0000 0.0000 0.0000 0.00004 .174 0.001% 0.012% 0.001% 0.002% 0.191 0.0000 0.0000 0.0000 0.0000 0 s .>s' . 0.176% 0.001% 0.013 0.001% 0.002% 0.194 0.0000 0.0000 0.0000 0.0000 0.178% 0.001% 0.014 0.001% 0.003% 0.198Y4 0.0000 0.0000N 0.0000% 0.0000 21 jS . 0.181% 0.001% 0.015 0.001% 0.003% 0.2010 0.0046 0.0000N 0.0000 0.0000 0.183% 0.001% 0.016 0.001% 0.003% 0.2050__ 0.0232 0.0000 0.0000 0.0000 ..... .... 0. 185% 0.001% 0.018 0.001% 0.003% 0.2080 _ 0.0608 0.0000S 0.0000 0.0000 s2s0'.2. ii 0.1830,q 0.001% 0.0180 0.001% 0.003% 0.206T _0 .1096 0.0000 0.0000 0.0000 0.183 _0.001% 0.018 0.001% 0.003% 0.206 0.1573 0.0000S 0.0000 0.0000 ....w 0.182 0.001% 0.019 0.001% 0.004% 0.208W4 0.1972 0.0000 0.00000 0.0000 0.180 0.001 0.022) 0.001% 0.004% 0.208_ 0.2304 0.0000 0.00004 0.0000 0.175 0.001% 0.022 0.001% 0.004% 0.204 0.2582 0.0000 0.0000 0.0000 0.170 0.001% 0.022 0.001% 0.004% 0.198_ 0.2805 0.0000 0.0000 0.0000 0.159 0.001 0.0225 0.001% 0.004% 0.1870 _ 0.2983% 0.0000 0.0000 0.0000 CONTRACrUALSAVINGSDEVELOP.MENTPRoGRAM ANNEX V Page 17 of 32 SCENARIO 2B (INFONAVIT's return 2% throughout estimation period) 0.053% 0.3903 0.3271 0.0607 0.1 0.063% 003650 0.327 0.000009 0.8 0.0735 0.3410 0.325% 7.Y 0.13 0.0830% 0_318 0.322% 0.0000090 3 A. :$ig2C@.". 0.094%( 0.2950A 0.318% 0.00001 076 0.102% 0 A 0.314 0.000014 0.6889 09 0.2520 0.309 0.0025 0.6729 X,0.1 190% 02329 - 0.305°A 0.00003N 0.6569A ...., ; : 0.128%A 0.2140A 0.300 i 0.000039A 0.6420A . . .z.. .:f0 0.148%A 0.19 025 0.00004i 0.6409 0.7160 0.1817A 012 0.20 04° 0.631 0.1689 0.15660 0.2851 0.00004S 0.640 0.2199Mn 0.1510°A 0.281 %i 0.000040 0.651 OA 0.2490 0. 1380A 0.276 i 0.00004°i 0.6630 .B. :zB ' B 0.280 % 0.1260°i 0.270°A 0.00004 °i 0.67R0 .> .. g2 ....0.305°ic 0.1140 0.26-55 0.00004°i 0.6840 .:..M~~ 0.3309(.. 0.104OA 0.260% 0.00003°i 0.6949( 0.3550 .. 0.094 A 0-.25-5i 0.00003°i 0.7040A ..... ^. .gg0.381 °i. 0.085OA 0.250% 0.000039 _ 0.716S( '>:.f:" .oB'i,I'. 0.399°i. 0.076°Ac 0.245%. .000° 0.7200S ::.:',,BS2. ... >.0.416°A 0.068i 0243% 0.0000 3 0 .72 ~~~~~~0.434A O 0061 OA G.-235 0.000039i 0.7300S *;a. sa lffi 0.4530A 0.0540 0.230°i 0.00003°A 0.737Y ~~~~~~0.4650A 0.049°A _0.225°A 0.00003°A 0.7390A ...... ... =0.478 0A 0.044°A 0.220°i 0.00465 i 0.747NA [ - ....... 0.492 9 0;039- 0.215 9 0.023170A 0.769; . ~~~~~0.505iv 0.035%i 0.1|00078°i 0.81 1 O sa .. 0.516%A 0,031 c% G .......... 05A - il109640A 0.862o 0 528-M 0.028°h C 7)-14T ;729-X 0.913-A 0.5165O 0 075,% 2,< 5% 0.933*. 0.502%( 0.2 Ji 9. ____302` 0.94,5 0.489%( A.Gt9°h ~'l 37G256 0.953 A 0.4769if 0.017° 0.182% 0.28048 0 - 050/4 ...................0.463°ie 0.015° 0-177X 0.29830° .5° ANNEX V CONTRACTUAL SAVD;GS DEVELOPMENT PROGRAM Page 18 of 32 Cig s>css fc ~~~~~~~~~~. 1I!N S_ s| 0.051St 0.000% 0.0029t 0.000% O.OOO1 0.0532 _ _ _ ss i0.1060 0.000% 0.0023q 0.000% 0.001 0.06311 _ _ .s 0.114si 0.000% 0.0034 0.000% 0.Q0 19 OQ3 C 0.12 seSg c0.000% 0.005 0. 000% 0.001% 0.083t C O .O O OOS _ Q .OQQO 0.140 ss O 0.001%9 0.0026 0.000% 0.001% 0.1 -_ O.Q94S% C ____ .OO Q098.0 0.001% 0.0038 0.000% 0.001% 0.162 0 0.QOOOff 0 Q.QQOO 16 0.00% 0.0101 0001% 0.00%1 0.11189 S O.OOOOS Q.QQOOSI 0.0 0.0011 0.013S 0.001% 0.001% 0.119S C O.QOOQSI Q. OOOOSI 2sjsgssSs s 0.1 229f 0.001% 0.005N 0.001% 0.001% 0.1 2849 0.0000O cc 0 c Q.1257 0.002% 0.017 0.O.1. 0.00000 029 0.002% 0.019N 0.002% 0.003% 0.3059 ____ 0.302f _0.001% 0.020 0.001% 0.001% 0.313 __ O O.OOOS O ,i,ci,O 0.35176f 0.001% 0.0122 0.001% 0.002% O. 1 8904 0 0.0000SJ 0.201 0.001% 0.01234 0.001% 0.002% 0.21 C O.O 0.2293 0.001% 0.015 0.002 %0 0.004%I 0.3499Z _._OOQS O.OOQOS eit<:.cc 0.381N 0.003St 0.026SZ 0.001% 0.00%3 0.241 C.QIQQ .2~f 0.396 0.003% 0.0289 0.002% 0.005% 0.43O4 0__ __ _____4 00.009 c$ g 0.279 0.002% 0.019% 0.002% 0.003% 0.453 C 0.0__0_ 0 0.OOQOSi 0.3021q 0.002% 0.02033 0.002% 0.004% 0.3304t C .OOOOff C 0.000__ 20* -0.3250 0.002% 0.0223 0.002% 0.004 0.345598 - - .OOOOS C O.OOO 0.349St 0.002% 0.02439 0.002% 0.004% 0.381492 St ___ O.OS Q.O 0.365t 0.003% 0.025 0.002% 0.004% 0.39950 C 0.0S C O.Q 0.381 S 0.003% 0.026 0.0030 0.08 0.516 C S 0.0000 0.469 0.003 0.045 0.003% 0.008% 0.528 _________ 0.4396t 0.003% 0.028 0.002% 0.005% 0.515St ____ ---C -.O 0.4131 0.003% 0.031 9t 0.002% 0.006t% 0.45302 O.OCS O.OOOO 0.421 0.003S 0.0533f 0.003% 0.006% 0.4659 0.0000C1 0 0.000O0 0.4308 0.003% 0.036ff 0.003% 0.006% 0.478 0.005ff0.0 _ _ C O.OOOO 0.4394 0.003% 0.03904 0.003% 0.007% 0.492S 0.023S% _______ _ O.OOC iiic+ gi i 0.4484 0.003S1 0.0439f 0.003SI 0.008S% 0.5059t 0,061 0f00009C C 0.00OOC ;' c;,<5 iMc0.458Y4 0.003SS _0.044St 0.003SZ 0.008S% 0.516S 0.11 0f .OCS 0 0.C0OOS 'isNigSxg| 5 0.46 0.003St 0.045St 0.003St 0.OC8S% 0.5289t 0.1 57S 0.OOS C O.O '55 ciiZ | X 0.003St 0.003St 0,003S 0.009S-OOOS 0.5i5SN 0.197St O.OOOOS - 0 .OOOOSS icsi tci.c i 0.44St0.003S% 0.053SZ 0.002St 0.010OS 0.502St 0.230S 0.OC0009X 0.0000°N ,iiincciicig>tc0.4QSi0.003f 0.054St 0.002ff 0.010S 0.4899S 0.2589q O.OOOOSt C O.OOOOSi Giiiiic 0.408Si0.003S 0.053ff 0.002S 0.010%S 0,476SN 0.28 0St 2 01 OOOOSTC .oa ccisi 0.394Si 0.003f 0.054S% 0.002%1 0.01 OS 0. 4 6S 0.298S O.OOS a .0000sl CoNTRAcruAL SAVINGS DEvELPDmENT PRoGRAm ANNEX V Page 19 of 32 SCENARIO 3B (Without INFONAVIT for transition generation) . .. ........ ... ........ ,~~~C ApR. ,.,. ',;,,,sst.P. . ... N .5.79I0 . 0.213T 0.390 0.327 0.00000N 0.931O 0.0520 0.365A 0.327N 0.00000 0.944A 02% 0 341OA 0.325 0.000000 0.9589 0.3320% 0.318 A 0.322% 0.00000 0.972T4 .. g :f^5552C ... ! 0.3730/4 0.318% 0.0000194 0.986 0.406% 0.273 0.314% 0.0000194 0.992W 0.440% 0.252 0.309% 0.00002 1.001 0.474% 0.232 0.305 0.00003 1.011 0.508% 0.214 0.3000 0.00003 1022 7R0.532% 0.197 0295 000004 1024 0.555 0.181 0.2909 0.00004 1.026 0.579% 0.166 0.2859 0.00004 1.030 0.604% 0.151 0.281 0.000049 1.0369 0.621 0.1389 0.276 0.00004 1.034 0.6389 0.1269 0.270 0.000049 1.034 0.6559 0.1149 0.265 0.00004 1.0359 0.6739 0.1049 0.260 0.000039 1.0379 0.688 0.0949 0.255 0.00003 1.037 0.7049 0.0859 0.250 0.000039 1.0389 0.719 0.076 0.245 0.00003 1.041 0.7359 0.068 0.2409 0.000039 1.043 0.7479 0.061 9 0.235 0.00003 1.043 0.7609 0.0549 0.230 0.000039i 1.044 0.7729 0.0499 0.225 0.000039 1.0460 0.7859 0.0449 0.220% 0.004659i 1.0530 0.798 0.0399 0.215% 0.02317 1.076 0.8129 0.0359 0.210% 0.06078 1.1189 0.801 0.031 0.205% 0.10964 1.148 0.8039 0.0289 0.201 0.157299i 1.188 0.8079 0.0259 0.1969 0.197259i 1.224 0.8069 0.022A 0.1919 0.230429- 1.249 0.789 0.019 0.187 0.25826 1.253 0.7699 0.0179 0.1829 0.280484 1.2489 0.7259 0.0159 0.1779 0.298309i 1.2169 ANNEX V CONTRACAL SAVINGS DEvELoPMENT PROGRAM Page 20 of 32 -s0: g V s' M 039 0.001% 00109 0.001% 0.002% 07 0.2401 0.002% 0.0102 0.001% 0.002% 0406 .. ..a 902791 0.001%1 00104 0000% 0002% 0440 0.318% 0.001% 00106 000%1 0.002% 043320 g2.s0 .48 0.35 0.001% 0.0108 0.001% 0.002% 0 3730 0.390% 0.002% 0.0122 0.001% 0.002% 0.4065 0.421% 0.002% 0.0142 0.001% 0.003% 0.440% . 0.453%i 0.002% 0.016% 0.001% 0.003% 0.474 0. 55 0.002% 0.0183 0.001% 0.003% 0.604 0.502% 0.002% 0.0223 0.001%1 0.004% 0.5321 ;Ssiss sss 0.520%8 0.002% 0.0263 0.002%1 0.005% 0.5553 * S06a% ...0.31 0.003% 0.040 0.002% 0.005% 0.5795 0sssSs 616 --0.003% 0.0364 0.003% 0.006% 0.6047 0.57063 0.004% 0.0374 0.003% 0.007% 0.621 0.585% 0.004% 0.0399 0.003% 0.007% 0.6387 0.601% 0.004% 0.0404 0.003%, 0.007% 0.675% : t ssssSs< 0.61673 0.004% 0.0415 0.004% 0.008% 0.6735 0.630%1 0.004%, 0.0429 0.004% 0.008% 0.6884 0.644% 0.005% 0.0435 0.004% 0.008% 0.704% 0.658 0.005% 0.0445 0.004% 0.008% 0.7197 . 20 0 706. 0.005% 0.0459 0.004% 0.008% 0.735% .s.0768131 0.005% 0.049% 0.004%i 0.009% 0.7479 .. i. .... 0.005% 0.0526 0.004% 0.009% 0.760%1 ...... 0.711 0.005%1 0.0556 0.004% 0.010% 0.772 0.70693 0.005% 0.0698 0.004% 0.011% 0.7850 .Ss.gs ~0.7139q 0. 0%1 0.064% 0.004%1 0.012% 0.7989% ;ss ~~~0.721 OM ~ 0.005%1 0.069°A 0.004%1 0.01 3% 0.812% 0.711%1 0.005% 0.0699 0.004% 0.013% 0.801 ss S.>s> ~0.7139q 0.005%1 0.068SZ 0.004%1 0.013% 0.8039% g s ~~~0.70994 0.005%1 0.0759400410.1% 087 *S ssssX ~0.9% 0.005%1 0.084% 0.004%1 0.016% 0.806%4 0.678 0.005% 0.086% 0.004% 0.016% 0.789 0.659 0.005% 0.085% 0.004%1 0.016% 0.769 0.617 0.004% 0.084% 0.004%1 0.01 6% 0.725N CONTRACIUAL SAVINGS DEVELOPMENT PROGRAM ANNEX V Page 21 of 32 SCENARIO 4B (2% real interest rate) .... .. ... .. .w.. , 0.107T 0.390A 0.327 0.00000 0.824 0126 0.3650 0.327% 0.00000 0.818 0.146 0.341 0.325% 0.00000 0.812 0.166 0.318 0.322% 0.00000 0.806 0.187 0.295 0.3189 0.00001 0.799% 0.203W4 0.273N 0.314* 0.00001 0.7890 0.220N 0.252 0.309 0.00002 0.781O 0.2370. 0.232 0.305 0.000030 0.774i 0.2540 0.214 0.300 0.000030 0.7680 0.2665 0.197 0.295% 0.000049 0.758 .......... 0.278* 0.181 0.290 0.000049 0.749 0.290O. 0.166 0285 0.000049 0.741 0.3020A 0.1510% 0.281 N 0.000049 0.7340 0.310 O 0.1380A 0.276% 0.00004N 0.7249 0.3190 0.126%| 0.270 0.000049 0.715 ~> 0.3289 0.1140A 0.265% 0.000049 0.708 0.337 0.104 0.260 0.00003 0.701 0.344 0.0949( 0.255% 0.00003 0.693 0.352% 0.085% 0.250% 0.00003N 0.687 |. 1 BB-gBXX 0.360 0.076% 0.245 0.00003 0.681 |. 1 BS YYRc 0.368% 0.068% 0.240% 0.00003% 0.676 |O~ ......0.374 0.061 0.235 0.00003 0.670 0.380%/ 0.054%1 0.230 0.00003 0.6641 0.386 0.049%1 0.225%| 0.00003 0.660 0.3920.044%A 0.2200 0.00483%/ 0.6610 0.3990 0.039%/ 0.215% 0.02334%/ 0.677 0.4079 0.031 0.205% 0.10964 0.753 0.401 0.028 0.201 % 0.15729 0.787 0.4030A 0.025% 0.1965 0.19859 0.822 0.4030 0.0224 0.191% 0.23170 0.848 0.3950 0.019 0.187 0.25950 0.860 0.384 0.017W4 0.182% 0.28250 0.866 0.3689 0.01594 0.177% 0.30026 0.861 ANNEX V CONTRACTUAL SAVINGS DEVELOPMENT PROGRAM Page 22 of 32 E 0.1019 0.000% 0.005% 0.000% 0.001% 0 0 0 0 0.120) 0.000% 0.005% 0.000% 0.001% 0 0 0 0 0.139 0.000% 0.005% 0.000% 0.001% 0 0 0 0 w | 0.1599 0000% 0.005% 0.000% 0.001% 0 0 0 0 b i 0.1799 0.001% 0.005% 0.000% 0.001% 0 0 0 0 t S 0.195 0.001% 0.006N 0.000% 0.001% 0 0 0 0 M . 0.210) 0.001% 0.007% 0.000% 0.001% 0 0 0 0 Bg | 0.2269 0.001% 0.008% 0.000% 0.001% 0 0 0 0 0.2425 0.001% 0.009% 0.000% 0.002% 0 0 0 0 ˘§ 0.2519 0.001% 0.011% 0.001% 0.002% 0 0 0 0 ) 0.2609 0.001% 0.013% 0.001% 0.002% 0 0 0 0 | l 0.269 0.001%1 0.016% 0.001% 0.003% 0 0 0 0 0.278 0.002% 0.018% 0.002% 0.003% 0 0 0 0 | | 0.2859 0.002% 0.019% 0.002% 0.003% 0 0 0 0 j 0.293 0.002% 0.019% 0.002% 0.003% 0 0 0 0 i .Q£" 0.300 0.002% 0.020 0.002 0.004% 0 0 0 0 2O 0.3085 0.002% 0.021 0.002% 0.004% 0 0 0 0 0315 0.002% 0.021% 0.002%1 0.004% 0 0 0 SC X.B 0.322% 0.002% 0.022 0.002% 0.004% 0 0 0 0 WlSE 0.3299 0.002% 0.022% 0.002% O.004% 0 0 0 0 0.336% 0.002% 0.0230 0.002% 0.004% 0 0 0 0 -ESC'XS;S:C.|83MW 0.3415 0.002% 0.024% 0.002% 0.004% 0 0 0 0 .*E... 0.345 0.002% 0.026 0.002% 0.005% 0 0 0 0 0.349W 0.002% 0.028S 0.002% 0.005% 0 0 0 0 0.3530 0.002% 0.029% 0.002% 0.005% 0.00% 0 0 0 Z.., 0.357 0.002% 0.032 0.002% 0.006% 0 .02% 0 0 0 >..S N 0.3609 0.002% 0.035 0.002% 0.006% 0.06% 0 0 0 0.361 0.002% 0.035% 0.002% 0.006% 0.11% 0 0 0 *E 2 0.356S 0.002% 0.034 0.002 0006% 0.16% 0 0 0 0.002% 1 0. 0 % .0379-__ _ __ _ __ _ _ __ _ _ ~ .~ . 0.3549 .0 0.037 ____ 0.00 7% ______ 0.20% 0 0 0 CS *2 0.349 0.002% 0.042C 0.002% 0.008% 0.23% 0 0 0O 0.3395 0.002% 0.043 0.002% 0.008% 0.26% 0 0 0 0.3299 0.002% 0.043 0.002% 0.008% 0.28% 0 0 0 S 0.3095 0.002% 0.046% 0.002% 0.009% 0.30% 0 0 0 CoNTRACTuAL SAViNGS DEVELOPMENT PRoGRAm ANNEX V Page 23 of 32 SCENARIO 1A 0.0439 0.349W 0.32796 0.00000 0.720 0.049°A 0.3270 0.327% 0.000009 0.704 0.0559 0.3069_ 0.325% 0.000009 06.86 0.061 0.285% 0.322° 0.000009 0.668 0.0679( 0.264% 0.318° 0.000019 0649 0.0719( 0.2449^ 0.314% 0.00002 0629 0.075°A 0.226N 0.309% 0.00003 0610 0.0799 0.20894 0.305° 0.00004 0A592 0.0839 0.192 0.300% 0.000059 0.575 0.0859 0.1760 0.295° 0.000069 0 557°A 0.0880A 0.1629( 0.290% 0.000079 0.540 0.0909 0.1480A 0.2859 0.000079 0.524'A 0.0920A 0.136% 0.281° 0.000079 0.508°A 0.093°A 0.1240A 0.276 0.00007 0.492S 0.094°A 0.1 139C 0.270% 0.00007 0.477 0.095N 0.103Y 0.265% 0.00007 0.463° 0.095 0.0939 0.260% 0.00007 0.449 .. ' ,.'''R 0.0969 0.084 0.255% 0.00007A 0.4359A 0.0960A 0.076 0.250 0.00007° 0.422 0.0960A 0.0680/ 0.245 0.000079 0.409 0.0969A 0.061 Y 0.240 0.00006'A 0.397 0.0970Y 0.055W4 0.235 0.000065A 0.386N 0.0970Y 0.049Y 0.230 0.000060. 0.376 ''', ' R' .... 0.0980A 0.04404 0.225 0.000060A 0.3679 0.0980C 0.0390/ 0.2209 0.005340/ 0.36391 0.0999: 0.035Y 0.215Y 0.0265094 0.3759 0.099"A 0.031 0.210% 0.06945 0.410 0.0970A 0.028Y 0.205% 0.12527T4 0.456 0.0960A 0.025 0.201Y 0.179709/ 0.501 0.0930A 0.0229C 0.196% 0.22534% 0.5369 0.091 % 0.0209q 0.1919 0.263239C 0.56594 0.088 0.017 0.18 0.954 0.8 0.084% 0.015Y 0.1829C 0.320411 0.602 0.079% 0.01 40A 0.1779 0.34078% 0 611 ANNEX V CONTRACrTuAL SAVINGS DEVEPMENT PROGRAM Page 24 of 32 004 . # 1 0000% 0002 0000% 0000% 043 o.000 0% 0% 0% .. 10.047 0.000% 0.0029 0.000% 0.000% 0.049 ___ 0.0009 0% 0%6 0% . ; 1 0.053SS 0.000% 0.002M 0.000% 0.000% 0.055 0.000 0% 0% 0% ; ,10.058N 0.000% 0.002% 0.000% 0.000% 0.0617 0.000) 0% 0% 0% | , 0.0686 0.000% 0.0029 0.000% 0.000% 0,071_ _ 0.000 0% 0% 0% 1 0.0684t 0.000% 0.0026 0.001% 0.000% 0.075 0.000 0% 0% 0% i I 0.082S 0.000% 0.0039 0.000% 0.000% 0.0794 0.0004 0% 0% 0% . 0.0879S 0.000% 0.0036 0.000% 0.001% 0.0836 0.000N 0% 0% 0% 0 0.087S6 0.000% 0.0049 0.000% 0.001% 0.085N 0.000S 0% 0% 0% 0.087SQ 0.001% 0.0048 0.001% 0.001% 0.088S1 0.0005 00 0 % 0.0%0 0.083S6 0.001% 0.0059 0.001% 0.001% 0.0909/ 0.0090 0% 0% 0% 0.085S6 0.001% 0.0068 0.001% 0.001 % 0.0927 0.15 0.0% 0% 0% 0.083 0.001% 0.009 0.001% 0.002% 0.06 0.10 0.0004 % 0 % 00 0.080N 0.001% 0.0069 0.001% 0.001% 0.093N 0.002 0 0.0% 0.00% 0.086 0.001% 0.006% 0.001% 0.001% 0.091N 0.000.0 0% 0% 0% . ~~~0.086N .01 0.006g 0.001% 0.001 % 0.096f 0.0% 0% 0%1 0% . 0.087%~~ 0.001% OO.0 .01S 001N .9%000% 0 % 0 .08074 0.001% 0.006N 0.001% 0.001% 0.0988 0.0029 0% 0% 0% 00A7 0.001% 0.006 0.001% 0.001% 0.084 0.000% 0% 0% 0% 0.087 0.001% 0.006 0.001% 0.001% 0.096 0.0003 0% 0% 0% 0 ~~~0.0870A 0.001 % 0.006N 0.001% 0.001 % 0.097% 0.000% 0% 0% 0% 0087f 0.001 % 0.007N 0.001% 0.001 % 0.0978% 0.0% 0% 0% 0%1 .g ~~~0.087ff 0.001 % 0.0078 0.001% 0.001 % 0.0989 .05 0.000 E 000% 0.000% 0.087ff4 0.001% 0.008% 0 .001% 0.001% 0.0980% 0.026% O.OOOf 0.000% 0.000% :i ~~0.0879q 0.001 % 0.008% 0.001%1 0.001% 0.099%/ 0.0269% 0.000% 0.000% 0.000% . ~~~0.086% 001T008 .01 .0N 007 0.069% 0.000% O.OW% 0.000% >' 0.083ff~ 0.001 % 0.009% 0.001% 0.002% 0.096%010 000 000% 000 g | ~~0.085W4 0.001 % 0.008% 0.001% 0.002% 0.093% 0.125% 0.000% 0.000% 0.000% . S " ~0.0783% 0.001 % 0.0109 0.001% 0.002% 0.096 0.263% 0.000 0.000% 0.000%1 0 iF 0.0740.0 .01 0.0109 0.001% 0.002% 0.093% 0.225% 0.000% 0.000% 0.000% 0 0.071 ff8 0.0019 0 .Of 0.001% 0.002% 0.084 % 0.2320 .0 0.000% 0.0% . M ~~0.074ff 0.001 % .00 001% 0.002% 0.079%1 0.2950% 0.000 .0% .0% CoNRAciuAL SAviNGs DEVELPMENT PROGRAM ANNEX V Page 25 Of 32 SCENARIO 2A (INFONAVIT's return 2% throughout estimation period) .. gj82gli ...0.0430A 0.3490 0.327% 0.00000 0.72 ~~~~~0.0490A 0.3270A 0.327% 0.00000 0A74 @S@B|8 ~~0.0559 - 0.30654 0.325% 0.000009 .66 0.061 N 0.285N 0.322% 0.00000N 0.6689 0.0670/ 0.264N 0.3180k 0.00001T4 0.6499 0.071 s 0.244N 0.314N U.00020/ 0.629 0 -75q0.226OX 0.309% 0.00003W4 0.61094 0.0799% 0.208sA 0.305% 0.000049q 0.592-4 0.083s o. 1 92si 0.300% 0,00005) 0.575s 0.095% o.1 760A 0.295% 0.00006v 0.5670si 9 o~~~~.11 0-. I 62s6 0.290 90.00007 0.563v S ~~~~0.125% 0.1 48sA 0.285% 0.00007v 0.559v 0.140% 0.1 3694 0.281% 0 .00007 0.557Y X-0.155 0. I240A 0.276s% 0.00007) 0.555N ~~~~~0.165N 0. 1 13%1 0.270%l 0.00007%l 0 .549s [&t ~~~~0.1I75W 0.103%A .265% 0.0000070/ 0.543v FXe2%~~0182 0.0939 0.260%1 0.0000754 0.535v 0.208s6 O.Oa4-A 0.255%{ 0.00007%1 0.548si ~~~~~0.234W4 0.076-M 0.250%1 0.00007T4 0.561i i>Sz . N>t 30.26194 0.068N 0.245s% 0.00007N 0.574W4 0.281 OA 0.061 /4 0.240% 0.00006N 0.58294 0.301 OA 0.oss 0.235s 0.00006% 0.591 ~~~~~0.321 OA 0.0499% 0.0230%( 0.000069( 0.60094 ffi E5 ii 0.341%O 0.044 0.225% 0.000060A 0.6109 9 | ~~0.326%A 0.039%M 0.220% 0.005340A 0.591 X ~~~0.31 1%O 0.035% 0.215% 0.02650%X 0.5889 E ~~~~0.296%A 0.031 % 0.210% 0.069450A 0.6079 g 8XtZ ~~0.2819 0 O028% 0.205% 0.12527%A 0.640 0.2669% 0.025%4 0.201- 0.179709% 0.672) .. § X ......0.2519% =0.022% 0.196E 0.22534% 0.6959 0.2369%=0.020% 0.191N 0.26323% 0.71094 t00>2gl; ~0.221 %0.017% 0.187 0.29504N 0.72 y .. { 2 ... .. 0.2062% 0.015% 0. 1822 0.32041 % 0.72494 IM M 0.188M 0.01 40% 0. I779q 0.340780h 0.7201 ANNEX V CONTRACTUAL SAVINGS DEVELOPMENT PROGRAM Page 26 of 32 0.04179 0.000% 0.002WS 0.000% 0.000% 0.04374 0.000 0.000% 0.000% 0.000 0075 0.000% 0.0023 . 0.000% 0.000% 0.049S 0.000 0.000% 0.000 0.000 0.0539 0.000% 0.0023 0.000% 0.001% 0 0.0558 _ 0.000 0000% 0.000% 0.000 ,.:cS fc 0.058S4 O.OOOS 0.0SOOONOOO6 .6 ;OOOiOOOS .O .OS 0090.0000%.00049 0s000% 0.001% 0.095 0000 0.000% 0.000% 0000 ZO e 0.063S 0.000% 0.0025 0.001% 0.001% 0.0671 0.0 ____ .OOOS O.O 0.01168 0.001% 0.00297 0.001% 0001% 007125 00OOOS_ O.OOOS .0.1728 0.001% 0.008S 0.001% 0.001% 0.10759 0.000 0.000% 0.000% 2,Sg fl 0.0794 0.001% 0.0039 0.002% 0.002% 0.015 0.000 0.000% 0.000% 0.000 ss O1 s . 2 0.050S 0.000% 0.003 0.002% 0.001% 0.086 0.000% 0.000% 0.000% 0.000 0.159, 0.002% 0.0011 0.002% 0.001% 0.0195 0.000S 0.000% 0.000% 0.000 2O~. 0.1 0.0% 0.002% 0.001% 0.182 I 0.0007 0.000% 0.000% 0.000 0.1 28S 0.001% 0.0013q 0.001% 0.001% 0.120 59 0.000S 0.000% 0.000% 0.000 2 Q1 s 0.21 S 0.001% 0.0015 0.003% 0.003% 0.21 345 0.00094 0.000% 0.000% 0.000 g 0.14235 0.003% 0.0106 0.002% 0.002% 0.15% 0.00O0 0.000% 0.000% 0.000 ZX t 2 0.159S 0.002% 0.018S 0.002% 0.002% 0.1 65S60.000 0.000% 0.000% 0.000 Z$ 0.215 000% 0.2 0.003% 0.004% 0.317 0.000A 0.000% 0.000% 0.000 Z ts 0.7164 0.002% 0.0112 0.002% 0.002% 0.38214 0.000S 0.000% 0.000% 0.000 0.188 0.003% 0.0123 0.0024 0.002% 0.208 0.000S 0.000% 0.000% 0.000 Z21ss 0.212 0.003% 0.0159 0.003% 0.003% 0.2342 0.00 0.000% 0.000% 0.000 0.235 0.003% 0.016S 0.003% 0.003% 0.261 % 0.02O6 0.000% 0.000% 0.000 0.254 0.003% 0.0128 0.003% 0.003% 0.281 0.000% 0.000% 0.000S sg S Zc 0.2714S 0.004% 0.020 0.003% 0.004% 0.301 0.125 0.000% 0.000% 0.000 . 0.2873 0.003% 0.025 0.00% 0.004% 0.326 .O 0.000% 0.000 0.3049 0.004% 0.025 0.004% 0.005% 0.341 0 0.000% 0.000% 0.000O g gs | ~0.28994 0.004% 0.025S 0.004% 0.005ff 0.326%4 0.0059H 0.00096 O.OOS .OOf +<5f.c*x; M 0.2749I 0.004% 0.026SI 0.003% 0.00596 0.3119% 0.02694 .OOOe6 O.OOOS6 O OOOf 0.201 0.004% 0.0265I 0.003% 0.005% 0.296% 0.26 0.000% 0.000% 0.000 2 >;ifs S 0.246 0.003% 0.0249i 0.003% 0.005% 0.281 % _ 0295 0.000% 0.000% 0.000 0.231 0.003% 0.0253 0.003% 0.005% 0.266 0.180 0.000% 0.000% 0.000 0.217 0.003% 0.024 0.003% 0.004% 0.188 0.22594 0.000% 0.000% 0.000 X t ~~0.201 Sl0.003% 0.0259I 0.003% 0.005S 0.2369% 0.2639f 0.000% 0.000%, O.OOOf scssscss w 0.187 0.003% 0.0249 .0% 000f .2 0.295W4 0.00096 0.000SS O.OOOf issgs8ci- 8 O.174! 0SO.003 % 0.023S 0.002% O0.004ff 0.0 .3209 O.OOS O.OffOOOf -scg Ess | 0.1569I 0.002% 0.0249q 0.002% 0.0059% 0.1889% O0.3419ff 0.000%1 O.0% OOS 0. OOOf CoNTRACTUAL SAVINGs DEvELopmEN PRooRAm ANNEX V Page 27 of 32 SCENARIO 3A (Without INFONAVIT for transition generation) .aZM:Mfl.1 L 0.17494 0.349OA 0.327% O.OOOOs 0851 0EMwt§ 0.197o 0.327N 0.327% 0.OOOoOn0.5 A ONt" 0.220 x 0.306 A 0.325% .Oo 0.00000 Stilt 1 0.243N 0.285Y4 0.3229 0.ooooo0 A .5 AMMM ~~0.266W 0.264- 0.3185q 0.00001 9 .88 ggggWO ~~0.282N 0.244s 0.314N 0.00002s 0.840s ggg323C < 0.2980/ 0.226s 0.309N 0.0003 0.833s ...;. ..# 0.314W .. 0.208s 0.305N 0.00004W4 0.827N . ...... . 0333... 0.192o 0.3009q 0.0000594 0.822 g2|lg222 ~0.338N 0.176% 0.295E 0.00006N 0.810N .0.347N 0.162% 0.290'q 0.00007Y4 0.799N S0@gW3$ ~0.355 0.148% 0.285% 0.00007 0.789N 0.363-4 0.136% 0.281 % 0.00007% 0.78094 _ 0.366 0.124% 0.276% 0.00007% 0.766N R ~~~~0.3699S 0.1 13%A 0.270% 0.000079% 0.753N .§ j.>N22tiw 0.373N 0.1I03%A 0.265% 0.00007%A 0.741N 0.37694 0.093%A 0.260% 0.000070A 0.729N .i ...'0.376N 0.0840A 0.255% 0.000070% 0.715N 0.3769 0.076% 0.250% 0.000070% 0.7029 @gggt3| ~0.377%{ 0.0680/ 0.245% 0.00007%1 0.690N [j;X& ~~0.377t 0.061 0.240% 0.00006%l 0.678N [i~~~~0.89 80.0449q 0.2259% 0.00006%{ 0.654 [.R,8,.J .... r0.386N 0.0390/4 0.220%| 0.00534% 0.651 |~~~~~.8N0.035 9 0.215% 0.02650%1 0.656 8@gS | ~0.3550A 0.025W4 0.201%1 0. 17970%Y 0.760W , ~~~~0.341 OA 0.022 0.196% 0.22534% 0.784S m ~~~~0.3250A 0.0209 0.9 6323 0.80 + + Rl W 0.3060A 0.01 7W 0.187% 0.29504% 085 S-iBSA.S'E.H* 0.2820A 0.0154 -0.1822 0.32041 % 080 m 0 256%~~' 0.01494 0. 1T7%1 0.34078% 078 ANNEX V CoNTRACTUAL SAVINGS DEVELOPmENTPROGRAM Page 28 of 32 . . . ... .. .. . ...... ... . , M A ; $v 7 0165 0000% 0008% 0000% 0002% 01 74 0.187% 0000% 0.008% 0.000% 0.002% 0.197% 1 :V:f::;i 0.210 0 000% 0.008° 0.000% 0.002% 0220Sz 0.233% 0.001% 0.007N 0.000% 0.002% 0.243% 2001 0.256% 0.001% 0.007s 0.000% 0.001% 0.266. 0.270% 0.001% 0.008% 0.001% 0.002% 0.282% 0 t 0OX 0.28&5 0.001% 0.009% 0.001% 0.002% 0.298% . 0O4 0 299% 0.001% 0.010% 0.001% 0.002% 0.314. 0.314% 0.001% 0.012% 0 001% 0.002% 0.3309H 0.318 0.002% 0.014% 0.002% X0002% 0.3389_ .. G 7 0.323% 0.002% 0.017% 0.002% 0.0030% 0.347- D Q~ . .30°327% 0.002% 0.01 9% 0.003% 0.003% 0.3556 0.332% 0.003% 0.022% 0.003% 0.004% 0.3630S .0.)13!3. 0 .334% 0.003%1 0.022% 0.004% 0.004% 0.3669 .-: 1 t4 0.336% 0.004%5 0.022% 0.004% 0.004% 0.369_ t. l: . . > 0.3379 0.004%1 0.023 0.G04% 0.004% 0.3739S ...... ...0.3394S 0.005% 0.023% 0.004% 0.004% 0.3767 - ... Z"7 0.340S. 0.005% 0.023% 0.004% 0.004% 0.3769° i: :.:It 0 340S 0.005% 0.023% 0.004% 0.004% 0.3768S ;: A . ::. 0.3403 0.005% 0.0232 0.004% 0.004% 0.3770 2| --0.3403 0.005% 0.024 0.004% 0.004% 0.3778A ..... 0 30 0.34 0. 005% 0.027% 0.004% 0.005% 0.381O ..... : $. 0.340S 0.005% 0.030% 0.004% 0.005% 0.384% 0.3390 0.005% 0.032% 0.004% 0.006% 0.3859S 202S-: 0 0337S 0.005% 0.0348 0.004% 0.006% 0.3864 S 0.332% 0.005% 0.033% 0.004% 0.006% 0.380N 0.324% 0.005% 0.0350/ 0.004% 0.007% 0.3749 ~Q4 0.313% 0.004% 0.03' 0.004% 0.006% 0.362 ___4 _ 0 302% 0 004% 0.03C0 0.004% 0.007% 0.355 0.288% 0.004% 0.0380 0.04 0.007% .4 0 274% 0.004% 0.0370A 0.004% 0.007% 0.325 3 s X 0.252S 0.004% 0.0390 0.003% 0.007% 0.306 0.227S 0.004%S 0.0400A 0.003%1 0.008% 0.282 0.203% 0.003% 0.3 .03 .0% .5 CoNTRAcTuAL SAviNGs DEvELop,ENT PROGRAM ANNEX V Page 29 Of 32 SCENARIO 4A (2% real interest rate) _ |,@EE .pi˘t0,$t,0 .... F., .". ..§E E. ' :'.' ' E ..0.0870A 0.3490A 0.327% 0.00000%A 0.7640A ........ f }3600.0989 0,327% 0.327% 0.00000% 0.753i ~~~~~~~0.1100A 0.306% 0.325% 0.00000% 0.7400 E"' :.'.'.E'.'' 01-21 1 0.285%A 0.322% 0.00000 0.7299 : '' . ' ~~0. 13359 0.26404 0.318% 0.00001% 0.715-4 ... ..'. .2o2....0.1410A 0.2440% 0.314% 0.00002% 0.6999 E% 0. 149N( 0.2260% 0.309% 0.00003%A 0.6849 E ' E '˘p˘ O 0.1570A 0.2080% 0.305% 0.000040% 0.6705 0.1650 0.192% 0.300% 0.00005%0A 67 .: . .2˘˘˘ .. 0.1690 0.176% 0.295% 0.00006 0A 61 0.1730A 0.1I62%M 0.290% 0.00007 0A 66 N. . ..... . 0.1770A 0.1I48%4 0.285% 0.00007 0.11 0.182% 0.136% 0.281% 0.00007%0.58 .. . ˘F O.183 0.180 0.124%1 0.276% 0.00007A 0.583N : ,,,5:.,2ar,|, 0. 1850 0.113% 0.270- 0.00007'M 0.568a " :':,'.$ ":'2 .$ l.0.1860A O.103 0.265N O0.00007E A.5 0.18 0.093%0.24 0 0.00007 0A 51 ...... 0S O1 880 0.084% 0.255% 0.00007 0.57 E ~~~~~0. 188N 0.0769% 0.250°% 0.00007 0.54 . . . .. . . .. .0.1880/ 0.068% 0.245°% 0.000079E 0.502-4 0. 188N 0.061 0.240% 0.000060E 0.4905 7gT|5i ~~~0. 1890, 0.0559% 0.23 % 0.00006 0.4795 .. ..... . 1 90 0.0499% 0.230°% 0.00006N 0.469W4 EWgHl%WW O~~.191N 0O.044%/ 0.225% 0.00006E 0.4605 SX7WW O.9S 009 .220% 0.00554 0.4575 ...... 0. 1929q 0.03594 0.215% .269049 ,;,,,,;EE;,E t21 0°193 0.031% 0.210% 0.06964 0.5049 gg0W%WG 0~~~.189 0.028% 0.205% 0.12545 0.5489 .. ........... 0. 187N 0.025%4 0.201 % 0.17988 0.5929 0.181 S 0.022% 0.196W 0.22687 0.6259 0.1779q 0.020% 0.191 W 0.26470W/ 0.6529 0.170N 0.01 7% 0.187% 0.29645N 0.6709 0.162 0.015% 0.182W 0.322731 0.6839 ...... 0.152W 0.0140,q 0.177°% 0.343029W 0.6875 ANNEX V CONTRACTUAL SAVINGS DEVELOPMENT PROGRAM Page 30 of 32 0.082O 0.000% 0.004% 0.000% 0.001% 0.087N 0 0 0 0 0.094% 0.000% 0.004% 0.000% 0.001% 0.098O 1 0 0 0 0 0.105 0.000% 0.004 0.000% 0.001% 0.110S 0 0 0 0 0.116% 0.000%, 0.004% 0.000% 0.001% 0.1219 0 0.0000 0 0.0009 201 0.128B 0.001% 0.0039 0.000% 0.001% 0.133 0C 0.0000% 0 0.000 0.135f 0.001% 0.004- 0.000% 0.001% 0.141_ 0 0.00009 _ 0 0°0 0.142 _ 0.001% 0.0059 0.000% 0.001% 0.149N 0 0.0000 0 0.000 0.150% 0.001% 0.0056 0.000% 0.001% 0.157N C 0 0.000O0 0.000 0.157S 0.001% 0.0067 0.001% 0.001% 0.1659/ 0 0.0000 0 .000 0.1596 0.001% 0.007, 0.001% 0.001% 0.169 0 0.0000 0.000 ~. 0.161 0.001% 0.008N 0.001% 0.001% 0.1737 0 0.0000 O C 0 0.000 0.1649 0.001% 0.010 0.001% 0.002% 0.1778 0 0.0000 % 0 0.000 0.166% 0.001% 0.011° 0.002% 0.002% 0.1 823% 0 0.0000 0 0.00OOf 0.167% 0.002% 0.011° 0.002% 0.002% 0.1835 0 0.0000% 0 0.000 ' | l 0.1689 0.002% 0.011% 0.002% 0.002% 0.185° 0 0.0000 0 0.00O0 0.169% 0.002% 0.0112 0.002% 0.002% 0.1886% 0 0.0000C 0 0.000f 201. 0.170% 0.002% 0.012° 0.002% 0.002% 0.188 0 0.0000 0 0.000 0.170° 0.002% 0.012°A 0.002% 0.002% 0.1880A 0 0.0000 0 0.000 . E 1._0.170% 0.002% 0.012A 0.002% 0.002% 0.188% 0 0.0000 0 0.000 0.170% 0.002% 0.012N 0.002% 0.002% 0.188% 0 0.0000 0 0.000 0.17094 0.002% 0.0123 0.002% 0.002% 0.1889 0 0.0000 0 0.000 0.170%} 0.002% 0.013% 0.002% 0.002% 0.1890 0 0.0000 0 0.000 0.170% 0.002% 0.0134 0.002% 0.002% 0.190 0 0. 0 0.000 0.170% 0.002% 0.0145 0.002% 0.003% 0.191 0 0.0000 0 0.000 202. 0.170 0.002% 0.0159% 0.002% 0.003% 0.192 0.0270.005 0.0000 0 0.000 0.1698 0.002% 0.016* 0.002% 0.003% 0.192 0.0270 0.0000 0 0.000 0.1686% 0.002% 0.0176 0.002% 0.003% 0.193 0.070 0.0000 0 0.000 0.1662 0.002% 0.01 6% 0.002% 0.003% 0.189 0.125° O.=__ O.OOf 0.162% 0.002% 0.018% 0.002% 0.003% 0.1879% 0.180% 0.0000 _ 0 0.000°° 0.1561 0.002% 0.017% 0.002% 0.003% 0.1817 0.227 O.O0000%______ 0.151N 0.002% 0.01 9 0.002% 0.004% 0. 177 ____ 0__265_ ______ 00 0.144 0.002% 0.019% 0.002% 0.004%1 0.170 0.296_ 0.0000_ O OO__ 0.137% 0.002% 0.018% 0.002% 0.003% 0.162 % _ 0.323% 0.0000% 0 .000% 0.1269. 0.002%1 0.019%1 0.002% 0.004% 0.152 0343° 0.0000 0 0.000 CONnATRAAL SAviNGs DEvELoPmEN PRooRAm ANNEX V Page 31 Of 32 Cost to be Incurred by State Contributions to the New System of Pensions (percentages) 259 S ~0.33 0.0002 0.331 U rll 0.33 0.0002 0.330 | i i 0.33 0.0002 °0326 0.32 0.0002 0.321 . 0.32 0.0002 0.317 0.31 0.0002 0.312 .1 0.31 0.0002 -0.308 0.30 0.0002 0.303 0.30 j.0002 - 0.298 | 0.29 0.0002 0.293 . 0.29 0.0002 0.289 0.28 0.0002 0.284 . 0.28 0.0002 0.278 0.27 0,0002 0.273 | | [ | 0.27 0.0002 0.268 | ~~~0.26 0.0002 0.263 7 | gl3EE1 0.25 0.0002 0.253 | gllll.|1 0.25 0.0002 0.248 | lllllli 0.24 0.0002 0.243 | l"|||||g 0.24 0.0002 r 0.238 | -~~~0.23 r 0.0002 r 0.232 | #SllEl 0.23 70.0002 0.227 | S L ~~0.22 0.0002 r 0.222 g ||gglX 0.22 0.0002 0.217 | E ~~0.21 0.0001l2 0.2028 | 2 ~ ~0.20 r0.0001 0.203 | S.ESS 0.19 1 0.0001 1 0.193 .M.l2Mlll.gG 0.19 1 0.0001 1 0.189 n 2uS§E.SlX 0.18 1 0.0001 1 0.184 g gl"gEE] 0.17 1 0.0001 1 0.175 E S.El ~0.17 1 0.0001 7 0.171 | l, ~~0.17 1 0.0001 r 0.166 | gSllffl 0.16 1 0.0001 1 0.162 E , ~~0.1S 0.0001 1 0.150 W SU320|g 0.15 1 0.0001 1 0.146 | l.0.9gES 0.14 1 0.0001 1 0.142 R lW"|Sl 0.14 1 0.0001 1 0.138- R 2§XMlllE1 0.13 I 0.0001 1 0.134 i 7 ~~0.12 7 .0001 0.124 | 23| - 0.12 1 0.0001 1 0.120 g lg|gl1 0.12 1 0.0001 1 0.117 E 269X>EE1 0.11 1 0.0001 1 0.114 ANNEX V CoNTRAcTuAL SAVINGS DEVELOPMENT PROGRAM Page 32 of 32 0.11 0.0001 0.110 0.11 0.0001 0.107 0.10 0.0001 0.104 0.10 0.0001 0.101 0.10 0.0001 0.098 0.10 0.0001 0.095 0.09 0.0001 0.093 0.09 0.0001 0.090 0.09 0.0001 0.087 0.08 0.0001 0.085 0.08 0.0001 0.082 0.08 0.0001 0.080 0.08 0.0001 0.078 0.07 0.0001 0.075 0.07 0.0001 0.073 0.07 0.0001 0.071 0.07 0.0000 0.069 0.07 0.0000 0.067 0.06 0.0000 0.065 0.06 0.0000 0.063 0.06 0.0000 0.061 0.06 0.0000 0.059 0.06 0.0000 0.057 ANNEX VI Page 1 of 4 MEXICO CONTRACTUAL SAVINGS DEVELOPMENT PROGRAM CURRENT PENSION SYSTEM Introduction With the passage of legislation in December 1995 reforming Mexico's Social Security Law, Mexico has embarked on a fundamental shift from a publicly-managed, pay-as-you-go social security system, which has been in place for more than fifty years, to a privately-managed, defined contribution system. This annex describes the evolution of the current social security system and its specific characteristics. The Current IVCM2 System Origin and Evolution Mexico's Social Security Law was enacted in 1942. It laid the basis for the founding in 1943 of the Mexican Social Security Institute (Instituto Mexicano de Seguridad Social - IMSS). Although the IMSS-managed pension program was designed to act as a collective fund, financed from contributions from workers, employers and the state, in practice, it operated as a pay-as you-go (PAYG) scheme as the fund's actuarial reserves were used to finance other social insurance activities. The commingling of funds for the different insurance coverages has been a key disincentive for improving the efficiency of IMSS' operations. Affiliation grew rapidly, increasing from 1.1 million to 12 million contributors during the period 1950-1970. Flush with workers' contributions, the social security scheme gradually expanded in terms of benefits and institutions and financed growing public expenditures in other social security programs, especially health. By the end of the 1970s, demographic changes combined with a growing macroeconomic imbalances began to reverse the financial health of the IVCM system. Demographic Change and Inflation From 1950 to 1970, Mexico's population grew at high rates, averaging 3% per year. Economic growth was robust, achieving annual growth rates of 6% while inflation was running on average at less than 4.5% per year. In 1960, Mexico's population structure was youthful. Of 35 million inhabitants, only 5.6% was older than 60 years, while 55% of total population was below 20 years of age. Over the next several decades Mexico's population structure, as shown in Table I below had begun to shift as the rate of population growth decreased and life expectancy began to rise (Table 2). By 1990, Mexico's population had more than doubled at more than 81 million inhabitants. Population growth averaged 1.9% during the 1990s. This Annex is based on a draft prepared by the Ministry of Finance and Public Credit. 2 IVCM is the Spanish acronym for Old Age. Severance, Disability and Life Insurance coverages. ANNEX VI Contractual Savings Development Program Page 2 of 4 Table 1. Population Structure by Age: 1960 and 1990 12000000 10000000 8000000 6000000 4000000- 2000000 0 '9 a CD a u~~~~~ C CD~ to CD to ID C 0 MI C D ml) CD '? q? 'U ' ' 9 '9 '9 O? O CD _ CD . DD _ am _ CD - CD - CD _ _ C' cI Cw7 Cs * sr CD CD ED CD r N_ eo ° |lo 1960 m190 I Table 2. Life Expectancy and Fertility and Mortality Rates LieEpect,ancy ~ ~ Rt *tlt Rtt -t~~~~~~~~~~~~~G 11 Vl ......... :Xe .r-.E- ; flX xS ~~~~~~~~~~~~~~~~~~. .. ....... .. ..... ..... . ................ .... 1970 61.19 6.76 n.a. 1975 63.93 5.97 n.a. 1980 66.68 4.70 6.5 1985 68.76 3.88 5.5 1990 70.83 3.35 5.1 1993 71.54 3.07 4.7 1/ Fertility rate per 1000 women between 15 and 49 years. Estimates by CONAPO, 1994. 2./ Mortality rate per 1000 inhabitants. n.a. not available. Source: President Salinas' Sixth State of the Union Address Although Mexico's population pyramid continued to show an important share of young people, lower population growth and mortality rates have resulted in a rapid aging of IMSS contributors. These changes in population dynamics have lead to an increasing dependency ratio in IMSS. In 1960, as seen in Table 3, there were four pensioners per one hundred contributors. By 1994 this ratio increased to a 12.5 to one hundred. Table 3. Pensioners as a Percent of the Insured Population 1960 1970 1980 1990 1994 IMSS 3.8 6.3 7.6 10.9 12.5 Source: President Salinas' Sixth State of the Union Address This trend is expected to continue as shown in Table 4. Nevertheless, Mexico's current demographic structure remains favorable for minimizing the fiscal costs of the reformed pension system. Contractual Savings Development Program ANNEX VI Page 3 of 4 Table 4. Elderly Dependency Ratio 160000 . 16.00% 140000 : - :- . : -. ;.: ... j : . : 14.00% I 12000012 0 X 100000 . 10.00% O 80000 8.00% z 60000 6.00% o 40000 4.00% 20000200 0 0.00% 1990 2000 2010 2020 2030 YEARS TOTAL POPULATION POPULATION OVER 65 --*-ELDERLY DEPENDENCY RATIO *Elderly dependency ratio = population over 65 years old/ working population SOURCE: OECD The high inflation of the 1980s led to a significant drop in real wages, which fell by 60% between 1980 and 1994. Contributions to the IVCM system began to tail off with the fall in real wages and the real value of pensions eroded. Today nearly 80% of IMSS pensioners receive the minimum guaranteed pension, equivalent to the minimum wage. The weakened linkage between contributions and benefits led to a growing (and largely correct) perception by employers and workers of the IVCM scheme as a payroll tax. Evasion and under-reporting of wages for qualifying and over-reporting for benefits increasingly occurred, further worsening the finances of the IMSS-managed pension scheme. The 1993 Reform In a partial effort to address growing deficiencies in the pension system, the Government introduced the Retirement Saving System (SAR) in 1993 which consisted of a new 2% employer contribution to private and public sector employees channeled into individual retirement accounts. These funds are collected by the commercial banking system and passed to the Central Bank, which guarantees a real rate of return of 2 percent. More than 13.5 million individual SAR accounts were opened by workers in the first year with contributions totaling NP$38.7 billion (US$5.2 billion) by mid-1995. Features of the IMSS-IVCM Pension System Contributions. The total contribution per worker is equal to 8.5% of wages (2.12% individual, 5.95% employer and 0.425% government). The contribution is distributed among the different insurance coverages as follows: * Disability and death 3.0% * Old Age and Severance 3.0% * Medical services for pensioners 1.5% * Administration expenses 0.6% * Social Assistance/ 0.4% 1/Includes cultural activities, theaters, vacation centers, etc. ANNEX VI Contractual Savings Development Program Page 4 of 4 Requirements and Benefits A comparison of eligibility requirements between the old and new pension system is summarized in Table 6 below. Table 6. Eligibility Requirements for Pensions under the Old and New Laws Benefit Old~c Law Ne aw* Disability 150 weekly contributions 250 weekly contributions Professional Risks 150 weekly contributions 150 weekly contributions Death 150 weekly contributions 250 weekly contributions Severance 500 weekly contributions 1,250 weekly contributions and 60 years old and 60 years old Old Age 500 weekly contributions 1,250 weekly contributions and 65 years old and 65 years old * A week is legally defined as seven working days. Disability. To fulfill the requirements for a disability pension, disability must be formally proven. In legal terms, a disability exists when the insured worker is unable to obtain, according to his capacity, professional qualifications and his last job situation, an income above 50% of the his usual wage, and which a similar worker would receive in that same geographic region. Illness or a non-professional accident or physical or mental exhaustion qualify. In order to receive disability benefits, a worker must have contributed to the IVCM system for at least 150 weeks. Despite the existence of a formal process for reviewing disability requests, there has been little incentive for IMSS to enforce the rules. More than 30% of current pensioners have qualified for disability pensions. Old Age and Severance. In order to be entitled to receive an old age pension, it is required that the insured is 65 years old, is currently working and has contributed a minimum of 500 weeks. The same conditions apply for severance except for the minimum age that is 60 years. Death. In case of death, the survivor's pension is paid to the widow and/or dependents, or, in case they do not exist, to the contributor's parents. The insured must have contributed at least 150 weeks. Minimum Pension. The IVCM system contains a guaranteed minimum pension equal to the minimum wage. To address the erosion in the real value of pensions, in 1989 pensions were indexed to changes in the minimum wage. At least 500 weeks of contributions are necessary to qualify for the minimum pension. Pensions are paid according to a complicated formula as contained in the old Social Security Law which favors workers at the bottom of the wage scale. The pension base is calculated as a percentage of the average wage in nominal terms for the last 5 years, plus a fraction for each year of contribution in excess of 10. As wages are higher, the percentage of the pension base is reduced. Pensions may never be higher than the average wage a worker received for the previous 5 years of contributions. As a result of the formula, workers earning more than five minimum wages subsidize minimum wage contributors. Benefits for low income contributors are very high with respect to contributions. Similarly, workers with longer periods of contribution subsidize workers contributing for only the minimum period required. ANNEX VII Page of 1 of 4 MEXICO CONTRACTUAL SAVINGS DEVELOPMENT PROGRAM INFONA VIT 1. The Mexican Constitution (Article 123) establishes a worker's right to housing provided by his or her employer. The interpretation of this constitutional right, particularly how employers should comply with this obligation, has varied since the promulgation of the Constitution in 1917. Prior to 1972, housing issues were largely delegated to the states, or even ignored. In 1972 the Constitution was amended to establish a Fondo Nacional de la Vivienda (National Housing Fund) into which employers would make contributions in benefit of individual employees and thereby comply with their obligations. In the same year, the Instituto del Fondo Nacional de la Vivienda para los Trabajadores (INFONAVIT) was created' to administer this Fund, and to establish and operate a financial system that would permit workers to obtain inexpensive and sufficient housing loans. INFONAVIT's principal source of funds is a 5% payroll tax that employers pay into the Fondo Nacional de la Vivienda on behalf of each enrolled worker. In 1996 this inflow is expected to be N$7.75 billion (approximately US$ 1.0 billion) 2. INFONAVIT is Mexico's principal pension fund for private sector workers and the country's largest single source of housing finance. Since its founding, INFONAVIT has financed 1.3 million housing units, with about half of those having been granted in the last seven years. Throughout its existence INFONAVIT has financed more housing in each sexenio than in the previous one, and, a result, each Mexican President can rightfully claim to have financed more housing through INFONAVIT than his predecessor. The projection for 1996 is for approximately 100,000 loans. (Table 1) TABLE 1 :, . :. : ,: : D . M . :4 - :: -: Originator Units Millions N$ BANKS* 138,839 36.3% 21,000 59.3% OTHER** 108,728 28.5% 4,593 13.0% ThtEONAYIT ,~*.. ::~.:.3 . .__. 0. :;.8. ... FOVI 40,585 10.6% 3,515 9,9% FOVISSSTE 3,564 0.9% 111 0.3% TOTAL 381,956 100.0% 35,409 100.0% * Includes FOVI Program ** Includes Inmobiliarios which fund progressive housing 3. INFONAVIT's structure reflects its mission to provide housing for organized labor. It is governed by a General Assembly of forty-five members, equally divided among representatives of the Executive branch, unions and employer organizations, and is headed by a Director General appointed by the President. All workers in the formal sector are inscribed in the Fund2, which in turn is denominated as the housing subaccount of the SAR. As of July 1995 there were 9 million inscribed workers. INFONAVIT provides "social interest"3 housing loans to its members for: (i) home mortgages; (ii) home improvement; and (iii) refinancing of existing (i.e. provided by private lenders) home mortgages. Most of its loans are home mortgages, made at fixed rates averaging 6% per year on outstanding balances, with maturities up to thirty years. Repayments are fixed at 20-25% of salary and indexed to changes in the minimum wage. Though all employers must contribute on behalf of all employees, loans are made only to a subset of members who must meet a number of eligibility criteria, including age, salary, contribution history and family size. In ILey del Instituto del Fondo Nacional de la Vivienda para los Trabajadores. published in the Diario Oficial de la Federaci6n on April 24, 1972. 2 Inscription requirements are specified in Article 123 of the Constitution. 3 Housing directed at persons earning no more than three times the minimum wage. ANNEX VII CoNTRAcTuAL SAVINGS DEVELOPMENT PROGRAM Page 2 of 4 practice, most loans are made to workers making 2-5 times the minimum wage. To carry out its mandate, INFONAVIT operates much like a retail mortgage finance institution, employing about 4,000 people to originate and service mortgages through a nationwide network of branch offices. 4. From 1972 to 1992 INFONAVIT financed the construction of housing units which were then allocated to eligible workers. Prompted by a deteriorating financial situation, a lack of transparency in awarding housing to workers, and significant evasion or underreporting by employers, the Government introduced a series of reforms in 1992: * INFONAVIT was required to implement a public bidding process for the construction of housing projects, and was prohibited from owning land. This effectively moved INFONAVIT out of the housing development business and into housing finance. * A points system-based on salary, age, balance in the account, the number of payments made by the employer and the number of dependents-was introduced to determine eligibility for an INFONAVIT loan. * Workers were also allowed to purchase used or new housing on the open market, i.e. without having to buy in INFONAVIT sponsored projects. * Accounts were "individualized" and linked to the SAR. Thereafter, each INFONAVIT account was considered the housing subaccount of the SAR. i INFONAVIT was required to manage its finances in such a way as to distribute annual profits to workers' accounts, and, as a minimum, maintain the real value of these same accounts. i Steps were taken to improve INFONAVIT's financial prospects, e.g. 100% loan recovery (based on an average 6% interest rate on the unpaid balance adjusted by the minimum wage increase) and the requirement that operating expenses should not exceed 0.75% of total resources. 5. The 1992 reforms were only partially successful. There have been four major problems. First, the housing developers have been able to circumvent the bidding process. Direct financing of housing construction was to be eliminated and a bidding process for INFONAVIT projects was to be introduced in its place. Under this process INFONAVIT would prepare a housing project and puts its construction out to bid. The winning developer then would obtain a bridge loan from a bank, knowing that mortgage finance will be forthcoming from INFONAVIT. The reforms allowed for direct construction finance (i.e. no bidding), however, in cases where an individual was already the owner of the land. In such case an eligible worker could simply present a project to INFONAVIT, and assuming that the project met financial, technical and legal standards, the worker could select a developer and construction company. In practice, however, developers have deeded their land to a trust in benefit of a group of workers who then present the project to INFONAVIT for direct financing. This avoids the bidding process and allows developers to operate in a pre-1992 fashion. Second, there continue to be administrative obstacles to financing housin2 purchased in the open market. The reforms were intended to introduce an element of competition in social interest housing and in local housing data banks. Under this scheme eligible workers could participate, for example, in housing projects financed by other government institutions (e.g. FOVI). At the same time the opportunity to purchase used housing was viewed as a step towards opening a potentially large market in used housing. Prior to 1992, such housing was not eligible for financing. Eligible workers, however, have been steered away from open market purchases by a series of administrative obstacles, such as the requirement for INFONAVIT's technical review and approval of the purchase. Moreover, beginning in March 1995 INFONAVIT authorized only credits in projects financed under the bidding process or the trust fund ownership scheme. Third, the reforms did not solve the major issue of rationing of housing credits. Eligibility for housing, based on the points system, far outpaces the number of credits that INFONAVIT in a given year. The point system was introduced to provide a fair, transparent mechanism for allocating credits under such circumstances. While it has succeeded to a degree, rationing of housing persists. The number of eligible workers far exceeds, however, the available credits. As a result INFONAVIT is forced to revise the eligibility cutoff level every two months, and in practice raises it to make a smaller number of workers eligible for credits. And, finally, the "individualization" of the SAR accounts (of which INFONAVIT is the housing subaccount) has been slow to materialize. CoNTRAcTuAL SAVINGS DEVELOPMENT PRoGRAM ANNEX VII Page 3 of 4 6. More fundamentally, INFONAVIT faces additional issues - beyond the fine-tuning of operating procedures that has taken place since 1992 - that raise questions about its role in the pension system. Today, INFONAVIT is saddled with conflicting objectives: to operate a housing finance system that provides inexpensive credit for workers and to maintain, as a minimum, the real value of individual workers' contributions to the Fund.4 INFONAVIT is part of a highly segmented housing finance system and was conceived to address a specific market niche. It operates as a retail lender with a captive source of funds, and provides subsidized credit under vauge underwriting standards. Such activities crowd out other sources of market-based housing finance and, moreover, provide an ineffective targeting of subsidies. INFONAVIT's optimal future role, fully consistent with its Constitutional mandate, is that of an indirect investor in the housing sector, i.e. as a purchaser of housing finance instruments issued by banks, FOVI and other institutions. 7. INFONAVIT lacks an appropriate governance structure. Its General Assembly is dominated by potential beneficiaries, i.e. labor unions and property developers, with no countervailing supervisory or regulatory authority. 8. The principal consequence of these fundamental issues and the failure of the 1992 reforms is that INFONAVIT is a weak financial link in the pension system. Real rates of return have been negative in past years. Its portfolio is weak, characterized by excessive number of overdue accounts ( 42% of accounts are estimated to be overdue more than 12 months). Mortgage servicing systems are weak and by law workers are not required to continue making payments when they lose their jobs. Loan recovery rates (net present value basis) are less than 100%, due to underwriting standards that permit excessive borrowing at less than market rates. Overall, individual account holders are forced to absorb these losses. Workers are paid two times the actual level of their contributions, less than one-fifth what they would receive had their contributions earned a 2% real rate of return (Table 2 below). 4 Articles 3 and 39, respectively, of the Ley del Instituto Nacional de la Vivienda para los Trabajadores. ANNEX VII CONTRACTUAL SAVINGS DEVELOPMENT PROGRAM Page 4 of 4 TABLE 2 T EACTUAIA B L N E FA ...................... YEAR ANNUAL ANNUAL INTEREST RATE CONTRIBUTION CPP INFLATION | 2% REAL RATE 1972 0.84 0.07 0.05 0.06 1973 1.34 0.19 0.47 0.52 1974 1.80 0.38 0.93 1.04 1975 2.16 0.70 0.85 1.02 1976 2.67 1.20 3.02 3.35 1977 3.30 1.89 3.61 4.11 1978 3.70 3.06 4.01 4.72 1979 4.97 4.62 9.31 10.54 1980 5.94 8.04 14.59 16.56 1981 7.70 15.60 20.45 23.43 1982 17.79 35.54 108.30 118.62 1983 27.55 85.57 198.25 218.36 1984 44.85 143.83 289.16 322.48 1985 67.20 276.34 538.15 602.22 1986 116.52 716.09 1,584.96 1,761.28 1987 245.83 1,748.27 5,301.79 5,871.65 1988 476.36 2,632.08 4,709.05 5,364.89 1989 571.10 3,245.42 2,834.55 3,456.04 1990 767.83 4,184.59 5,379.29 6,427.96 1991 973.44 3,710.30 4,576.61 5,730.76 1992 188.95 3,818.87 3,464.00 4,652.53 TOTAL N$3,531.84 24,164.50 32,573.25 38,123.98 2 Actual Amount N$7,063.68 Earned Actual Earnings/Potential 29.23% 21.69% 18.53% Earnings ANNEX VIII Page 1 of 2 MEXICO CONTRACTUAL SAVINGS DEVELOPMENT PROGRAM Economic Indicators Actual Projected Indicator 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2005 National accounts (as % GDP at current market pnces) Gross domestic product 100.0 100.0 100.0 1000 1000 100.0 1000 1000 100.0 1000 100.0 1000 Agriculturea 9.1 8 9 8 4 8.2 8 0 8.2 Industry' 30 3 29 6 291 28.2 281 27 8 Servicesa 60.6 61.4 62 5 63 6 64 0 64 0 Total Consumption 78 3 79.7 81.0 81 0 81 6 777 78.7 780 773 76.7 763 75 1 Gross domestic 22.8 23 4 24.4 23 2 23 5 19.4 19 2 20 6 21.9 23 7 24 2 26 3 investment Govenmient investment 4 8 4 5 4.1 4.1 4 2 41 3 8 4.1 4 3 4 6 4 6 4 8 Private investment 136 147 163 159 16.1 123 120 13.2 143 158 16.1 176 Increaseinstocks 45 4.2 39 32 3.1 31 3.3 33 33 3.3 34 39 Exports (GNFS)b 15.6 13 6 12.4 12.2 12 7 24 0 26 2 27 8 29 2 301 30 7 31.3 Imports (GNFS) 16 7 16 8 17.9 16.4 17 8 21.2 241 26.5 28 4 30 5 311 32.7 Gross domestic savings 21.7 20.3 19 0 19 0 18.4 22.3 21 3 22 0 22 7 23 3 23.7 24 9 Grossnationalsavings' 198 18.4 170 169 16.0 187 17.9 190 200 216 221 243 Memorandum items Grossdomesticproduct 247057 290529 334356 367581 377112 250038 289920 305128 324538 348739 376597 556562 (US$ million at current prices) Grossnationalproductper 2450 2981 3490 3810 4090 3320 2964 2897 3223 3445 3658 5100 capita (US$, Atlas method) Real annual growth rates (%, calculated from 1980 prices) Gross domestic product at 444% 3.6% 2 9% 0.7% 3 5% -69% 3 0%/ 3 5% 4 0% 5 0l/ 5.0% 5 3% market prices Gross Domestic Income 56%/ 3.2% 32% 08% 3.4% -11 1% 23% 31% 36% 4.7% 48% 5 1% Total consumption 55% 48% 37% 04% 35% -11.7% 0.4% 08% 2.1% 34% 40% 4 5% Private consumption 6.1% 4 9% 3.9% 02% 3 7% -12.9% 1 0% 1 2% 2 3% 3 5% 40% 45% Real annual per capita growth rates (%, calculated from 1980 pnces) Gross domesticproduct at 0.5% 1.6% 09% -12% 1.6% -86% 1.1°': 17% 22% 33%. 3.4,: 37% macket pnces (Continued) ANNEX VIII Page 2 of 2 MEXICO CONTRACTUAL SAVINGS DEVELOPMENT PROGRAM Economic Indicators (continued) Actual Projected Indicator 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2005 Public flnance (as % of GDP at current market prices)' Currentrevenues 27.0 25.8 26.1 25.4 25.6 26.9 25.4 25.5 25.7 26.0 26.2 26.6 Current expenditures 26.3 22.5 20.6 21.8 21.8 23.1 22.6 22.8 22.5 22.4 22.2 21.6 Current account surplus(+) 0.7 3.3 5.5 3.6 3.8 3.8 2.8 2.7 3.2 3.6 4.0 5.0 or deficit (-) Capital expenditure 3.8 3.9 4.0 3.3 4.2 3.7 3.5 3.7 3.8 3.9 4.2 4.9 OverallBalance -3.1 -0.6 1.5 0.3 -0.4 0.1 -0.7 -1.0 -0.6 -0.3 -0.3 0.1 Monetary Indicators M2IGDP (at current market 26.3 30.7 31.3 32.0 34.9 38.5 .. . . . pnces) Growth ofM2(%) 46.2 47.1 20.3 13.4 21.3 38.7 Pnvatesectorcreditgrowthl 83.7 105.2 161.5 193.3 139.9 43.1 total credit growth (%) Price indices( 1980 =100) Merchandise exportprice 87.3 82.3 84.9 86.4 95.8 110.6 112.1 115.1 118.7 122.1 125.1 139.8 index Merchandisenimportprice 1344 135.6 137.1 138.5 141.7 153.5 151.0 154.7 158.9 162.8 166.7 188.2 index Merchandise terms of trade 65.0 60.7 61.9 62.4 67.6 72.0 74.2 74.4 74.7 75.0 75.0 74.3 index Real exchange rate 128.8 117.5 107.4 101.5 105.3 152.8 135.0 135.0 135.0 135.0 135.0 135.0 (US$/LCU)' Consutnerpriceindex 26.7% 22.7% 15.5% 9.8% 7.1% 34.9% 39.0% 19.8% 10.8% 80% 6.0% 5.0% (% growth rate) (period average) Consumerpriceindex 29.9% 18.8% 11.9% 8.0% 7.0% 51.3% 27.0% 12.5% 9.0% 7.0% 5.0% 5.0% (% growth rate) (end-of-period) GDP deflator 29.8% 21.8% 14.7% 9.9% 7.4% 35.4% 33.8% 17.8% 9.8% 7.2% 5.6% 4.9% (% growth rate) a. GDP components are at market prices. b "GN'FS" denotes "goods and nonfactor services." c. Includes net unrequited transfers excluding official capital grants. d. Consolidated non-financial public sector. e. "lCU" denotes 'local currency units." An increase in US$/LCU denotes appreciation. Annex IX Page 1 of I MEXICO CONTRACTUAL SAVINGS DEVELOPMENT PROGRAM Balance of Payments Actual Projected Indicator 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2005 (IJS$m) Exports (GNFS)' 38411 39695 41451 44872 50717 63532 76070 84948 94695 105119 115434 174227 Merchandise FOB 30390 30905 32259 35453 40416 53362 65047 72923 81138 89896 98781 148078 Imports (GNFS)' 41215 48725 59681 60473 71136 55203 69937 80734 92258 106427 117253 182047 Merchandise FOB 31272 38184 48193 48924 58880 46274 57816 67574 77065 89197 98405 152521 Resource balance -2804 -9030 -18230 -15601 -20419 8329 6133 4214 2437 -1308 -1819 -7819 Net current transfers 3978 2745 3386 3640 4011 3965 4101 4354 4520 4525 4803 10601 (including official current transfers) Current account balance -7451 -14892 -24438 -23399 -29419 -655 -3563 -4967 -6276 -7163 -7735 -11254 (aiter official capital grants) Net private foreign direct 2633 4761 4393 4389 10973 6964 5800 6000 6400 7100 9600 9700 investment Long-tern loans (net) 9224 4171 51 3227 4271 7817 354 1836 363 1749 78 -1802 Official 4181 1392 620 20 -624 10341 -7113 -385 -2718 -3343 -1088 -123 Private 5043 2779 -569 3207 4895 -2524 7467 2221 3080 5092 1166 -1680 Othercapital(net including -1175 14099 21168 21724 -4216 -3275 -1991 1308 1155 1570 3813 6622 errors and omissions) Change inreserves' -3231 -8139 -1174 -5941 18391 -10851 -600 -4177 -1642 -3256 -5756 -3266 Memorandum items Resource balance (% of -1 1% -3 1% -5.5% -4.2% -5.4% 3.3% 2.1% 1 4% 0 8% -0 4% -0.5% -1.4% GDP at current market prices) Current account balance (% of -3.0% -5.1% -7 3% -6.4% -7.8% -0 3% -1 2% -1.6% -1.9% -2 1% -2.1% -2.0% GDP at current market prices) Reservesinrnonths of imports 38 5.6 47 6.2 13 4.4 32 3.1 2.7 2.4 2.5 3.6 of goods a 'GNFS' denotes 'goods and nonfactor services." b. Includes use of IMF resources. ANNEX X Page 1 of 1 MEXICO CONTRACTUAL SAVINGS DEVELOPMENT PROGRAM External Capital and Debt Actual Projected Indicator 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2005 Totaldebtoutstandingand 104439 114065 112227 127436 136125 161096 159048 159731 160730 161155 159889 173482 disbursed (TDO) (US$m)a Net disbursements (US$m)a 17637 10117 2162 4798 7475 16466 -6295 -2629 -2581 -3107 -4463 -410 Total debtservice (TDS) 11316 13545 20822 21931 19938 29206 39280 34481 41118 45909 47374 50296 (US$m)a Debt and debt service indicators (%) TDO/XGSb 25.9 249.5 238.6 254.7 239.9 229.7 191.4 173.4 157.2 142.8 129.5 91.4 TDO/GDP 42.3 39.3 33.6 34.7 36.1 64.4 54.9 52.3 49.5 46.2 42.5 31.2 TDS/XGS 25.9 29.6 44.3 43.8 35.1 41.6 47.3 37.4 40.2 40.7 38.4 26.5 TDS/(XGS+ curenttransfers 26.7 31.9 46.4 45.2 36.4 43.3 48.9 38.6 41.4 41.9 394 27.2 ConcessionaVTDO 1.0 1.0 1.1 1.1 1.2 0.0 0.0 0.0 0.0 0.0 0.0 0.0 IBRD exposure indicators (%) IBRDDS/publicDS 16.2 16.6 11.2 15.5 15.1 13.2 8.4 11.0 9.1 8.2 7.8 8.3 PreferredcreditorDS/public 39.3 36.5 22.9 33.3 31.1 24.1 21.5 25.9 26.2 31.0 24.9 14.6 DS IBRDDS/XGS 3.6 4.0 4.0 3.8 3.5 3.4 3.0 2.8 2.5 2.4 2.2 1.4 ShareoflBRDportfolio 11.4 11.7 121 11.9 11.8 12.0 12.3 12.4 11.9 11.1 10.2 8.2 IFC (US$m) Loans 119 69 67 53 133 63 194 310 340 375 400 420 Equity and quasi-equityc 20 60 64 36 21 12 38 75 85 90 100 105 MIGA MIGA guarantees (USS$m) 0 0 0 0 0 0 0 .. .. a. Includes public and publicly guaranteed debt, private nonguaranteed, use of IvF credits and net short- term capital. b. 'XGS' denotes exports of goods and services, including workers remittances. c. Includes equity and quasi-equity types of both loan and equity instuments. ANNEX Xl Page 1 of 3 MEXICO CONTRACTUAL SAVINGS DEVELOPMENT PROGRAM STA TUS OF BANK GROUP OPERATiONS IN MEXICO A. S TA TEMENT OF BANK LOANS (as of September 27, 1996) ORIO]NAL AMouNT iN US$ MITIIONS LOAN OR CREDIT FISCAL BORROWER PURPOSE IBRD IDA UNDISBTURSED No. YEAR L28240 1987 BANOBRAS URBN TRNSPRT I 125.00 0.00 8.63 L29160 1988 NAFINSNC STEELRSTRCTRNG 400.00 0.00 .56 L32720 1991 NAFIN BASICHEALTH 180.00 0.00 11.77 L33590 1991 NAFIN MINING SCTR 200.00 0.00 51.93 133580 1991 NAFIN VOCTRNGSCTR 152.00 0.00 22.52 L34190 1992 NAFINSA IRRIGSCTR 400.00 0.00 115.55 L34750 1992 NAFIN SCIENCE/TECH 189.00 0.00 10.03 134070 1992 NAFIN PRIMARY EDUCATION 250.00 0.00 26.85 L34970 1992 GOVERNMENTOFMEXICO HOUSINGMARKETDEVEL 450.00 0.00 47.35 134610 1992 ENVIRON/NATURLRESOU 50.00 0.00 5.61 135590 1993 BANOBRAS MEDIUM CITIES TRANSP 200.00 0.00 169.85 135430 1993 NAFIN TRNSPRT AIR POLL CON 220.00 0.00 123.08 L35180 1993 GOVERNMENT OF MEXICO INITIAL EDUCATION 80.00 0.00 46.92 L36280 1993 BANOBRAS HWY RHB & SAFETY 480.00 0.00 273.16 L35420 1993 NAFIN LABORMARKET&PROD. 174.00 0.00 50.51 L37520 1994 BANOBRAS SOLID WASTEII 200.00 0.00 55.31 L37040 1994 NAFIN ON-FARM&MINORIRRI 200.00 0.00 149.90 L37510 1994 BANOBRAS WATER/SANIT II 350.00 0.00 219.21 L37500 1994 BANOBRAS N. BORDER I ENVIRONM 368.00 0.00 178.88 127220 1994 NAFIN PRIM.EDUC.II 412.00 0.00 313.61 L38380 1995 NAFINSA FINANCIAL SEC T.A. 23.60 0.00 17.67 138381 1995 NAFINSA FINANCIALSECT.A. 13.80 0.00 13.80 L38050 1995 NAFIN TECH EDU/TRAING 265.00 0.00 212.89 L39120 1995 NAFIN ESSENTIALSOCIALSER 500.00 0.00 192.23 137780 1995 GOVERNMENT RAINFED AREAS DEVELO 85.00 0.00 63.72 137900 1995 SEDESOL SECOND DECENTRALZTN 500.00 0.00 345.89 L39370 1996 NAFIN INFRA. PRIVATZTN TA 30.00 0.00 27.05 L39430 1996 NAFIN BASIC HLTH II 310.00 0.00 297.00 L40500 1996 GOM WATER RESOURCES MANA 186.50 0.00 186.50 L41010 1997 TBD RURALFIN. MKTS T.A. 30.00 0.00 30.00 7,023.90 0.00 3,267.99 Active Loans Closed Loans Total Total Disbursed (IBRD and IDA): 3,066.42 17,997.81 21,064.23 of which has been repaid: 211.57 8,892.88 9,104.45 Total now held by IBRD and IDA: 6,122.84 9,104.93 15,227.77 Amount sold: 0.00 92.34 92.34 Of which repaid: 0.00 92.34 92.34 Total Undisbursed: 3,267.99 0.00 3,267.99 a. Intended disbursements to date minus actual disbursements to date as projected at appraisal. b. Rating of 1-4: see OD 13.05. Annex D2. Preparation of hnplementation Summary (Form 590). Following the FY94 Annual Review of Portfolio perfomiance (ARPP), a letter based system will be used (HS = highly Satisfactory, S = satisfactory, U = unsatisfactory, HU = highly unsatisfactory): see proposed Improvements in Project and Portfolio Performance Rating Methodology (SecM94-90 1), August 23, 1994. c. Following the FY94 ARPP, "Implementation Progress" will be reported here. ANNEX XI CONTRACTUAL SAVINGS DEVELOPMENT PROGRAM Page 2 of 3 B. STATEMENT OFIFC'S COMMITTED AND DISBURSED PORTFOLIO (as of August 31, 1996) (US$ million) COMMITTED DISBURSED ----IFC-… I FY APPROVAL COMPANY LOAN EQUITY QUASI PARTIC LoAN EQUITY QUASI PARTIC 1978 TEMEX 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 1979 Camino Real 0.00 2.27 0.00 0.00 0.00 2.27 0.00 0.00 1979 CONDUMONT 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 1981 Camino Real 0.00 .83 0.00 0.00 0.00 .83 0.00 0.00 1984 Metalsa 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 1984 Primex 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 1986 Camino Real 0.00 1.10 0.00 0.00 0.00 1.10 0.00 0.00 1987 CALICA 4.37 0.00 0.00 0.00 4.37 0.00 0.00 0.00 1987 Metalsa 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 1987 VULICA 12.00 0.00 0.00 0.00 12.00 0.00 0.00 0.00 1988 Apasco 5.75 0.00 0.00 0.00 5.75 0.00 0.00 0.00 1988 Sigma 0.00 0.00 .50 0.00 0.00 0.00 .50 0.00 1989 Banca Serfin 40.00 0.00 0.00 0.00 40.00 0.00 0.00 0.00 1989 Cemex 5.57 0.00 0.00 3.00 5.57 0.00 0.00 3.00 1989 Grupo FEMSA 20.00 16.78 0.00 0.00 20.00 16.78 0.00 0.00 1990 Banca Serfin 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 1990 BANAMEX 26.77 0.00 0.00 6.35 24.37 0.00 0.00 6.35 1990 Condumex 12.41 0.00 0.00 8.69 12.41 0.00 0.00 8.69 1990 Indelpro 9.92 0.00 6.25 .38 9.92 0.00 6.25 .38 1990 PetrOcel 10.40 0.00 4.80 5.60 10.40 0.00 4.80 5.60 1990 Primex .60 0.00 3.51 2.00 .60 0.00 3.51 2.00 1991 Apasco 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 1991 Condumex 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 1991 CALICA 10.09 0.00 0.00 0.00 10.09 0.00 0.00 0.00 1991 CONDUMONT .22 0.00 0.00 0.00 .22 0.00 0.00 0.00 1991 GIBSA 12.02 0.00 0.00 47.50 12.02 0.00 0.00 47.50 1991 Indelpro 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 1991 Vitro 0.00 10.17 0.00 0.00 0.00 10.17 0.00 0.00 1991 Vitro Flotado 15.65 0.00 0.00 31.79 15.65 0.00 0.00 31.79 1991 CEDETEL 4.38 .77 10.00 30.26 1.88 .77 10.00 30.26 1992 Aislantes Leon 3.50 0.00 3.50 0.00 3.50 0.00 3.50 0.00 1992 Apasco 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 1992 Banorte-Arancia 5.74 0.00 0.00 0.00 5.74 0.00 0.00 0.00 1992 Banorte-SABROZA 3.00 0.00 0.00 0.00 3.00 0.00 0.00 0.00 1992 BANAMEX 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 1992 Grupo Posadas 12.74 0.00 0.00 34.94 12.74 0.00 0.00 34.94 1992 GrUpo Probursa 0.00 7.50 0.00 0.00 0.00 7.50 0.00 0.00 1992 Indelpro 1.25 0.00 1.17 0.00 1.25 0.00 1.17 0.00 1992 Toluca Toll Road 8.99 0.00 0.00 0.00 8.99 0.00 0.00 0.00 1992 Vitro 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 1992 Banorte-PYOSA 7.62 0.00 0.00 0.00 7.62 0.00 0.00 0.00 1993 Apasco 6.00 0.00 0.00 44.00 6.00 0.00 0.00 44.00 1993 Derivados 11.00 0.00 0.00 24.07 11.00 0.00 0.00 24.07 1993 GrUpo Posadas 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 1993 GIDESA 15.00 8.00 0.00 38.25 15.00 8.00 0.00 38.25 1993 Masterpak 12.00 0.00 0.00 25.93 12.00 0.00 0.00 25.93 1993 GOTM 1.55 2.00 0.00 1.98 1.55 2.00 0.00 1.98 1994 Aurum-Heller 0.00 .98 0.00 0.00 0.00 .98 0.00 0.00 CoNTRAcTuAL SAVINGS DEVELOPMENT PROGRAM ANNEX XI Page 3 of 3 B. STATEMENT OF IFC'S COMMITTED AND DISBURSED PORTFOLIO (as ofAugust 31, 1996) (US$ million) COMMITTED DISBURSED - -----WIFC-- FY APPROVAL COMPANY LOAN EQUITY QUASI PARTIC LOAN EQUITY QUASI PARTIC 1994 CTAPV 5.00 0.00 2.31 0.00 5.00 0.00 2.31 0.00 1994 Interceramic 15.00 0.00 6.00 17.50 15.00 0.00 6.00 17.50 1994 Metalsa 11.00 0.00 6.00 42.00 11.00 0.00 6.00 42.00 1994 MEXCOBRE 22.38 0.00 0.00 31.33 22.38 0.00 0.00 31.33 1994 Sigma 20.00 5.00 0.00 20.00 20.00 5.00 0.00 20.00 1994 TEMEX 18.92 0.00 0.00 18.33 18.92 0.00 0.00 18.33 1995 Apasco 20.00 0.00 0.00 80.00 20.00 0.00 0.00 80.00 1995 Baring Mex. FMC 0.00 .15 0.00 (.00 0.00 .15 0.00 0.00 1995 Baring Venture 0.00 6.50 0.00 0.00 0.00 .98 0.00 0.00 1995 Cifunsa 18.00 0.00 0.00 12.00 18.00 0.00 0.00 12.00 1995 Grupo Posadas 0.00 0.00 0.00 0.00 (.00 0.00 0.00 0.00 1995 Mexplus Puertos 0.00 1.04 0.00 0.00 0.00 1.04 0.00 0.00 1995 MEXCOBRE 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 1995 Sigma 0.00 0.00 0.00 12.00 0.00 0.00 0.(0 12.00 1996 Aurum-Heller 0.00 1.00 (.00 0.(( 0.0( 1.00 0.00 0.00 1996 Baring Mex. FMC 0.00 .03 0.00 0.00 0.00 .02 0.00 0.00 1996 Grupo Posadas 15.00 5.00 5.00 25.00 15.00 5.00 5.00 25.00 1996 GrUpo Probursa 0.00 .98 0.00 0.00 0.00 .98 0.00 0.00 1996 GIBSA 30.00 0.00 10.00 100.00 30.00 0.00 10.00 100.00 1996 Metalsa 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 1996 NEMAK 24.00 0.00 6.00 35.00 0.00 0.00 6.00 0.00 1997 Grupo Probursa 0.00 .57 0.00 0.00 0.00 .57 0.00 0.00 Pending Commitments 1996 * BANCO 100.00 0.00 0.00 200.00 NACIONAL 1996 * GIRSAI 30.00 0.00 10.00 115.00 1996 * PROBURSA RI II 0.00 .23 0.00 (.00 ANNEX XII Page I of 2 MEXICO CONTRACTUAL SAVINGS DEVELOPMENT PROGRAM SUPPLEMENTARYDATA SHEET Section I: Timetable of Key Events (a) Time taken by the country to prepare the loan: 13 months (b) Project prepared by: Ministry of Finance (SHCP) and CONSAR (c) First presentation to the Bank: September 1995 (d) Departure of Appraisal Mission: May 1996 (e) Completion of Negotiations: October 2, 1996 (f) Planned date of effectiveness: November/December 1996 Section II: Special Implementation Actions None Section m: Special Conditions Actions taken before Board Presentation: (i) Reform of Old Age Insurance System: Congress approved reforms to the Social Security Law to reform IMSS and move to a defined contribution scheme for private sector workers; (ii) Regulation of pension fund administrators and supervision of the reformed system: enacted the Ley de Coordinaci6n de Fondos de Ahorro para el Retiro containing guiding principles acceptable to the Bank; finalized of draft key regulations on fund administration and the investment management regime containing guiding principles acceptable to the Bank; (iii) Fiscal transition costs: (a) completed sensitivity analysis and satisfactory evaluation of actuarial methodologies and data base; (b) agreed to publish annually the actuarial income and expenses for IVCM programs to make fiscal transition costs explicit; (c) adopted transfer arrangements for accumulated SAR balances (5/1992-1996) from the central bank to AFOREs over a period of four years; (iv) INFONAVIT: initiated measures to improve financial performance including: (a) initiation of a regular supervisory process by CNBV; and (b) establishement of disclosure requirements for the returns obtained by INFONAVIT; and (v) Account individualization and strengthening of IMSS: (a) CONSAR signed agreements with IMSS, ISSSTE, and INFONAVIT to use one number to uniquely identify SAR and SIEFORE accounts and to interchange and reconcile account information for each contributor; (b) CONSAR issued circulars providing rules for identification of accounts and account transfers and to individualize aggregated contributions of multiple contributors; and (c) special agreement signed between CONSAR/SHCP and IMSS to strengthen its capacity to manage the implementation of the new operational scheme. ANNEX XII CONTRACTUAL SAVINGS DEvELOPMENT PROGRAM Page 2 of 2 The following policy actions would be taken prior to Effectiveness: (i) Regulation of pension fund administrators and supervision of the reformed system: issuance by CONSAR of key regulations containing guiding principles acceptable to the Bank; and (ii) Investment management rules: issuance by CONSAR of key regulations containing a series of general principles governing investment management rules and principles acceptable to the Bank. ANNEX XHI Page I of 2 MEXICO CONTRACTUAL SAVINGS DEVELOPMENT PROGRAM _______________ MEXICO AT A GLANCE PE~~~~~~~~~~~T~~~~~~~~AL ~ ~ ~ ~ r: uIo .. ........le '!wdrb;.: ....om Development diamond* .... .. .. m .d..0 ...lna ..... . 442. Life expectancy GNP p~~r~spita ~~9954US$-) 332 :332 430Q4 P~UIatott~% . ....... . ..G. L $ , 7Gross . ... .....per primary Ott.i" s e ha !O) capita enrollment ~~ovey:ad~~untinde%ofpopL~~~Iaf0. .. .... . 3 L 0expectanoy a ....eaa)7 .. Child mnlnutrittott (~~~~ c#ch#(o*eituodeo'5) ~Access to safe water llIoteyf~~~dpopuM~~oita~e 154 .......... .1 ~~~~~ v~~~o ~ 13 Mexico .'Upper-middle-in come group is7~~~~ 1~4 ~~ Economic ratioe* * 23,5 19.4 ~~~~Openness of economy PO., ...... iqP$ Av'0s(IP . i d5, 18.4.. ; . . -4.4 0.4 ~ic . 5 ~. vng nesmn P*0$e,K~~~~~~~~~r~~~)P . . 32.7~... . ... P~esntvakePlebV~.. . ......... . ..Idetdns ( qf~~~~~~~~~t~~~~~W tl~~~~~~~~~ .... .... ... . ... . -Me ic (% of GDP) Growth rates of output andInvestment % Serice 59.4 57.4.64.0.64.1.. Prvt con. uptio 71..64..70..67. .aerg annual. grormidlwncmegru Agrculur 3.G03 4.P-. Growth rates of exortsu and invsmeort I/% Industry 59.2 23.4 48.1 -78. 1o Manufacturing 41.4 23.8 39 6 1-.4 I20 Services 59.4 27.0 340 -67 40 Private consumption 41.1 34.8 370. -12.9 .20GD General government consumption 6.6 1.2 21. 5 0-4. 2 Imports of goods and non-factor services 2.8 13.3 12.9 -27.6 Agrossuntiona prdc3.5 2.2 3.1 -38. Grwh -aesoexports andimportsI% IThediaoduhwsorkyiniaosintecutryi od compared4. witit inoegopaeae.I3aaaemsin,tedaodwl brvae iconsmplte. 372 ANNEX XIII CONTRACTUAL SAViNGS DEVELOPMENT PROGRAM Page 2 of 2 Mexico PRICES and GOVERNMENT FINANCE 1975 1985 1994 1995 inflation (%) Domestic prices (% change) 40 Consumer prices (period average) .. 57.7 7.1 34.9 Implicit GDP deflator (period average) 15.5 56.2 7.4 35.4 20 Govemment f1nance c (% of GDP) 90 01 92 93 94 95 Current revenue .. 31.5 25.6 26.9 Current budget balance .. -1.6 3.8 3.8 Overall surplus/deficit .. -6.2 -0.4 0.1 -GDPdet. CPI(periodaye) TRADE 1976 1986 1994 1996 Export and Import levels (mill. US$ (millions USS) Total exports (fob) .. 22931 40416 53362 Fuel .. 14767 7445 8422 80000 n.a. ~~~~~~~~~~~~~~~~~~~~~~~~~~~~40000 arhl Manufactures . 6245 29936 40379 400 -11r _ Total imports (cif) .. 14533 58880 46274 20000 I 11.L + 11 Food ..1082 9510 5335 Fuel and energy ..__ _I___ _I___ __ _ __ __ _ Capital goods .. 3165 13322 8697 89 90 01 92 93 94 95 Export price index (1987=100) .. 125 110 122 Import price index (1987=100) .. 99 119 123 C Exports O Imports Terms of trade (1987=100) . 127 93 99 _ BALANCE of PAYMENTS 1975 1985 1994 1995 (millions US$) Exports of goods and non-factor services 6066 27726 50717 63532 Current account balance to GDP rafto (%) Imports of goods and non-factor services 8466 19915 71136 55203 0 Resource balance -2400 7811 -20419 8329 90 91 92 03 94 99 Netfactorincome -1783 -8996 -13012 -12948 Net current transfers 59 1986 4011 3965 4- . Current account balance, before official transfers -4124 801 -29419 -655 3 L Financing items (net) 4327 -3222 11028 11505 -8 Changes in net reserves (- = increase) -204 2421 18391 -10850 Memo: Reserves including gold (mill. US$) 1897 4997 6300 16870 Conversion rate (loca/US$, pe3iod average) 1.25E-02 0.3 3.4 6.4 EXTERNAL DEBT and RESOURCE FLOWS 1976 1986 1994 1995 (millions US$) Total debt outstanding and disbursed 18231 96867 136125 161096 IBRD 1123 4034 13038 13824 IDA 0 0 0 0 Composition of total debt,1995 lii. US$) Total debt service 2613 15293 19938 29206 G A C IBRD 116 597 1990 2375 3584e 1369861 IDA 0 0 0 0 D Composition of net resource flows t 48I9 Official grants 8 78 47 . 19755 Official creditors 381 809 -623 10341 F Private creditors 3365 -831 4985 -2424 70866 Foreign direct investment 609 491 10973 6964 Portfolio equity 0 0 4088 519 World Bank program Commitments 310 928 2815 1877 A - IBRD E - Bilateral Disbursements 188 840 943 1733 B - IDA D - Other multilateral F - Private Principal repayments 39 335 1065 1411 C-IMF G- Short-term Netflows 150 505 -123 322 Interest payments 78 262 924 964 Net transfers 72 243 -1046 -642 1-4 CD ['-. Li CL4 T- N- - lC E- F