As 2010 was drawing to a close, the Mexican mass media devoted a river of ink to the possibility that a major crisis was brewing in the country's pension system, endangering the economic security of many workers who are close to retirement age. The controversy was sparked by the announcement by Daniel Karam Toumeh, director general of the Mexican Social Security Institute (IMSS) — the entity that brings together the government, workers and employees, and provides them with retirement and health services — that IMSS' debt was equivalent to 56% of the country's gross domestic product.

Toumeh also announced that the IMSS's approach to handling retirement pensions and health insurance was the factor responsible for most of the organization's deficit. He told the media that if measures were not taken to alleviate the structural financial problems of the IMSS, the quality of health care, and access to it, would be drastically reduced.

Since then, Toumeh's comments have set off a fierce debate about how much the Mexican pension system really costs the country. Nevertheless, experts told Universia-Knowledge at Wharton recently that it is a half-truth to state that there is a "pension crisis" in Mexico. To be sure, they say, some sectors of the population, grouped together into public retirement programs, have not been adequately reformed in recent decades, and they are approaching a critical situation. However, the active population in the "formal" sector still has good prospects for its future retirement. The chief challenge, experts add, lies in "formalizing" the employment status of the overall population, and making sure that employer and employee contributions for retirement and Social Security become universal, or at least the general pattern.

For most workers in the formal sector of the population, Mexico's pension system consists of workers making contributions that eventually fund their retirement. This approach replaces a structure in which the contributions of currently employed workers were used to fund payments to retired people. The new system drastically reduces the problems caused by the so-called "demographic transition" that is happening worldwide as a result of the reduction in birth rates and the increase in the life span. Mexico's pension structure is public, but the administrators of the retirement funds, known as "Afores," are private. In this way, the various administrators compete among themselves to manage the individual funds of each worker.

The change in the system went into effect in 1997, during the administration of Mexican President Ernesto Zedillo. The goal was to reduce the fiscal burden that retirees represented for the government, and to make workers individually responsible for their future savings. The new system does not entirely eliminate those pensions that had existed under the previous scheme, since they were rights acquired by workers who contributed under the previous regime. But those workers, when they retire, will now be able to choose between a pension that was authorized under the previous scheme and one that is the equivalent of their individualized account.Despite all the changes that have been introduced, the retirement plans of government workers, the Armed Forces and Pemex, the giant state-run oil company, have yet to be reformed.

Not a Question of Financing

Alejandro Villagómez, professor and researcher at CIDE, an educational research center, notes that, unlike the situation in Europe, there is no problem when it comes to financing the Mexican pension system. "The problem is that the system is fragmented and that, within it, there are some programs that will eventually not be financially viable. For example, those programs that cover state workers in many states of the Republic, and the public universities."

Gabriel Martínez, professor of labor economics at ITAM, the Autonomous Technological Institute of Mexico, agrees. Martínez, who is also secretary general of CISS, the Inter-American Conference on Social Security, says, "In reality, the system is a mixture of various programs. Among these, the insurance program for work-related disabilities and risks is very solvent. As for the Afores, the level of savings is very high. In Mexico, between 12% and 13% of total salaries are devoted to financing old-age pensions." Nevertheless, Martinez warns that while this percentage looks very good on paper, "of this money, five of those percentage points go to the housing fund, which has historically not had very good returns." This fund is used for buying and remodeling homes, and it can be accessed at any time during one's working career.

For his part, Manuel Garcia Huitrón, professor of financial microeconomics at ITAM, stresses that in the past, the system has demonstrated its capacity to survive. "The pension reform of 1995, which went into effect in 1997, prevented the collapse of the country's public finances," he says, because the contributions of active workers did not then seem sufficient to sustain retirees. Garcia Huitrón, a recognized researcher in this area, adds that the system has since revealed its true strength. "SAR [literally, the Retirement Savings System], as the new system is called, not only survived the global financial crisis, but was able to recover quickly from the impact of the crisis." Even better, the multi-funded design of SAR involves a life-cycle scheme known as the "Siefores." This family of five investment funds is characterized by the strategy that, the younger a person is, the more diversified the investments made with his or her funds. The closer the person gets to retirement, the more conservative those investments become. This system "provides more protection to workers who are closer to retirement," according to Garcia Huitrón.

Garcia Huitrón adds that almost 14 years after SAR was created, "More than 41 million registered accounts are administrated daily by the Afores, making SAR the financial service with the greatest [market] penetration in the history of the country." Garcia Huitrón notes that the Afores annually receive, register, and invest the equivalent of about 8.3 billion U.S. dollars (at the current peso-dollar exchange rate.) "The results show that SAR functions in accordance with our expectations, since the contributions made by millions of workers have been regularly transferred to their individual accounts. On the other hand, the Afores also comply with their legal obligations; the assets of individual SAR members are secure, and can be continuously monitored through their individual accounts and other services offered by the Afores. In addition, these investments have generated an average rate of return that is quite competitive, and there have been no frauds or breakdowns in this business."

Coverage Concerns

However, not all that glitters is gold. Experts agree that one of the main challenges facing the system is to achieve coverage for the entire population. According to IMSS, in November 2010 a total of only 14,736,752 formally-employed workers were registered. However, according to the National Institute for Statistics and Geography, during the third quarter of 2010, there were 47.1 million economically active people in Mexico — or more than three times as many workers as in the "formal" labor sector.

The real problem, according to Martínez, is that the system doesn't cover those people, and that many people contribute to the system for only brief periods of time i.e. when they are formally employed. "Someone who contributes for 30 years to the Social Security system will have an adequate pension, which will enable him to maintain a level of life equivalent to what he had during his working years. The problem is that in Mexico, there are so many people who don't have more than 10 to 15 years to make their contributions." In his view, the problem could be eliminated "if contributions to Social Security became obligatory, regardless of the source or the type of income." Martinez estimates that for the system to provide an adequate pension, it would be necessary for men to make contributions for about 35 years, and for women to do so for about 30 years (since women work fewer years than men.)

Martinezbelieves that the origin of the problem is not in the pension system itself, but in the labor market, the tax laws, and the regulations regarding industry and trade. "Day by day, for both workers and companies, it is becoming more convenient to reduce the fiscal and social burden of salaries, and to compensate people with higher current incomes rather than formal jobs. Labor regulations and tax laws permit workers to receive professional fees, and service providers to avoid paying their Social Security and pension contributions, so that they can increase the current income of informal workers and reduce the tax burden of employers."

Garcia Huitrón, co-author of "New Policies for Mandatory Defined Contribution Pensions," notes that the Mexican system for retirement savings "faces important challenges for maximizing expectations about pensions, mainly relating to competition between its administrators, as well as the optimization of investment regulations."

Nevertheless, from a global perspective, perhaps the main challenges of the Mexican pension system come from outside SAR; that is to say, from the interaction and compatibility of SAR with other public pension systems in Mexico, and with conditions in the Mexican labor market. This factor, Garcia Huitrón notes, "affects the coverage and size of the contributions of those people who belong to the system, as well as the current social protection system in Mexico, while it also generates perverse incentives when it comes to informality."

García Huitrón also mentions the ideas of Santiago Levy, former director of the IMSS. In his book, "Good Intensions, Bad Results," Levy noted, "The continuous passage of Mexican workers back and forth between formality and informality constitutes one of the main obstacles for the accumulation of resources aimed at the goal of [building up individuals'] pensions. This is the case because when people participate in the informal labor market, it interrupts their contributions to their individual accounts."

Alejandro Villagómez, a researcher of pensions and social security, agrees that the structure of the labor market is a source of problems. "The way the social security system is structured, it generates incentives, in the broadest sense, for workers to prefer to stay within the informal sector, rather than get into the so-called formal system. The informal market is a very large part of the economy, and not all informal workers are covered, since it is floating population."

On the other hand, he notes, "This is a fragmented system, in which there are a lot of people who are not covered. Among the programs that exist, yes, there has been progress in the reforms of IMSS and ISSSTE, the social security institute for government workers, which is authorized to provide social security benefits to government workers."

However, he warns, "There is still a long way to go in order to achieve broader coverage and make progress toward a convergence of the various programs. The ISSSTE program is beginning to get closer to the IMSS program; that is to say, to incorporate its new workers into its individualized savings system. However, this is a process that takes time."

According to Martínez, conditions in Mexico's public sector pension system are not unique to that country. "Special regulations and state-run enterprises are a common problem in many countries, and there have been problems of that sort in France as well. In Mexico, public enterprises don't have enough money to pay off their commitments to workers regarding their pensions and healthcare expenses." Nevertheless, Martínez believes that this particular problem is less acute in Mexico than in developed countries because the public sector in Mexico is relatively small. "The reform of ISSSTE [in 2008] has already done part of the job for this sector. Now the state-owned enterprises remain to be reformed: The Federal Electricity Commission, IMSS [for its own workers, who ironically are ruled by a different system], and Pemex, among others."

Villagómez calls for people to be patient about seeing progress in the pension system, and for the desired convergence [of various pension programs] to take place. "Each state has its own program for its public workers. In some states, yes, there is a crisis; and there are indeed some states in Mexico that are already insolvent. Their pension programs are totally unsustainable. In addition, reforms must be made at the local level. Pemex's pension system has had only minor modifications. Over the long run, it should get closer to the type of program IMSS has, so that we have a homogenous system. Only then, will we be able to say that there isn't any crisis in the Mexican pension system."