The Future of Private Pension Plans

1. The Future of Private Pension Plans January 22, 2013 Gene Wickes Global Director, Benefits Segment, Towers Watson

2. Overview • The backdrop • Gaining economic momentum • Favorable demographics, but for how long? • Retirement system choices • The case for private pensions • Lessons from North America and Europe • Outlook for Mexico and taking advantage of an opportunity • Where do we go from here?

3. An emerging Mexican economy • Booming “middle class” in a changing Mexico • “Mexico: A Middle Class Society, Poor No More, Developed Not Yet” • Center of Research for Development, A.C. (CIDAC) and Woodrow Wilson International Center for Scholars, Mexico Institute • Key Highlights: • Greater economic and financial stability (absence of widespread financial ruin) • Dual-income families and more women in the workforce • More highly educated and skilled workforce • Increased home ownership and more sophisticated buyers (use of credit and purchase of insurance products) • Improvements in life expectancy and thus quality of life

4. Rebound in economic growth in Mexico outpaces its neighbors to the north Compound annual growth in GDP per capitaBetween 2009 and 2011,constant dollars 3

5. Mexico’s economic growth has been fueled by the in-flow of foreign direct investment Foreign direct investment in the Mexican Economy in Billions of US Dollars Billions of US Dollars Source: The World Bank Group, World Development Indicators – WDI Online; United Nations Foreign Direct Investment (WIR 2012 data).

6. An emerging Mexican economy Source: The World Bank Group, World Development Indicators – WDI Online; United Nations Foreign Direct Investment (WIR 2012 data).

7. Linking demography to our economic prospects • Demography provides a window into many aspects of our economies • Driving factor behind labor force growth • Consumption and investment patterns • Particular impact on public entitlement programs • Remarkable similarity in the demographic shifts in all countries • Steep declines in fertility rates • Baby Booms primarily in U.S., Canada and Australia • Stabilized in many developed countries today • Sharp declines underway in many advancing economies (like Mexico) • Rapid improvement in life expectancy • Infant mortality improves to low rates • Followed by significant improvement in old age life expectancy

8. Linking demography to our economic prospects • Mexico will age dramatically over the next 20 to 30 years • Fertility rates are plummeting • Tremendous improvements in life expectancy • But Mexico today is entering a period of favorable demographics which can help to drive economic growth – “Demographic Dividend” • China has been in this period for the last twenty years but it will end by 2020 • Rapid aging • Mexico will age as rapidly in 40 to 50 years as most developed countries including the US did in 200 years • But can Mexico grow rich before it grows old? • Demography is not destiny

9. Fertility rates expected to dip below replacement in the near future Source: United Nations, World Population Prospects, The 2010 Revision

10. Good news on life expectancy but this has created challenges for financing longer retirement periods Source: United Nations, World Population Prospects, The 2010 Revision

11. Can we continue to afford longer retirement periods? Life Expectancies at Retirement (Age 65) Source: United Nations World Population Prospects, Extended Country Profiles.

12. Mexico’s demographic dividend; taking advantage of favorable demographics Demographic Dividend Source: United Nations, World Population Prospects, The 2010 Revision

13. Brazil’s demographic dividend Demographic Dividend Source: United Nations, World Population Prospects, The 2010 Revision

14. United States’ demographic dividend Demographic Dividend Source: United Nations, World Population Prospects, The 2010 Revision

15. China’s demographic dividend Demographic Dividend Source: United Nations, World Population Prospects, The 2010 Revision

16. Favorable demographics won’t last in Mexico Source: United Nations, World Population Prospects, The 2010 Revision

17. Retirement system choices Filling the gap

18. Retirement system choices • Many countries base their retirement systems on a combination: • Public vs. Private designs • Mandatory vs. Voluntary • Funded vs. Pay-go • Defined benefits vs. Defined contribution • Core questions every country must ask: • How generous should our mandatory system be? • How do we fill the gap left by the mandatory system? • Who bears the risk and how do we manage disappointment?

19. Wide range of generosity among global pension schemes Gross pension replacement rates Public, mandatory schemesfor average worker Average: 57.3% Source: OECD, Pensions at a Glance, 2011, p. 121. 18

20. The retirement income picture in Mexico Many modern day analysts and retirement planners put target retirement income at around 70 to 80 percent of preretirement earnings for people to maintain living standards Target Income GAP 44% for AWW Total Mandatory Pension Schemes Source: OECD Pensions at a Glance: Pension Calculator. http://www.oecd.org/els/socialpoliciesanddata/pensionsataglancepensioncalculator.htm .

21. The retirement income picture in the United States Many modern day analysts and retirement planners put target retirement income at around 70 to 80 percent of preretirement earnings for people to maintain living standards Target Income GAP 36% for AWW Source: OECD Pensions at a Glance: Pension Calculator. http://www.oecd.org/els/socialpoliciesanddata/pensionsataglancepensioncalculator.htm .

22. The retirement income picture in Chile Many modern day analysts and retirement planners put target retirement income at around 70 to 80 percent of preretirement earnings for people to maintain living standards Target Income GAP 30% for AWW Source: OECD Pensions at a Glance: Pension Calculator. http://www.oecd.org/els/socialpoliciesanddata/pensionsataglancepensioncalculator.htm .

23. Gross pension replacement rates for average wage workers at retirement age in various countries Source: OECD, Pensions at a Glance, 2011, p. 121.

24. Gross pension replacement rates for average wage workers at retirement age in various countries Countries with mandatory DC plans How to fill the gap? Source: OECD, Pensions at a Glance, 2011, p. 121.

25. The case for private pensions Lessons on where we went wrong

26. Evolving pensions in the developed economies • Largely defined benefit programs throughout the 20th Century • Why DB? • Employers generally more paternalistic • Companies increasingly worried about “hidden pensioner” issues and incenting early retirement • Demand by many union groups • Money management and annuity efficiencies • DC programs were still evolving in most countries

27. Unraveling of DB pensions in the developed economies • Three forces were increasing defined benefit liabilities during the 1980s and 1990s • The baby boomers were settling into career jobs and average service in plans was rising because of their relative share of the workforce • The baby boomers were also aging toward retirement day and the power of compound discounting was accelerating the growth of benefit obligations in present value terms • Interest rates were falling

28. Unraveling of DB pensions in the developed economies • Three forces were increasing defined benefit liabilities during the 1980s and 1990s • Irrational exuberance about financial market performance gave the impression we could manage the systems on thin margins • Businesses don’t control their markets • Highly publicized collapses • E.g., Bethlehem Steel in the United States • Now, significant legacy obligations need to be financed off the backs of current workers, raising the cost of retirement • Global financial crisis magnified these challenges

29. Options for dealing with increasing costs of retirement • Contribute more to the plans than we have been contributing • Cut back on the generosity of benefit levels (at a time retirement is even more in focus) • Keep workers in the workforce longer

30. The case for private pensions Opportunity in Mexico

31. Current landscape • 1997 reforms increased the “gap” needed to supplement pension income from social security • But voluntary contributions in Mexico are low today • Legal termination indemnity is the predominant scheme • Many multinationals and large domestic employers offer retirement plans • Most are DB plans today but hybrids and DC on the rise

32. Hybrid DC DB Evolving Mexican private pension plans All Registered PlansBy Plan Type DB -12 Source: CONSAR, October 2012. 31

33. Hybrid DC DB Companies increasingly adopt hybrid and DC plans Newly Registered PlansBy Plan Type Source: CONSAR, October 2012. 32

34. Looking ahead • Recent regulatory changes could create opportunity • Accounting standards require accrual methods • Revenue ruling on tax deductibility of company contributions to DC plans • Tax advantages increase as household income climbs • Growing demand from employees in post-global crisis world

35. EMPLOYEE ATTITUDES Growing demand for retirement security Retirement security more important issue over last three years Developed economies Fast-growing economies Disagree Agree Mixed Source: Towers Watson 2012 Global Workforce Study.

36. EMPLOYEE ATTITUDES Employee willingness to pay for guaranteed retirement benefit Willing to pay a higher amount from paycheck each month to ensure guaranteed retirement benefit Developed economies Fast-growing economies Disagree Agree Mixed Source: Towers Watson 2012 Global Workforce Study.

37. Sometimes we forget what we are trying to achieve • Goals • Employers’ goals are primarily related to workforce management • Workers’ goal is to have a period later in life when lifestyle needs are met through means other than selling own human capital • Social goal is to provide retirement income security across the broad cross section of society

38. EMPLOYEE ATTITUDES Retirement plans support attraction & retention goals My organization does a good job of hiring highly qualified employees Likely to leave employer in next two years Prefer to remain with current employer, even if comparable job available elsewhere Would like to work with current employer until retirement Agree Mixed Disagree Source: Towers Watson 2012 Global Workforce Study — Mexico.

39. EMPLOYEE ATTITUDES EVP and sustainable engagement My organization does a good job living up to the employee value proposition My organization has a reputation for providing a good employee value proposition Sustainable Engagement Retirement plan No plan Highly Engaged: Those who score high on all three aspects of sustainable engagement Unsupported: Those who are traditionally engaged, but lack enablement and/or energy Detached: Those who feel enabled and/or energized, but lack a sense of traditional engagement Agree Mixed Disagree Disengaged: Those who score low on all three aspects of sustainable engagement Source: Towers Watson 2012 Global Workforce Study — Mexico.

40. Closing remarks Where do we go from here?

41. Where do we go from here? Need to rescale the retirement system to provide basics without impoverishing the future Give those able to work longer the incentives to do so without harming those who cannot Must acknowledge that defined contribution savings are a critical part of retirement security Must provide an attractive and efficient means to convert these benefits into dependable lifetime support Social insurance should remain a backstop but will likely be less bountiful than today

42. Sometimes we forget what we are trying to achieve • Goals • Employers’ goals are primarily workforce management • Workers’ goal is to have a period later in life when lifestyle needs are met through means other than selling own human capital • Social goal is to provide retirement income security across the broad cross section of society • Constraints • Need for labor inputs to produce the goods and services to satisfy society wants • Need for workers to retain sufficient share of productivity to be adequately rewarded for inputs • Cost levels and management

43. One closing reminder • Pensions evolved because of the mutual benefit provided to employers and workers • Employers had to worry about “hidden pensioners” • Workers had to worry about having adequate income to meet economic needs beyond careers • Policymakers worried about a vulnerable segment of society • Evidence that pensions are still relevant in the “knowledge economy”