the future of private pension plans

© 2012 Towers Watson. All rights reserved.

The Future of Private Pension PlansJanuary 22, 2013

Gene WickesGlobal Director, Benefits Segment, Towers Watson

towerswatson.com© 2012 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.

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


0.4%

0.7%

1.0%

1.1%

2.3%

2.5%

2.8%

2.9%

4.4%

6.1%China

India

Russian Federation

Brazil

Germany

Mexico

Canada

United States

France

United Kingdom

Compound annual growth in GDP per capitaBetween 2009 and 2011, constant dollars

4

Rebound in economic growth in Mexico outpaces its neighbors to the north


5

Mexico’s economic growth has been fueled by the in-flow of foreign direct investment

$0

$5

$10

$15

$20

$25

$30

$35

1980 1985 1990 1995 2000 2005 2010

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

Bill

ions

of U

S D

olla

rs

Foreign direct investment in the Mexican Economy in Billions of US Dollars


An emerging Mexican economy

$-

$10,000

$20,000

$30,000

$40,000

$50,000

$60,000

$3,627 $8,400

$11,640 $15,266

$32,644

$38,582

$48,112

GDP per Capita, 2011 (in current $, PPP)

World Average $11,594

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


Fertility rates expected to dip below replacement in the near future

Source: United Nations, World Population Prospects, The 2010 Revision1950-1955

1955-1960

1960-1965

1965-1970

1970-1975

1975-1980

1980-1985

1985-1990

1990-1995

1995-2000

2000-2005

2005-2010

2010-2015

2015-2020

2020-2025

2025-2030

2030-2035

2035-2040

2040-2045

2045-2050

2050-20550

1

2

3

4

5

6

7

8

Mexico

Replacement Rate

Child

ren

per w

oman

Fertility in All Countries1950-1955 2010-2015

India 5.9 2.5 Mexico 6.7 2.2 United States 3.5 2.1 France 2.8 2.0 United Kingdom 2.2 1.9 Brazil 6.2 1.8 Canada 3.7 1.7 China 6.1 1.6 Russia 2.9 1.5 Germany 2.2 1.5


Good news on life expectancy but this has created challenges for financing longer retirement periods

1950-1955 1975-1980 2000-2005 2010-2015 2025-2030 2050-20550

10

20

30

40

50

60

70

80

90

50.7

65.3

74.9 77.2 79.5 82.3

Year

s

Source: United Nations, World Population Prospects, The 2010 Revision

Life Expectancies of All Countries

1950-1955 2010-2015 Change France 67.3 81.7 14 Canada 69.0 81.2 12 Germany 67.5 80.6 13 United Kingdom 69.3 80.4 11 United States 68.6 78.8 10 Mexico 50.7 77.2 27 Brazil 50.9 74.0 23 China 44.6 73.8 29 Russia 64.5 69.2 5 India 37.9 66.0 28


Can we continue to afford longer retirement periods?

Source: United Nations World Population Prospects, Extended Country Profiles.

1950-1955 1980-1985 2010-2015 2020-2025 2040-2045

France 13.6 16.6 20.8 21.6 23.0

Canada 13.8 16.4 20.1 20.8 22.3

Germany 13.5 15.5 19.3 20.3 21.8

UK 13.3 15.3 19.3 20.1 21.7

US 15.0 16.6 19.3 20.1 21.6

Mexico 12.1 15.7 18.4 19.2 20.6

China 8.7 13.9 15.5 16.5 18.1

Turkey 10.9 12.1 15.4 16.2 17.8

Russia 15.6 14.3 15.1 15.8 17.0

India 9.8 11.9 14.0 14.7 16.1

Life Expectancies at Retirement (Age 65)


Mexico’s demographic dividend; taking advantage of favorable demographics


1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 20500

20,000

40,000

60,000

80,000

100,000

Working Age (20-64) and Dependent Populations (0-19 and 65+)

WorkingDependent

Thou

sand

s of

Peo

ple

Demographic Dividend


Brazil’s demographic dividend


1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 20500

20,000

40,000

60,000

80,000

100,000

120,000

140,000

160,000


WorkingDependent

Thou

sand

s of

peo

ple



United States’ demographic dividend


1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 20500

50,000

100,000

150,000

200,000

250,000


WorkingDependent

Thou

sand

s of

peo

ple

Demographics are beginning to

work against the U.S.



China’s demographic dividend


1950 1955 1960 1965 1970 1975 1980 198519901995 2000 200520102015 2020 2025 2030 2035 2040 2045 20500

200,000

400,000

600,000

800,000

1,000,000


WorkingDependent

Thou

sand

s of

peo

ple

The demographic peak for China is at the end of the current decade



Favorable demographics won’t last in Mexico

1950 1960 1970 1980 1990 2000 2010 2020 2030 2040 20500.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

Ratio of 20-64 to 65+ year olds


Old-Age Support Ratios of All Countries2010 2050

Brazil 7.0 2.0 Canada 3.5 1.5 China 6.8 1.7 France 2.7 1.5 Germany 2.4 1.1 India 9.8 3.8 Mexico 7.1 2.3 Russia 4.2 1.9 United Kingdom 2.8 1.6 United States 3.6 1.8


Filling the gapRetirement system choices

17


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?


0

25

50

75

100

Wide range of generosity among global pension schemes

Gross pension replacement ratesPublic, mandatory schemes for average worker

19

Average: 57.3%

Source: OECD, Pensions at a Glance, 2011, p. 121.


20

The retirement income picture in Mexico

0%

20%

40%

60%

80%

100%

0.50 0.75 1.00 1.25 1.50 1.75 2.00

Other sourcesSocial Security

Retirement income goal relative to earnings

Preretirement earnings level (multiple of average wage)

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

Source: OECD Pensions at a Glance: Pension Calculator. http://www.oecd.org/els/socialpoliciesanddata/pensionsataglancepensioncalculator.htm.

Target Income GAP44% for AWW

Total Mandatory Pension Schemes

http://www.oecd.org/els/socialpoliciesanddata/pensionsataglancepensioncalculator.htm



21

The retirement income picture in the United States

0%

20%

40%

60%

80%

100%

0.50 0.75 1.00 1.25 1.50 1.75 2.00










22

The retirement income picture in Chile

0%

20%

40%

60%

80%

100%

0.50 0.75 1.00 1.25 1.50 1.75 2.00










Gross pension replacement rates for average wage workers at retirement age in various countries

Mandatory Mandatory Voluntarypublic private private Total

(percent) (percent) (percent) (percent)Austria 76.6 76.6Belgium 42.0 15.6 57.6Canada 38.9 30.8 69.7Greece 95.7 95.7Netherlands 29.2 58.9 88.1Spain 81.2 81.2Sweden 31.1 22.7 53.8United Kingdom 31.9 36.7 68.6United States 39.4 38.8 78.2Source: OECD, Pensions at a Glance, 2011, p. 121.


Gross pension replacement rates for average wage workers at retirement age in various countries

Mandatory Mandatory Voluntarypublic private private Total

(percent) (percent) (percent) (percent)Australia 11.8 35.4 47.3Chile 3.2 41.7 44.9Denmark 28.9 50.7 79.7Estonia 25.5 22.5 48.0Hungary 44.4 31.4 75.8Israel 19.4 50.2 69.6Mexico 4.0 26.9 30.9Slovak Republic 26.0 31.6 57.5

Source: OECD, Pensions at a Glance, 2011, p. 121.

Countries with mandatory DC plans

How to fill the gap?


Lessons on where we went wrongThe case for private pensions

25


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


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


Opportunity in MexicoThe case for private pensions

30


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


69% 66% 62% 60% 56% 58%

11% 12% 13% 13%10% 9%

18% 20% 22% 25% 27% 34% 33%

72%

10%

0%

20%

40%

60%

80%

100%

2006 2007 2008 2009 2010 2011 2012

-12DB

HybridDCDB

Evolving Mexican private pension plans

All Registered PlansBy Plan Type

32

Source: CONSAR, October 2012.

Number of plans 1,629 1,702 1,793 1,809 1,832 1,946 2,002


68%51%

37%21%

54%

5%

10%15%

25%

9%

7%27%

39% 48% 54%37%

92%

1%

0%

20%

40%

60%

80%

100%

Before1996

1996-2000

2001-2005

2006-2010

2011 2012

Y ax

is la

bel

HybridDCDB

Companies increasingly adopt hybrid and DC plansNewly Registered PlansBy Plan Type

33

Source: CONSAR, October 2012.


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


Growing demand for retirement security

EMPLOYEE ATTITUDES

Russia

China

Mexico

Brazil

India

Japan

France

Germany

UK

US

Canada

40%

47%

53%

63%

67%

32%

51%

55%

60%

67%

68%

30%

25%

26%

22%

22%

39%

20%

28%

19%

19%

17%

29%

28%

21%

15%

11%

29%

29%

17%

20%

15%

15%

Retirement security more important issue over last three years

Agree Mixed DisagreeSource: Towers Watson 2012 Global Workforce Study.

Developed economies

Fast-growing economies


Employee willingness to pay for guaranteed retirement benefit

Russia

Mexico

Brazil

China

India

Japan

France

Germany

UK

US

Canada

34%

65%

68%

73%

78%

28%

47%

48%

59%

59%

60%

33%

20%

19%

21%

17%

42%

20%

31%

25%

27%

25%

33%

16%

13%

6%

5%

30%

33%

21%

16%

15%

15%

Willing to pay a higher amount from paycheck each month to ensure guaranteed retirement benefit

Agree Mixed DisagreeSource: Towers Watson 2012 Global Workforce Study.

Developed economies

Fast-growing economies

EMPLOYEE ATTITUDES


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


No plan

Retirement plan

No plan

Retirement plan

No plan

Retirement plan

No plan

Retirement plan

50%

77%

50%

68%

31%

17%

46%

58%

23%

15%

22%

14%

25%

21%

25%

23%

26%

8%

27%

18%

44%

62%

29%

19%

Retirement plans support attraction & retention goals

My organization does a good job of hiring highly qualified employees

Source: Towers Watson 2012 Global Workforce Study — Mexico.

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

EMPLOYEE ATTITUDES


No plan

Retirement plan

No plan

Retirement plan

42%

67%

39%

69%

26%

22%

24%

19%

32%

11%

37%

12%

EVP and sustainable engagement

39

My organization does a good job living up to the employee value proposition

Source: Towers Watson 2012 Global Workforce Study — Mexico.

My organization has a reputation for providing a good employee value proposition Agree Mixed Disagree

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

Disengaged: Those who score low on all three aspects of sustainable engagement

67%

20%

5%7%

Retirement plan

48%22%

17%13%

No plan

Sustainable Engagement

EMPLOYEE ATTITUDES


Where do we go from here?Closing remarks

40


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

41


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


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”

the future of private pension plans

Documents

towers watson client

middle class society

middle class status

year middle class citizens

improved quality of

life expectancy

economic stability

capacity of mexicans