Mexican States' Growing Pension Liabilities Pose A Mid-Term Challenge

SPECIAL COMMENT
SUB-SOVEREIGN
JULY 3, 2014

Table of Contents:
SUMMARY 1
MEXICAN STATE PENSIONS HAVE
BECOME A GROWING CREDIT
CONCERN 2
YOUNG DEMOGRAPHICS HELP
MITIGATE POOR PENSION FUNDING
PRACTICES, FOR NOW 2
THE AFFORDABILITY AND RISK
PROFILE OF STATE PENSION PLANS
VARIES WIDELY ACROSS STATES 4
RELATIVELY MINOR REFORMS HAVE
HELPED CONTAIN IMMEDIATE COST
PRESSURES BUT ARE INSUFFICIENT TO
ENSURE LONG-TERM PENSION PLAN
HEALTH 4
APPENDIX 1 6
APPENDIX 2 7
APPENDIX 3 9
MOODYS RELATED RESEARCH 10

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Mexican States Growing Pension Liabilities
Pose a Mid-Term Challenge

Summary
Mexican State pensions will become a growing credit concern and pose a mid-term
challenge. Though currently manageable, pension liabilities are exerting growing financial
pressure that, if unaddressed, will force 14 states to pay pension benefits directly through
additional contributions in the next decade.
Young demographics help mitigate poor pension funding practices, for now.
The affordability and risk profile of state pension plans varies widely across states. Yet,
contributions to pension plans are a growing portion of state budgets, representing up to
10% of total revenues in some cases.
Seven of the 20 rated states now have to assist with direct payment of pension benefits
because past funding has been inadequate. While still not a major budgetary burden, it
already reflects an unfavorable trend.
Relatively minor reforms have helped contain immediate cost pressures but are
insufficient to ensure long-term pension plan health. Absent further reforms, asset
depletion, or insufficiency, for pension systems will become the new norm, adding
pressure to this sectors credit quality.

Pensions of Mexican States - Overview
In Mexico, the responsibility for state employees pensions resides with each state. Exceptions are the state of Baja
California Sur (not rated), Mexico City (A3 stable debt rating) and the state of Quintana Roo (not rated) whose
employees are incorporated into the federal pension system.
Most states have defined benefit plans where the state as employer pays a specified monthly benefit on retirement,
determined by formula based on the employee's earnings history, years of service and age. States defined benefit
plans are multi-employer cost-sharing plans that include state employees as well as those of municipalities and
decentralized entities. Theoretically, all these entities make monthly contributions to their state plans to help fund
pension payments and accrued liabilities.
A number of states have also established defined contribution pension plans, where individual employee accounts are
funded by employee and employer contributions; here the state as employer has no risk beyond the annual funding
requirement. The defined contribution plans are offered as a supplement in some cases, while in other states they
have replaced the defined benefit plans for new employees. (Appendix 2).
Neither state statutes nor accounting standards require the disclosure of pension liabilities or define specific
guidelines for the updating of actuarial studies. However, almost all of the Mexican states have actuarial studies that
follow standard parameters along the guidelines established by the National Association of States Social Security
Institutions, an independent body. Those guidelines provide relatively conservative assumptions on discount rates
(ranging from 3% to 4%).
Moodys uses several measures in its studies to gauge the credit risk emanating from pension liabilities. These include
ratios of unfunded pension liabilities (as reported) to total revenues and the annual ordinary and additional cash flows
to total revenues that the states will need to cover with their budgets.

SUBSOVEREIGNS
2 JULY 3, 2014

SPECIAL COMMENT: MEXICAN STATES GROWING PENSION LIABILITIES POSE A MID-TERM CHALLENGE
Mexican State pensions have become a growing credit concern
Pension liabilities and the lack of structural measures taken by states either to reform or adequately fund
their plans has started to exert financial pressure on their operations, and will pose a mid-term challenge
if left unattended. Reported unfunded pension liabilities represent a median of 104% of total revenues,
with 12 rated states surpassing 100% of total revenues. These unfunded liabilities have resulted from
inadequate contributions to the plans by employers and employees to fund the costs of benefits
1
.
For example, most Mexican states have deferred contributions to their plans for many years, which has
exacerbated the underfunding. With the exception of the State of Mexico whose pension related liabilities
amount 564% of total revenues
2
, pension related liabilities of the remaining Mexican states range from
0.9% to 303% of total revenues (Exhibit 1), which is a comparable range to the 50 US states
3
.
EXHIBIT 1
Unfunded Pension Liabilities* / Total Revenues (%)

Source: Actuarial Studies by Valuaciones Actuariales del Norte and Farell provided by each state, Moodys
*Data corresponds to the latest actuarial study (Appendix 1) .
Young demographics help mitigate poor pension funding practices, for now
Demographic trends will help mitigate pension driven financial pressures over the near term as a majority
of Mexicos population is below 50 years of age (Exhibit 2). Mexican states current tax payers
outnumber current retirees by almost eight times, on average (Exhibit 3). Particularly in states that are
funding pension benefits directly, Mexicos current and relatively young age distribution of taxpayers
helps to prevent pension costs from substantially crowding out other spending priorities. Conversely, in
the United States and Canada, there is almost an equal number of current employees as there are
retirees
4
. While demographics currently provide some breathing room, the relative burden of retirement
costs could continue to grow for Mexican states as the population ages if funding is not improved.

1
In most states, public employees can retire either after reaching a minimum amount of years of service (median of 30 years) regardless of age, or if the worker reaches a
combination of a median age of 50 years plus 15 years of service, both of which are generally below the minimum age required for workers in the private sector.
Moreover, in most instances, pension benefits are held for life and can be transmitted to espouse and descendants as long as they are under 18 years old.
2
With 125 municipalities and the largest population for Mexican states (15,175,862 inhabitants according to INEGIs 2010 census), the State of Mexico registers the
highest unfunded pension liabilities reflecting a lack or delay of contributions coming from municipalities and other entities. Nevertheless, in December 2012 the state
implemented a parametric reform of its pension plan in which it will be able to retain federal funds for municipalities to cover their ordinary contributions.
3
Although we adjust US reported liabilities to market-based (almost always lower) discount rates, we do not perform adjustments to those of the Mexican states. For
further detail, please refer to Adjusted Pension Liability Measures for 50 Largest US Local Governments, September 2013. (158713)
4
For further detail, please refer to Sub-sovereign Governments in Four Countries Feel the Pinch of Pensions, September 19, 2013. (157882)
0
100
200
300
400
500
600
This publication does not announce
a credit rating action. For research
publications that reference Credit
Ratings, please see the ratings tab
on the issuer/entity page on
www.moodys.com for the most
updated Credit Rating Action
information and rating history.

SUBSOVEREIGNS
3 JULY 3, 2014

EXHIBIT 2
Mexicos Population Distribution in 2010 (%)

Source: INEGI

EXHIBIT 3
Tax Payers per Current State Retiree (x)

Source: Actuarial Studies by Valuaciones Actuariales del Norte and Farell, Moodys
*Data corresponds to the latest actuarial study (Appendix 1)

4.61%
4.85%
4.80%
4.90%
4.52%
4.08%
3.96%
3.85%
3.26%
2.76%
2.37%
1.80%
1.46%
1.09%
0.89%
0.59%
0.39%
0.36%
4.76%
4.99%
4.94%
4.91%
4.28%
3.74%
3.58%
3.53%
2.98%
2.51%
2.14%
1.66%
1.31%
0.97%
0.78%
0.52%
0.32%
0.27%
0 - 4 years
5 - 9 years
10 - 14 years
15 - 19 years
20 - 24 years
25 - 29 years
30 - 34 years
35 - 39 years
40 - 44 years
45 - 49 years
50 - 54 years
55 - 59 years
60 - 64 years
65 - 69 years
70 - 74 years
75 - 79 years
80 - 84 years
85 +
0
5
10
15
20
25

SUBSOVEREIGNS
4 JULY 3, 2014

The affordability and risk profile of state pension plans varies widely across states
In 2013, seven of the 20 rated Mexican states made additional contributions to cover what otherwise
would be shortfalls in direct benefit payments to retirees
5
. The lack of clear guidance from the federal
government and the absence of specific federal regulations governing states pensions has translated
into diverse approaches to managing them.
During 2013, pension contributions of Mexican rated states represented an average of 3.0% of total
revenues. Relative to total revenues, these contributions are expected to increase to 3.2% in 2014. The
states of Baja California (Baa2 negative), Tabasco (Ba1 positive) and Veracruz (Ba3 stable) will transfer
over 5.5% of their budgets to pensions during 2014 as shown in Exhibit 4. Additional contributions
to cover fund shortfalls account for roughly half of those transfers
6
, because pension trust fund assets
are insufficient to cover the full amount of pension payments. Other states making direct payments to
retirees due to pension asset depletion include Chiapas (Ba2 stable), Chihuahua (Ba2 negative),
Sinaloa (Ba1 stable) and Tlaxcala (Baa3 stable).
EXHIBIT 4
Pension Payments* / Total Revenues (%)

Source: Actuarial Studies by Valuaciones Actuariales del Norte and Farell, Moodys
*Estimated pension payments for 2014
Relatively minor reforms have helped contain immediate cost pressures but are
insufficient to ensure long-term pension plan health
Mexican states possess the legal capacity and authority to mitigate pension related risks. They are not
constrained by constitutional or legal provisions at the federal or state level that impede modification
of benefits or other aspects of pension system reform. Reforms can allow States to close defined benefit
programs, provide incentives to current workers to switch from a defined benefit plan to another plan
such as defined contribution. States cannot, however, unilaterally reduce the acquired benefits of
workers. This has allowed them to implement relatively minor reforms that have helped contain
immediate cost pressures. However, many reforms to date have proven insufficient to ensure the long-
term sustainability of the systems.

5
Some states incorporate their municipalities and decentralized entities into their pension systems. While these entities need to contribute to the system, the states are
responsible for paying pensioners.
6
Ordinary cash outlays include current employee and employer contributions to the pension plans from states, municipalities and decentralized agencies. Additional cash
outlays are transferred from the states budget to cover current retirees payments when pension trust fund assets are not sufficient.
-
2.00
4.00
6.00
8.00
10.00
12.00
Ordinary Additional

SUBSOVEREIGNS
5 JULY 3, 2014

Over the past 20 years, 17 Mexican states shown in Appendix 2 have implemented reforms that
include increasing state, employee and pensioner contributions, introducing defined contribution
plans for new employees, extending the retirement age and years of service and changing the formula
to calculate pension benefits. These reforms help reduce the rate at which new liabilities accrue and
may begin to materially reduce employer normal costs in the medium to long term. Yet, since they
have been primarily applied to new hires, they do not have a material impact on reducing states
unfunded pension liabilities in the short term. States have thus far refrained from pursuing more
comprehensive solutions because of the high political sensitivity around this issue.
In some cases, growing liabilities result from the incorporation of municipalities and decentralized
entities into the states pension system. These entities often fail to contribute to the state pension
system.
Some states such as the State of Mexico (Ba2 stable) and Sonora (Ba2 stable) have ensured payment of
contributions from their municipalities through the retention of federal transfers. According to the
states actuarial studies, failure to implement reforms in the near to medium term as shown in
Appendix 1 could result in plan asset depletion, or insufficiency. Pension system insufficiency could
force impacted states to directly fund pension benefits to retirees from their operating budgets, while
simultaneously eliminating the budgetary flexibility associated with deferring pre-funding
contributions.

SUBSOVEREIGNS
6 JULY 3, 2014

Appendix 1
State
Year of Latest
Actuarial Study
Actuarial Assets
MXN billion
Actuarial Liabilities
MXN billion
Net Liability
MXN billion Sufficiency*
Baja California
(Baa2/Aa2.mx negative)
2011 133.9 237.0 -103.1 2012
Chiapas
(Ba2/A2.mx stable)
2011 na na -58.4 2011
Chihuahua
(Ba2/A2.mx negative)
2012 10.3 93.2 -83.0 2030
Durango
(Ba1/A1.mx stable)
2013 13.4 43.3 -29.9 2016
Guanajuato
(Baa1/Aa1.mx stable)
2012 71.1 103.4 -32.3 2032
Guerrero
(Ba2/A2.mx stable)
2011 25.4 40.4 -15.0 2023
Hidalgo
(Ba2/A2.mx positive)
2012 na na -10.3 2013
Jalisco
(Ba2/A2.mx stable)
2009 184.8 185.5 -0.7 2100
Morelos**
(Ba2/A2.mx stable)
na na na na na
Nayarit
(Ba3/A3.mx stable)
2013 38.9 65.9 -27.0 2022
Nuevo Len
2013 72.7 151.2 -78.5 2015
Oaxaca
(Ba2/A2.mx stable)
2013 20.5 27.9 -7.3 2026
Puebla
2011 59.3 119.5 -60.2 2028
Quertaro
2012 0.1 24.4 -24.3 2012
San Luis Potos
(Ba3/A3.mx stable)
2012 52.0 135.4 -83.4 2018
Sinaloa
(Ba1/A1.mx stable)
2009 8.7 86.2 -77.4 2009
Sonora
(Ba2/A2.mx stable)
2011 75.2 100.1 -24.9 2027
State of Mxico
(Ba2/A2.mx stable)
2012 297.5 1121.5 -824.0 2014
Tabasco
(Ba1/A1.mx positive)
2010 44.6 151.4 -106.8 2010
Tamaulipas
(Ba1/A1.mx stable)
2012 24.4 82.8 -58.5 2018
Tlaxcala
2011 4.1 18.2 -14.1 2011
Veracruz
(Ba3/A3.mx stable)
2012 103.2 247.1 -143.9 2015
Zacatecas
(Ba3/A3.mx stable)
2012 21.3 46.2 -24.9 2021
*Last year in which assets, including reserve funds, cover current retirees pension payments without the states additional payments.
** The state of Morelos has not provided any actuarial information.
Source: States Actuarial Studies, Moodys

SUBSOVEREIGNS
7 JULY 3, 2014

Appendix 2
Main Reforms of States Pension Plans as of 2013
State Actual Plan Main Changes
Aguascalientes
(unrated)
All employees have a mix of both plans, defined
benefit and defined contribution
For new employees:
- Increase of retirement age and years of service
- New salary definition for retirement in the case of defined benefit plans
- Higher contributions from employer and employees
Campeche
(unrated)
Defined benefit* For all employees:
- New salary definition for retirement
- Higher contributions from employee and employer

For new employees (2011):
Chihuahua
Mix: defined benefit for current employees and defined
contribution for new employees (2014)
For all employees:
- Higher contributions from employer and employee

For current employees:
Coahuila
(unrated)
All employees have a mix of both plans, defined
benefit* and defined contribution
For new employees:
- Defined salary for retirement
Durango
(Ba1/A1.mx stable)
Mix: defined benefit and optional defined contribution
for all employees
For new employees:
Guanajuato (Baa1/Aa1.mx
stable)
Defined benefit For new employees:
Guerrero (Ba2/A2.mx
stable)
Defined benefit For all employees:
- Increase of retirement age

For new employees:
- Increase of years of service
Hidalgo (Ba2/A2.mx
positive)
Defined benefit for current employees and federal
pension plan (ISSSTE) for new employees
The group was closed
Jalisco (Ba2/A2.mx stable) Defined benefit For new employees:

For all employees:
- Higher contributions from employer and employees

SUBSOVEREIGNS
8 JULY 3, 2014

State Actual Plan Main Changes
Nuevo Len (Ba2/A2.mx
negative)
Mix: defined benefit and defined contribution for
employees hired after 1993
For all employees:
Oaxaca (Ba2/A2.mx stable) Defined benefit For new employees:

For all employees:
Puebla (Baa3/Aa3.mx
stable)
Defined benefit For all employees:

For new employees:
- Increase years of service
Sinaloa
(Ba1/A1.mx stable)
Defined benefit* and optional defined contribution for
all employees
For all employees:
Sonora (Ba2/A2.mx stable) Defined benefit For all employees:
State of Mexico
(Ba2/A2.mx stable)
Mix: defined benefit and defined contribution (for
employees hired after 2002 and optional for
employees hired before)
For new employees:

For all employees:
Tlaxcala (Baa3/Aa3.mx
stable)
Mix: defined benefit and defined contribution for
employees hired since 2013
For all employees:
- New salary definition for retirement in the case of defined benefit plans
Veracruz (Ba3/A3.mx
stable)
Defined benefit For new employees:
Source: Valuaciones Actuariales del Norte, Moodys
*Defined benefit with a minimum pension guaranteed

SUBSOVEREIGNS
9 JULY 3, 2014

Appendix 3
Ratings for Mexican States
State Global Scale Rating National Scale Rating Outlook
Baja California Baa2 Aa2.mx Negative
Chiapas Ba2 A2.mx Stable
Chihuahua Ba2 A2.mx Negative
Durango Ba1 A1.mx Stable
Guanajuato Baa1 Aa1.mx Stable
Guerrero Ba2 A2.mx Stable
Hidalgo Ba2 A2.mx Positive
Jalisco Ba2 A2.mx Stable
Morelos Ba2 A2.mx Stable
Nayarit Ba3 A3.mx Stable
Nuevo Len Ba2 A2.mx Negative
Oaxaca Ba2 A2.mx Stable
Puebla Baa3 Aa3.mx Stable
Quertaro Baa1 Aa1.mx Stable
San Luis Potos Ba3 A3.mx Stable
Sinaloa Ba1 A1.mx Stable
Sonora Ba2 A2.mx Stable
State of Mxico Ba2 A2.mx Stable
Tabasco Ba1 A1.mx Positive
Tamaulipas Ba1 A1.mx Stable
Tlaxcala Baa3 Aa3.mx Stable
Veracruz Ba3 A3.mx Stable
Zacatecas Ba3 A3.mx Stable
Source: Moodys

SUBSOVEREIGNS
10 JULY 3, 2014

Moodys Related Research
Special Comments:
Sub-sovereign Governments in Four Countries Feel the Pinch of Pensions, September 2013
(157882)
Adjusted Pension Liability Measures for 50 Largest US Local Governments, September 2013
(158713)
The US Public Pension Landscape: Patterns of Funding, Correlation and Risk, September 2013
(157154)
To access any of these reports, click on the entry above. Note that these references are current as of the date of publication of
this report and that more recent reports may be available. All research may not be available to all clients.

SUBSOVEREIGNS
11 JULY 3, 2014


Report Number: 171696
Authors
Roxana Muoz
Rafael Rodriguez
Production Specialist
Shubhra Bhatnagar

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