1. The Revenue Structure of ISSSTESON

ISSSTESON (Instituto de Seguridad y Servicios Sociales de los Trabajadores del Estado de Sonora), an institution that provides medical and social security services to public workers in the state of Sonora, Mexico, faces a difficult financial conjuncture. A recent fact-finding mission revealed that one of the main concerns for ISSSTESON’s senior management is the lack of a stable revenue stream, which has resulted in issues of solvency for the institute, with delays in payments to suppliers. This situation has practical implications for its affiliates, and is likely to deteriorate unless reforms are introduced. ISSSTESON needs a comprehensive restructuring to ensure its financial stability. This chapter analyses ISSSTESON’s revenue structure, its recent evolution and its most important challenges, and offers recommendations to set it on the path toward financial sustainability.

    

The statistical data for Israel are supplied by and under the responsibility of the relevant Israeli authorities. The use of such data by the OECD is without prejudice to the status of the Golan Heights, East Jerusalem and Israeli settlements in the West Bank under the terms of international law.

1.1. Recent evolution and current situation

In Mexico, some local governments, including those of the 32 federal states and about 2 450 municipalities, as well as 55 public universities, have their own pension schemes, mostly of the defined-benefit type, with no portability of entitlements among them (OECD, 2016[1]). In the federal state of Sonora, ISSSTESON is the institution in charge of providing pensions and health services to the public employees of the state government.

To explain the sources of ISSSTESON’s financial challenges and to propose solutions, it is necessary to understand the institute’s legal framework and its financial situation in recent years. This section will review the institute’s legal structure and analyse the state of its finances by evaluating its sources of revenue, the balance between revenue and spending in the last five years, and its current financial situation. It will also discuss certain elements that may be preventing the institute from functioning in a cost-effective manner.

1.1.1. Regulatory framework of the finances of ISSSTESON

In 1948, the Legislature of Sonora passed a law that established the Fund for the Protection of Public Workers (Fondo de Protección Burocrática), creating an institution to administer and provide pensions for public workers. A year later, the Fund was reformed and renamed the Directorate of State Pensions (Dirección de Pensiones del Estado). In 1962, a new law mandated that workers contribute an additional 5% of their salary for medical assistance and medicine. That year, Congress passed Law 38 (Ley 38), creating ISSSTESON and establishing the legal basis for the institute.

ISSSTESON was initially conceived of as an institution whose sole responsibility was to manage pensions and healthcare. In 1989, however, Ley 38 was reformed to include new services, like mortgage and instalment credit. Today, ISSSTESON provides a wide-ranging set of pensions, medical and financial services to its affiliates (a full list appears in ‎Annex 1.A). Thanks to these additional services, the institute’s spending has increased, while its sources of revenue have remained constant.

The disparity between income and spending has become more acute, which is why Ley 38 was revised again in 2005, to address the structural flaws of the pension scheme. These modifications, however, were not sufficient to shore up the institute’s financial architecture. Box ‎1.1 presents a summary of the main reforms of Ley 38, and Table ‎1.1 summarises the main elements of Ley 38 as it stands today. Subsequent sections argue that the law may be straining ISSSTESON’s financial viability.

Box ‎1.1. The 2005 reform of Ley 38

In 2005, Ley 38 was reformed to attempt to rectify ISSSTESON’s unstable and deteriorating financial profile. The reform consisted of two main changes: i) an increase in the percentage of “quotas” (which are paid by the workers) and contributions (paid by the state) and ii) an increase in the number of years of contributions workers must make to receive a pension. Before the 2005 reform, workers contributed 5% of their salary to medical services and 4% to the pension fund. After 2005, the percentages were raised to 5.5% for medical services and 10% for the pension fund. The state, meanwhile, contributed 6% of the workers’ salaries for medical services and 4% for pension funds. After the reform, the share paid by the state increased to 7.5% of the workers’ salaries for medical services and 17% for pensions. A new contribution for hospital infrastructure was also introduced, both for quotas and for contributions. In terms of years of contribution, local public officials who were affiliated with ISSSTESON after 2005 have to contribute 35 years of service in the case of men and 33 years in the case of women. For those affiliated with ISSSTESON prior to 2005, the additional years of service required to receive a pension were determined based on the number of years they had served prior to the reform.

Table ‎1.1. Key elements of Law 38
Topics	Article	Explanation and relevance
Sources of revenue	Article 4	Establishes ISSSTESON’s obligations to workers affiliated with the institution and to workers affiliated with other local entities that have signed agreements with ISSSTESON. The basic benefits include medical services, credits (mortgage credits and instalment credits) and pensions. Pensions represent the bulk of the institute’s expenses.
	Article 16	Establishes that every worker must provide a quota of 17.5% of his salary to ISSSTESON, which is divided as follows: 10% for pensions, 5.5% for medical services, 0.5% for short-term loans, 0.5% for instalment credit and 1% for hospital infrastructure, equipment and maintenance.
	Article 21	Establishes that the state must contribute 29.5% of each worker’s salary. This includes: 17% for pensions, 7.5% for medical services, 0.5% for short-term loans, 0.5% for instalment credit, 0.4% for global indemnity, 0.1% for funeral arrangements, 2.5% for administrative expenses and 1% for hospital infrastructure, equipment and maintenance.
	Article 116	States that when ISSSTESON is not able to carry out its mandate, Sonora’s Ministry of Finance has an obligation to cover the deficit.
Structure and operation	Article 98	Specifies that the Board of Directors will be composed of seven members: the General Director of the institute; three members appointed by the executive, legislative and judicial powers; and three designated by Sonora’s Federation of Labour Unions.
	Article 104	Establishes that the Board of Directors has the authority to plan ISSSTESON’s operations and services; decide on investments for the institute; authorise any necessary measures to guarantee the provision of services, including the transfer of resources between programmes, with the exception of the pension and mortgage funds; grant, modify or suspend pensions within the legal framework; designate or remove personnel; approve internal rules governing the institute’s finances and the medical services; approve income and spending budgets, and the work plan that follows; grant benefits and rewards to employees, with the authorisation of the General Director; propose reforms of this law to the state’s executive power; and ask for actuarial valuations to evaluate the institute’s solvency.

1.1.2. Sources of revenue

One of ISSSTESON’s main problems is insufficient income to provide the level of services required by law. This makes a review of the institute’s revenue structure necessary: of its composition, the scope of its affiliation, and how resources are managed.

As shown in Table ‎1.1, Articles 16 and 21 of Ley 38 contain the legal provisions related to ISSSTESON’s sources of income. The income structure is based on a system of quotas and contributions, in which workers provide a 17.5% quota of their salary to ISSSTESON, and in turn, the state of Sonora pays a counter-contribution of 29.5% of the worker’s wage. Article 22 creates an obligation for the State and other local entities to transfer retained resources to ISSSTESON every 15 days, through their respective administrations.

Despite the legal obligation, no mechanism is in place to enforce this allocation. Meetings with ISSSTESON’s senior management made clear that the lack of practical enforcement has resulted in a significant amount of debt owed to the institute, and has required additional administrative efforts to pressure debtors to pay.

Without an effective enforcement mechanism, ISSSTESON is left with an unpredictable and ineffective revenue system that significantly reduces its resources. It also faces the challenge of managing its resources more efficiently.

The system of quotas and contributions specifies how income should be allocated among services. However, the fact-finding mission to ISSSTESON revealed that income is concentrated in a common fund and used as needed. The biggest portion of this fund is used to pay for pensions, which, according to Article 58 bis of Ley 38, should have its own, independent fund. This management of resources in a common instead of a compartmentalised way is concerning, since it implies that there is no effective control over the income and spending of each of the main services of ISSSTESON. Furthermore, there is an opportunity cost, in the form of lost interest.

There are two ways in which ISSSTESON receives contributions and quotas:

• Through the Ministry of Finance (Secretaría de Hacienda): Some municipalities withhold resources from their workers and then transfer them to the Ministry, which should in turn transfer them to ISSSTESON. As previously noted, Articles 21 and 22 establish the state’s contribution and the mechanism by which it is to transfer the resources to ISSSTESON every 15 days. There is no mention, however, of any sanctions or mechanisms to ensure that this transfer is executed promptly. The lack of authority to enforce the requirements makes negotiation the only instrument available to ISSSTESON in collecting revenue from the state. The ministry also withholds the quotas of state employees, and the problem of delayed or incomplete transfers applies as well.

• Directly from municipalities and other state public institutions: Article 3 of Ley 38 states that the institute can enter into agreements with municipalities and other public entities (such as universities and the teachers’ union) so their affiliates can participate in ISSSTESON’s benefit scheme. These entities transfer resources to ISSSTESON directly, not to the Ministry of Finance. The Board of Directors has the authority to establish the conditions under which these entities are incorporated. This broadens the scope of coverage for workers in Sonora, but complicates the auditing of income, since monitoring and negotiating the different streams of debt requires extra administrative effort.

1.1.3. ISSSTESON’s current financial situation

According to documents ISSSTESON provided, the institute’s deficit in 2017 was MXN 2 737 million. Income increased 6% from 2016 to 2017, while spending increased by 12%. This suggests that spending is increasing at higher rates than income – and in recent years, at almost twice the rate. A significant portion of the deficit can be attributed to the liabilities due to ISSSTESON from the Ministry of Finance and from municipalities and other local institutions. Documents provided by ISSSTESON estimate these liabilities at MXN 2 540 million, with the ministry owing MXN 2 300 million and the municipalities and local institutions close to MXN 240 million. Indeed, in Mexico, most municipalities lack a formal pension system, and pension obligations for municipal employees are paid through current expenditure (OECD, 2016[1]).

As for the debt owed by the Ministry of Finance, an interview with some of its senior officials suggested that the 2015-2021 administration has fully adhered to its financial obligations to ISSSTESON. The pending debt can mainly be attributed to past administrations. Given that the liquidity issues extend to the ministry’s finances and to the state of Sonora in general, it has been difficult to pay ISSSTESON the accumulated liabilities. Despite the unfavourable circumstances, on 30 April 2019, ISSSTESON and the Ministry established an agreement for payment of the outstanding debt (see Box ‎1.2).

Box ‎1.2. The agreement between ISSSTESON and Sonora’s Ministry of Finance for the payment of outstanding debt

On 30 April 2019, ISSSTESON and the state of Sonora’s Ministry of Finance entered into an agreement to settle the outstanding debt from the previous state administration from 2009-2015, as well as from municipalities, entities and other public bodies. This agreement aims to improve ISSSTESON’s financial situation, to service its 180 000 beneficiaries.

As of that date, the state government had paid around MXN 1 080 million of the outstanding debt, leaving a balance of a little more than MXN 1 200 million.

In order to pay, the State Government will sell 65 unutilised land properties located in nine municipalities. The sale of these properties will be overseen by Sonora’s Supreme Audit Institution (Instituto Superior de Auditoría y Fiscalización, or ISAF), which can audit the procedures at any stage.

Source: (ISSSTESON, 2019[2]), Firman Hacienda e ISSSTESON convenio para pago de adeudo heredado, http://www.isssteson.gob.mx/index.php/articulos/ver/970, (accessed on 6 May 2019).

One of the main issues associated with ISSSTESON’s insolvency concerns the debt owed to suppliers, which, according to documents provided by the institute, totals MXN 496 378 229.38. Since they have no guarantee of payment, suppliers’ distrust towards ISSSTESON has grown significantly, to the point where they are sceptical about participating in further procurement processes with the institute. When they do, their prices include a premium to account for the uncertainty over payment. Fewer incentives to participate and fewer suppliers means that competition is reduced, leading to higher prices. The institute thus ends up acquiring goods and services through direct awards at uncompetitive prices, further increasing its revenue/spending gap.

1.1.4. Balance revenue/spending in the past 10 years

ISSSTESON’s current financial situation reflects a sustained discrepancy between its revenue and spending, as illustrated in the figures below. Figure ‎1.1 presents an overview of ISSSTESON’s inconsistent income, at a time when spending has increased at a stable pace over the past five years. It also illustrates that ISSSTESON has operated at a deficit for the past five years. 2014 was the only year that income was almost sufficient to cover the institute’s expenses. Figure ‎1.2 shows that since 2012, ISSSTESON’s spending deficit has ranged between 11% and 22% in relation to income (with the exception of 2014). In 2015, ISSSTESON experienced its most critical deficit in recent years.

Figure ‎1.1. Evolution of ISSSTESON’s income and spending balance (2012-16)

Source: (Altavista Soluciones, 2016[3]), "Informe sobre el Análisis de la Estructura Financiera del ISSSTESON”, internal working document, Sonora.

Figure ‎1.2. ISSSTESON’s annual deficit trends (2012-16)

Source: (Altavista Soluciones, 2016[3]), "Informe sobre el Análisis de la Estructura Financiera del ISSSTESON”, internal working document, Sonora.

1.1.5. Potential resistance from ISSSTESON’s stakeholders and local public entities

Over the last two decades, 14 federal states in Mexico reformed their pension system, including Sonora. Some pension programmes had come under strong financial pressure and dire prospects remain in more than half of the states (OECD, 2016[1]).

After the fact-finding mission to ISSSTESON and after interviewing the relevant actors, it became clear that the governance and the political dynamics within the institute and with local public entities might be holding back the reforms necessary to increase ISSSTESON’s chances of building a sustainable financial structure. This section will explore some of the obstacles for deeper and structural reforms.

First of all, as previously noted, the debt owed by the state Ministry of Finance is, to date, the most significant factor in ISSSTESON’s liquidity crisis. In this respect, the ministry’s willingness to co-operate with the institute is a significant first step. However, it is important that discussions between the two institutions develop constructively, so they can reach agreement on the exact amount of debt owed to ISSSTESON and on a concrete payment plan through the end of this administration (2015-2021). ISSSTESON could push for a thorough implementation of this plan based on the ministry’s legal obligation under Ley 38 to finance ISSSTESON’s deficit whenever its obligations cannot be met.

While the relationship with the ministry is promising, the political dynamics within the institute – particularly with the Board of Directors – may prove challenging. The board plays an important role in defining operational, day-to-day activities and is responsible for the institute’s overall strategy and long-term vision. The unions, which occupy three out of the seven seats on the Board of Directors, have particularly strong influence over the institute and are likely to resist measures that could provide more stability if they reduce or eliminate benefits. Box ‎1.3 lists the most important responsibilities of Boards of Directors for effective governance in public enterprises; guidelines C, D and E are particularly relevant for ISSSTESON.1

Box ‎1.3. OECD Guidelines on Corporate Governance of State-Owned Enterprises: The Responsibilities of Boards

A. The boards of state-owned enterprises (SOEs) should be assigned a clear mandate and ultimate responsibility for the performance of the enterprise. The role of SOE boards should be clearly defined in legislation, preferably according to company law. The board should be fully accountable to the owners, act in the best interest of the enterprise and treat all shareholders equitably.

B. SOE boards should effectively carry out their functions of setting strategy and supervising management, based on broad mandates and objectives set by the government. They should have the power to appoint and remove the CEO. They should set executive remuneration levels that are in the long-term interest of the enterprise.

C. The composition of SOE boards should allow the exercise of objective and independent judgement. All board members, including any public officials, should be nominated based on qualifications and have equivalent legal responsibilities.

D. Independent board members, where applicable, should be free of any material interest or relationships with the enterprise, its management, other major shareholders and the ownership entity that could jeopardise their exercise of objective judgement.

E. Mechanisms should be introduced to avoid conflicts of interest that prevent board members from objectively carrying out their board duties and to limit political interference in board processes.

F. The Chair should assume responsibility for boardroom efficiency and, when necessary, in co-ordination with other board members, act as the liaison for communications with the state ownership entity. Best practices call for the Chair to be separate from the CEO.

G. If employee representation on the board is mandated, mechanisms should be developed to guarantee that this representation is exercised effectively and contributes to the enhancement of the board skills, information and independence.

H. SOE boards should consider setting up specialised committees, composed of independent and qualified members, to support the full board in performing its functions, particularly in respect to audit, risk management and remuneration. The establishment of specialised committees should improve boardroom efficiency and should not detract from the responsibility of the full board.

I. SOE boards should, under the Chair’s oversight, carry out an annual, well-structured evaluation to appraise their performance and efficiency.

J. SOEs should develop efficient internal audit procedures and establish an internal audit function that is monitored by and reports directly to the board and to the audit committee or the equivalent corporate organ.

Source: (OECD, 2015[4]), OECD Guidelines on Corporate Governance of State-Owned Enterprises, 2015 Edition, OECD Publishing, Paris, https://doi.org/10.1787/9789264244160-en.

Lack of compliance by local public entities is also an obstacle to improving ISSSTESON’s financial administration. As noted earlier, no enforcement mechanism is set up to guarantee the appropriate transfer of resources to ISSSTESON. This not only creates liquidity issues, but adds to the administrative burden of having to negotiate directly with several entities. In this context, it becomes essential that ISSSTESON reviews which agreements have already expired and which institutions are behind in their contributions, in order to consider whether to cease to providing service to their affiliates.

Finally, it is possible that affiliates of ISSSTESON may resist administrative reforms. Measures that could alter the pension or healthcare scheme are usually rejected based on the perception that they will take away previously promised benefits that unions have won for employees. A communication campaign is vital, to explain the need for reform effectively (as well as the risks of not introducing reforms).

1.1.6. Sustainability of political support for reform

Many of ISSSTESON’s financial issues can be traced to the lack both of a long-term strategy and the sustainable implementation of financial reforms. Strategies appear to vary depending on the government in power, but the structural and operative issues remain and accumulate. Any comprehensive reform to rescue ISSSTESON should have a long-term perspective and be designed to ensure sustainability, regardless of the administration in office. Minor managerial improvements or adjustments will not be enough to secure the long-term sustainability of the institution.

As previously noted, the State Government of Sonora expects to be able to pay off its debts to ISSSTESON in 2021. If these resources are forthcoming, there should be careful planning on how this income will be administered. The process should be transparent, and close collaboration with ISSSTESON can improve co-ordination and efficiency.

Similarly, it is important to anticipate that comprehensive legislative reforms may take some time to design, promote and pass in the state Legislature. External consultants commissioned by ISSSTESON have suggested that the only long-term solution for the institute’s issues is a comprehensive modification of Ley 38 that redefines the scheme by which social security for workers in Sonora is granted. Reform efforts in the past have resulted in strong opposition from unions, which protested outside Sonora’s State Congress during a previous attempt to pass reforms. Similar pressure has been mounted by ISSSTESON’s workers themselves, many of whom are unionised and refuse to be affected by any legal modification.

1.2. Challenges in improving the governance of ISSSTESON’s finances

After a review of ISSSTESON’s finances, it becomes necessary to look more deeply into the main causes of the institute’s lack of revenue. The lack of solvency and the absence of a long-term strategy to deal with it have practical implications for 180 000 affiliates.

1.2.1. Structural problems

The previous section described how ISSSTESON’s financial status is the result of a flawed and progressively weakening social security structure. This section will explore these issues to demonstrate that ISSSTESONS’ current pension and healthcare system is unsustainable both in the short and the long term.

The chief cause of ISSSTESON’s sustainability crisis is its pension scheme. At present, 13 500 people receive pensions, a number that is expected to increase significantly. Actuarial valuations commissioned by ISSSTESON suggest that 6 487 people will start receiving pensions in 2017 alone, and that by 2057, the number of pensioners will increase by 100%. Demand for ISSSTESON’s services is growing at a rate that exceeds the institute’s capacity, given the increase of life expectancy in Sonora. In 1970, life expectancy for women was 66 years and for men, 64 years. In 2015, life expectancy for women has risen by 12 years to 78, and for men, by eight years, to 72 (Sin Embargo, 2013[5]). If this issue is not addressed, thousands of affiliates are at risk of not receiving pensions.

In addition to ISSSTESON’s coverage of affiliates, the system’s requirements for retirement with pension benefits is also becoming unsustainable. While the 2005 reform to Ley 38 attempted to modify these structures, it fell short of the comprehensive reform that ISSSTESON needs to move towards financial stability. Retirement age for public servants is 55, subject to a minimum of at least 15 years of contribution. For workers who were affiliated with ISSSTESON before 2006, the number of years of contribution required for retirement is 30 for men and 28 for women, with a pension of 100% of the salary base for life. For workers affiliated after 2006, the mandatory number of years served required for retirement is 35 for men and 33 for women. The pension is 100% of the salary base for life, capped at 20 times the minimum wage per month.

For years of contribution, retirement age and pension returns, Sonora stands far from national and international standards. The average age of retirement for OECD countries is 64 for men and 63 for women. The OECD countries that require minimum years of contribution tend to approach the 40-year benchmark, and, with the exception of the Netherlands and Turkey, no OECD country has a net pension replacement rate of 100%. Box ‎1.4 includes benchmarks for some international and national best practices for age of retirement, required years of contribution for retirement and net pension replacement rates.

Box ‎1.4. International and national practices

When comparing Sonora’s pension requirements to those of other Latin American or OECD countries, it is clear that the former represents a much less demanding scheme for workers. The figure below illustrates the age of retirement for workers in OECD countries:

Figure ‎1.3. Age of retirement in selected countries by gender

Source: (OECD, 2017[6]), "3.8. Current retirement age in 2016 for a person who entered the labour force at age 20", in Design of pension systems, OECD Publishing, Paris, https://doi.org/10.1787/pension_glance-2017-graph34-en.

Most of the countries illustrated above also require more years of contribution before workers receive full pensions:

Figure ‎1.4. Years of contribution required for pension benefits in selected countries

Source: (OECD, 2015[7]), “Years of contribution or residence required for basic pensions”, in Pensions at a Glance 2015: OECD and G20 indicators, OECD Publishing, Paris, https://doi.org/10.1787/pension_glance-2015-graph10-en.

Life expectancy upon retirement and pension replacement rates for the countries indicated in the figures also tend to be lower, easing the pressure on governments to support retired workers with expensive pensions over long periods. The following figure illustrates a benchmark for net replacement rates for OECD countries, with an average rate of 63%.

Figure ‎1.5. Net pension replacement rates for OECD countries (2016)

Source: (OECD, 2019[8]), “Net pension replacement rates” (indicator), https://doi.org/10.1787/4b03f028-en (accessed on 5 August 2019). .

Compared to other states in Mexico, Sonora has still not yet set minimum and maximum rates for pensions based on a clearly defined salary (19 state laws comply with this stipulation, while seven define a maximum rate) or established a reasonable age for retirement (only four states in the country allow workers to retire between 53 and 57 years old; 13 states have set a minimum age of 63-65 years old).

Source: Information provided by ISSSTESON.

Moreover, the salary base on which ISSSTESON calculates pensions is also proving problematic. Ley 38 does not provide a clear definition of the salary base on which pensions will be determined, which has meant that pensions are calculated differently for affiliates. Municipalities sometimes reduce their workers’ salaries when they declare them to ISSSTESON and the state of Sonora. Because pensions are based on the salary declared, most pensions are less than they would have been if the real salary had been used as a basis. ISSSTESON’s audits on pension determinations show that miscalculations are common, not only due to the lack of legal clarity on how to calculate them, but because state employees are often not recognised in official records. This has had costly implications: ISSSTESON has been involved in 129 cases of pension readjustment lawsuits – all of which it has lost – in which pensioners demanded higher benefits based on their real salaries. According to documents provided by ISSSTESON, these complaints have already cost the institute MXN 143 million (Altavista Soluciones, 2016[3]).

Moreover, ISSSTESON relies on a fragile fact-checking system for calculating pensions. While Ley 38 grants the institute the legal authority to request information relevant to performing its duties, it does not provide ISSSTESON with attributions for verifying accounting records. Thus, the basis for calculating pensions is not always precise, and calculations are often based on whatever data is available, rather than the most accurate figures, which has also led to pension readjustment lawsuits.

These issues have inflated ISSSTESON’s payroll to a point that the institute cannot sustain. Documents provided by ISSSTESON suggest that the monthly payroll for pensioners has steadily increased in the last three years. In January 2014, it reached MXN 128 million, and by December 2016, MXN 192 million, an increase of 50% (MXN 64 million). In addition to the flaws already mentioned, this discrepancy can also be explained by an increase in pension amounts. The average pension in 2014 was MXN 17 480, but rose to MXN 20 006 in 2016. This problem is compounded by the rise in the number of pensioners each month: by January 2014, there were 10 750 pensioners, and by December 2016, 13 000. Figures 1.6 and 1.7 show the progression in pension rates and number of pensioners since 2000.

Figure ‎1.6. Evolution of average pension rates in MXN (2000-16)

Source: Information provided by ISSSTESON.

Figure ‎1.7. Evolution in the number of pensioners (2014-16)

Source: Information provided by ISSSTESON.

The evolution of medical conditions has also compromised ISSSTESON’s sustainability. Information provided by the institute suggests that, as life expectancy increases, the diseases most often treated at the institute from 1985 to 2016 have shifted from curable and temporary conditions, which were then more complicated to treat than they are today, to more complex and chronic diseases. Such conditions as measles and malaria were common until the early 1990s, while chronic heart disease and obesity have become more prevalent in the past decade (ISSSTESON, 2017[9]). Conditions such as respiratory infections, diabetes, hypertension and pneumonia, however, have remained constant since 1985. The change in the nature of medical conditions and the need for long-term treatments have entailed a heavier financial burden on ISSSTESON.

In conclusion, ISSSTESON’s income and expenditure structure is now severely misaligned. While income is solely determined by the number of state employees that the institute covers, spending is determined not just by the number of state employees, but by the number of pensioners and the health of both groups. With higher life expectancy and more demand for pension and health coverage, the discrepancy between income and spending will only increase. The most practical solution to this problem would be to turn the pension system into a defined-contribution scheme, with workers saving for their retirement in individual accounts. This would significantly reduce spending.

1.2.2. Institutional operational issues

In addition to its structural problems, ISSSTESON’s administrative operations have also contributed to its financial weakness. The fact-finding mission revealed that ISSSTESON, with its 3 302 employees, does not practise performance-based management. Rather, the allocation of benefits and bonuses appears to be independent of any systematic monitoring of performance and results. Benefits for punctuality and attendance, for example, appear to be standard, while unionised workers receive even more substantive benefits. Some of these include food allowance vouchers, seniority bonuses, medical incentives, economic support for transport, full scholarships for undergraduate and graduate studies, quarterly and annual incentives, bonuses for years of service, an annual bonus and bonuses for unionisation anniversaries. These add to the already onerous monthly payroll of MXN 87 million.

1.2.3. Leadership and co-ordination issues

Meetings during the fact-finding mission showed that four key state institutions, the Office of the Governor, the Ministry of Finance, the Ministry for Control and Sonora’s Supreme Audit Institution (Instituto Superior de Auditoría y Fiscalización, or ISAF), recognise that improving ISSSTESON’s finances should be a top government priority. They consider the condition of the institute among the state of Sonora’s top three concerns. ISSSTESON and these institutions have begun a process of discussion and collaboration to create a pathway to recovery. This is a positive improvement that needs to be maintained; cohesion and close collaboration will be vital in the push for comprehensive reform.

As already noted, resistance to reforms that could restore financial stability is likely from unions and unionised workers, as well as from ISSSTESON employees. Anticipating and preparing for this opposition will be crucial in pushing for wide-ranging reform. Moreover, ISSSTESON should expect substantial discussions with the judicial branch as pension and benefit adjustment lawsuits continue.

1.2.4. Enforcement issues

As noted, one of the key issues for ISSSTESON’s solvency is its resource collection system, particularly from municipalities and other local public institutions. One way to ensure these stakeholders keep up to date with their obligations is to decide that ISSSTESON stop providing services to affiliates, which would pressure local authorities to respect their payment obligations. This should go hand in hand with a communications strategy that explains to affiliates the urgency of these measures and the disastrous consequences of the present course.

Proposals for action

ISSSTESON’s main weaknesses can be attributed to two core issues: a flawed financial and administrative structure, particularly with respect to pensions, and operations that could be more efficient, that is, doing more with less and making decisions based on creating value for money. This section will provide focused recommendations to address these issues in order to upgrade ISSSTESON’s financial architecture. These include a section on comprehensive reform of ISSSTESON’s structure and one on short-term modifications to alleviate the institute’s financial situation.

A comprehensive reform of ISSSTESON’s financial and administrative structures

Restructuring ISSSTESON’s pension scheme is necessary and urgent. Some possible measures to approach this include:

• Increasing the effective age of retirement: By 2014, the average pension age for OECD countries was close to 64 years for men and 63 years for women; the retirement age in Mexico is 65. ISSSTESON would undoubtedly benefit from moving towards national and international practice.

• Increasing the required years of contribution: Not all OECD countries have established minimum years of contribution as pension requirements. While Sonora requires 30 years for men and 28 for women, countries like Belgium or Germany have contribution requirements of 45 years, and Luxembourg, Canada and Spain, average mandatory contributions of 39 years. Increasing the number of years of contribution could provide ISSSTESON with a more robust pension fund to sustain current and future pensioners.

• Revising pension calculation by establishing a clear salary base, including assessing what the salary should be and stipulating it unambiguously in the law.

• Establishing pension ceilings on replacement rates: As figure ‎1.5 shows, the average net pension replacement rate for OECD countries is 63.2%, and for Mexico 28.4%. Sonora’s 100% replacement rate has proven to be excessive and a clear deviation from international and national practice.

Modernisation and standardisation of the collection system

The institute could increase its financial resilience if its ability to collect revenue was enhanced by setting up a common resource transfer system for all public institutions. This should include transparent communication arrangements informing each party of the amounts owed. If parties fall behind in their obligations, the institute would suspend the healthcare and pension benefits of affiliated workers. To achieve this, it is recommended that a sanctions and responsibilities scheme be created, clearly linking lack of compliance to a well-defined, proportional sanction. This scheme should be based on the fact that lack of compliance by local entities has serious implications for Sonora and all its public workers.

Transfer of pension savings to individual accounts

Maintaining an independent and productive trust fund for pensions is particularly important given the burden that the pension scheme represents for ISSSTESON. In its current form, it resembles a resource-retaining tool more than an investment fund. Since projections suggest that demand will continue to grow, it is important to reform ISSSTESON’s normative structures to allow these resources to be invested. This could be done by transforming the pension system into a defined-contribution scheme, where workers save and invest for their own pension in individual accounts. Box ‎1.6 describes how ISSSTE adopted the recommended scheme and turned the institute’s pension fund into an autonomous institution that competes in market conditions for the best rates of return.

Compartmentalising ISSSTESON’s main areas

Maintaining closer control of ISSSTESON’s finances would require a reform to set up independent budgets and decentralised bodies for each of its services. Ideally, the institute should return to its core business of pensions and healthcare.2 Each area should have complete control over its finances, and spending should be directly related to income. The state would cover any deficit, rather than relying on the budgets of other areas. This would not only be more efficient but increase accountability.

Short- and mid-term modifications to alleviate the institute’s financial situation

Mitigating ISSSTESON’s present and future debt

One solution for reducing ISSSTESON’s debt to its suppliers would be to subrogate it to the Ministry of Finance. ISSSTESON would be relieved of its obligations to suppliers, which could in turn return to participate in ISSSTESON’s procurement processes, making them more competitive. This transfer would partially pay off the ministry’s debt to ISSSTESON.

Another possible solution for relieving ISSSTESON’s financial obligations would be to negotiate early voluntary pensions. It could then pay off pensions for life in a single transfer, at a lower rate than if they were paid gradually.

Establishing attainable short and mid-term financial plans

It is important that Sonora’s Ministry of Finance abide by the payments established in the agreement to settle the outstanding debt. The ministry recognises its debt to ISSSTESON, but settling this debt and avoiding future delays in payments are essential. This payment plan could be made conditional on a performance review of ISSSTESON’s operational structure and efficiency, which would pressure the institute to improve its management.

Optimising procurement and service provision in healthcare

Meetings with suppliers and the heads of medical administration of ISSSTESON revealed that medical purchases are often made through direct awards, implying high costs. Many factors lead to these direct awards, such as inadequate planning or the fact that suppliers may not provide the required goods because of delays in payment. One possible solution could be to leverage rental or purchase of private services.3 The resulting competition would help make prices more affordable.

Restructuring operational efficiency and cost-reducing management

A comprehensive reform of ISSSTESON’s financial structure, income sources and spending will, however, not sufficient to restore the institute’s finances. A close assessment of operational efficiency and resource management within the institute is also vital. Some elements to consider include:

• Restructuring the benefits scheme of ISSSTESON workers, to reduce expenses. While it is important to maintain basic benefits granted by law, additional benefits should only be granted after careful evaluations of performance and productivity.

• Reducing or eliminating unnecessary bureaucratic processes. An assessment could be made showing how improvements in technological and organisational skills could make the institute more efficient. For example, introducing electronic signatures would be more efficient and yield savings in printing, paper and office supplies. Such improvements could also be applied in procurement and human resources, for example.

• Harmonising, updating and communicating operation manuals for each area. ISSSTESON could become more efficient if it established a common methodology for operations. The current process of institutional re-engineering, which requires the drafting of new organisational manuals, offers an opportunity to address this recommendation.

• Establishing more transparent transactions (for example, payments to suppliers and contributions by affiliated institutions). This would not only improve efficiency, but help build stronger relationships with suppliers, affiliated institutions, state employees and pensioners.

Box ‎1.5 describes a successful case of pension reform that could be instructive for ISSSTESON.

Box ‎1.5. Chile: Comprehensive reform of a pension system

In 1981, Chile transformed its pension system from a defined-benefit, pay-as-you-go plan to a privately managed defined-contribution scheme, with workers’ contributions administered by specialised fund management firms (Administradoras de Fondos de Pensiones, or AFP). This change was considered revolutionary, and many countries with unviable pension systems, especially in Latin America, tried to replicate it.

While the new approach helped develop capital markets and led to a period of sustained growth in Chile, reality proved that the model fell short of expectations: it omitted essential social security components, such as poverty alleviation and gender inequality, and required expensive administrative machinery.

Pension reform was thus one of President Michelle Bachelet’s central campaign promises. Shortly after she was elected, in March 2006, the Presidential Council on Pension Reform (CAPRP), or the Marcel Commission, was established. The intent was to create a diverse, open space for discussion as the basis for a comprehensive reform proposal. The council involved over three months of work, in which actors such as international and national experts, representatives of workers’ organisations and women’s groups, pensioners, businesses, research institutes, academics and independent professionals were encouraged to share their experiences and requests for pension reform. A report on these hearings appeared in July, and in December, a draft of the reform was presented to Congress.

The reform was instituted in 2008, modifying two major pillars of the pension scheme: it added a non-contribute pension benefit element to alleviate poverty and inequality, and it designed auction mechanisms for AFPs, to reduce administrative charges. Although some concerning issues, like low pensions and deficient coverage remain, prompting renewed demands for reform, the 2008 reform succeeded in integrating social components and making administrative procedures more efficient.

Chile’s 2008 pension reform was successful for several reasons. First, it was an inclusive process involving many voices and interests, which improved the quality of policy and created broad consensus on the benefits of reform. Second, it was a transparent process with an effective communication strategy. Stakeholders understood the need for reform and were encouraged to propose solutions. Third, it was a democratic effort and authorities were aware of the complexity of the concerns at stake. Sustained leadership ensured cohesion and allowed the time necessary to make the effort comprehensive and sustainable.

Source: (Barr and Diamond, 2016[10]), “Reforming pensions in Chile”, Polityka Społeczna, No. 1, 2016, pp. 4-9, https://www.ipiss.com.pl/?lang=en, (accessed on 15 August 2017).

Box ‎1.6. Mexico’s ISSSTE, an independent pension fund

Until recently, the structure of Mexico’s pension scheme for public workers, regulated by the State Employees Social Security and Social Services Institute (Instituto de Seguridad y Servicios Sociales de los Trabajadores del Estado, or ISSSTE), retained the structure it had when it was created in 1959. As demographic, economic and social changes occurred, this scheme, based on a defined-benefit plan, began to threaten ISSSTE’s financial solvency.

In 2007, Congress approved a reform to the Law on ISSSTE (Ley del ISSSTE), which replaced the pension scheme with a defined-contribution plan under which workers contribute to their own pension savings through individual accounts, rather than financing those of current pensioners. These resources would be accumulated in Pensionissste, a new body created within ISSSTE to manage and invest pension savings. This body would act as a public Retirement Fund Manager (Afore) and compete with private funds to offer the best market conditions and the most attractive rates of return.

In 2015, Ley del ISSSTE was modified again to turn Pensionissste into a state enterprise (paraestatal) with administrative, operative and financial independence from ISSSTE. While Pensionissste became a decentralised body, it would still remain a public entity subject to supervision. In addition, its operations would also be regulated by the rules of the National Pension System Committee (Comisión Nacional del Sistema de Ahorro para el Retiro, or CONSAR), which oversees the functioning of Afores.

An independent Pensionissste based on individual contributions implied:

• More rigorous regulation: Pensionissste became a highly regulated entity in both the public and private systems. This guaranteed not only more productivity, but more transparency and accountability.

• Increased efficiency: Pensionissste began to depend on how strategically it managed its resources, rather than relying on federal budget contributions.

• More stability: The possibility of investing individual savings based on market competition guaranteed more revenue and thus more productivity for Pensionissste. This, in turn, made the pension scheme more stable.

Source: (Government of Mexico, 2015[11]), “Diez cosas que debes saber sobre la Reforma a la Ley del ISSSTE”, www.gob.mx/gobmx/articulos/diez-cosas-que-debes-saber-sobre-la-reforma-a-la-ley-del-issste, (accessed on 15 August 2017).

Further reading

OECD (2015), All on Board: Making Inclusive Growth Happen, OECD Publishing, Paris, https://dx.doi.org/10.1787/9789264218512-en.

References

[3] Altavista Soluciones (2016), “Informe sobre el Análisis de la Estructura Financiera del ISSSTESON”, internal working document, Sonora.

[10] Barr, N. and P. Diamond (2016), “Reforming pensions in Chile”, Polityka Społeczna, Vol. 2016/1, pp. 4-9, https://www.ipiss.com.pl/?lang=en (accessed on 15 August 2017).

[11] Government of Mexico (2015), Diez cosas que debes saber sobre la Reforma a la Ley del ISSSTE, https://www.gob.mx/gobmx/articulos/diez-cosas-que-debes-saber-sobre-la-reforma-a-la-ley-del-issste (accessed on 15 August 2017).

[2] ISSSTESON (2019), “Firman Hacienda e ISSSTESON convenio para pago de adeudo heredado”, Instituto de Seguridad y Servicios Sociales de los Trabajadores del Estado de Sonora, Sonora, http://www.isssteson.gob.mx/index.php/articulos/ver/970.

[9] ISSSTESON (2017), “Veinte principales causas de enfermedad por grupo de edad 1985-2016”, internal working document, Instituto de Seguridad y Servicios Sociales de los Trabajadores del Estado de Sonora, Sonora.

[8] OECD (2019), Net pension replacement rates (indicator), https://dx.doi.org/10.1787/4b03f028-en (accessed on 12 August 2019).

[6] OECD (2017), “3.8. Current retirement age in 2016 for a person who entered the labour force at age 20”, in Pensions at a Glance 2017: OECD and G20 Indicators, OECD Publishing, Paris, https://dx.doi.org/10.1787/pension_glance-2017-en.

[1] OECD (2016), OECD Reviews of Pension Systems: Mexico, OECD Reviews of Pension Systems, OECD Publishing, Paris, https://dx.doi.org/10.1787/9789264245938-en.

[4] OECD (2015), OECD Guidelines on Corporate Governance of State-Owned Enterprises, 2015 Edition, OECD Publishing, Paris, https://dx.doi.org/10.1787/9789264244160-en.

[7] OECD (2015), “Years of contribution or residence required for basic pensions”, in Pensions at a Glance 2015: OECD and G20 indicators, OECD Publishing, Paris, https://dx.doi.org/10.1787/pension_glance-2015-en.

[5] Sin Embargo (2013), “INEGI señala que es de 75 años la esperanza de vida en Sonora”, http://www.sinembargo.mx/01-11-2013/802618 (accessed on 1 October 2017).

Annex 1.A. List of services provided by ISSSTESON

Healthcare	Healthcare at ISSSTESON is provided based on three levels of complexity. The first level encompasses basic dental services, laboratory tests and X-rays. The second level includes consultations, general hospitalisation (specialisations like paediatrics, OB/GYN, surgery and internal medicine); special lab tests, ultrasounds and X-rays with contrast agents. Finally, the third level includes high-specialty hospitalisations, cardiovascular surgery, haemodialysis, CT scans, neurosurgery, complex lab tests, radiotherapy, coronary angiographies and nuclear medicine tests. Some of the other services provided are: pacemakers, stents, electrophysiology study, cardiac valves, lithotripsy extracorporeal, bone densitometry, orthopaedic prosthesis, external hearing system, intraocular lenses, contact lenses, conventional glasses, laser-ray ophthalmological surgery, orthodontics, dental guard, eye tomography, splenectomy with X-rays, ocular-tissue grafts, bariatric surgery, intra-gastric balloon, orthoses and endoscopic surgery with laser rays.
Pensions	Retirement; retirement for old age; handicapped pensions; pensions for widowhood of pensioner; pensions for widowhood of active affiliates; pension for orphans; pensions for parents who depend economically on a child who predeceases them; pensions from a work-related accident or condition.
Credits	House credits through FOVISSSTESON (Fondo de Vivienda ISSSTESON): Short-term credits; instalment credits for furniture; instalment credits for vehicles; liquidated damages.
Culture and recreation	Sindicato Único de Empleados del Instituto de Seguridad y Servicios Sociales de los Trabajadores del Estado de Sonora (SUEISSSTESON) and Sindicato Único de Trabajadores al Servicio de los Poderes del Estado de Sonora (SUTSPES) scholarships for children of workers, workers who are studying and children of pensioners: Scholarships for undergraduate studies for SUEISSSTESON; promotion and economic support for sports with SUEISSSTESON and SUTSPES; provisions for infants of affiliates for SUEISSSTESON, SUTSPES and Sindicato Nacional de Trabajadores de la Educación (SNTE) Section 54; economic support for scholarships for children of workers of Sindicato Independiente de los Trabajadores del ISSSTESON (SITISSSTESON).
Clubhouses	Workshops, events, and trips for pensioners in the localities of Hermosillo, Obregón, Nogales and San Luis Río Colorado.

Notes

← 1. Although ISSSTESON is not a state-owned enterprise, the OECD Guidelines on Corporate Governance of State-Owned Enterprises are still useful for illustrating the role ISSSTESON’s Board of Directors can play.

← 2. The report OECD Review of Pension Systems: Mexico even recommends that pension and health social security institutions should be clearly separated both legally and financially.

← 3. Currently, ISSSTESON rents some medical equipment for its healthcare services. Likewise, medical and hospitalisation services are contracted out for care that is not provided by the institute.