The Mexican Pension Annuity Market that by regulation puts zero, or tending to zero, weights on maturity mismatch on long term maturities may underestimate the interest rate risk stemming from yield curve movements in the same region; i.e., there may be a need to complement this with an economic maturity gap analysis that uses unit weights at all maturities. In any case, maturity gap analysis (weighted, like in Mexico, or not weighted, as generally used) is a marked improvement on any ALM framework observed in all jurisdictions in the region, and clearly a vast improvement on ad hoc fixed paid up capital rules. However, it is no substitute of a full fledged ALM framework for ongoing monitoring and controlling the various types of risks that stem from the asset and liability side of the balance sheet.

As a result of the underwriting and investment performance of pension annuity companies over the last nine years, as well as the specific structure of assets and liabilities that obviously affect the solvency margin, the regulatory solvency position of pension annuity providers (measured in terms of MXN in excess of the required CMG) and other performance indicators like ROE and ROA have improved over time as reported in the next table.

**Table 18: Pension Annuities Solvency and Profitability Indicators (1997–2005)**

||**1997**|**1998**|**1999**|**2000**|**2001**|**2002**|**2003**|**2004**|**2005**|
|---|---|---|---|---|---|---|---|---|---|
|Solvency Margin (MXN million)|667.2|292.5|811.3|862.0|570.8|829.1|2,176.8|1,761.2|2,927.5|
|ROE (percent)|-8|-29.2|-20.2|-19.8|-6.4|15.6|22.5|26.1|24.3|
|ROA(percent)|-2.9|-3|-1.2|-0.9|-0.3|0.7|2.9|4.0|1.9|

**Source** : CNSF

There is a seeming contradiction between, on the one hand, the sudden decrease in premiums since 2002, the worsening of the underwriting profitability and the decrease in investment yield and, on the other hand, the improvement over time in the solvency margin. One possible explanation for this is that the size of assets corresponding to the more important portfolio of business (in relative terms) is still growing quickly enough to compensate for the other negative trends mentioned before related especially to the reduced new business. Another possible explanation is that companies are still obtaining high levels of ROE and ROA for assets invested at higher yields in the past. Alternatively, it is possible that the worsening of the underwriting performance, together with lower long term yield on fixed income paper has indeed translated in lower economic solvency margins for the industry in the medium term. However, this is not disclosed by the regulatory solvency margin due to its low weights on long term mismatches between assets and liabilities. The adoption of other forms of solvency margins based on economic capital, at least for prudential purposes, would enable the CNSF to better monitor the economic solvency of the industry and take eventual appropriate remedial actions.<sup>31</sup>

> 31 Notice, that the CNSF has completed and implemented a dynamic solvency model, an important step toward the adoption of statutory solvency rules envisioned within the Solvency II framework.  The model uses historical data to construct claim distributions for different lines of business.  It allows the CNSF to calculate the probability of capital shortages of each insurance company by stressing variables that affect its

- 27 -