Nest Egg

Is the introduction of pension schemes in the GCC overdue? 

Regions like the UAE are making progress towards implementing this important safety net but pensions are still not a common benefit provided within a total reward package. Indeed there are enormous differences in the typical design of a reward package in the UAE, compared to that in other developed regions such as the UK, not least the fact that in the UK pensions have been a mandatory requirement since regulations were introduced in October 2012.

As of then, all employees not in a workplace pension scheme and who earn above a certain threshold are now ‘auto-enrolled’ into one, on a phased basis. The biggest employers have already conformed to the legislation, with the smaller employers required to follow suit by February 2018.

Where an employer does not offer a pension scheme of its own, they need to enrol their employees into a third party scheme such as the UK government run National Employment Savings Trust (NEST), a Defined Contribution (DC) vehicle. Employers are required to pay contributions, as are the employees, and the government offers a further incentive by way of tax relief.

The only group exempt from this pensions reform is the self-employed. However, employees are not obliged to remain in the scheme they are enrolled into, and can ‘opt-out’, if they have a heavy debt to pay off for instance. A similar arrangement operates in New Zealand – The KiwiSaver.

The concept of pensions, as provided for in the UK and New Zealand, is completely different to the End of Service Gratuity Benefit (ESGB) we have in the UAE.

There’s no denying that the ESGB is insufficient to fund someone’s retirement and therefore those UAE employers who offer an ESGB ‘enhancement’, such as a supplemental employee savings plan (ESP), are to be commended. ESPs are seldom offered to UK employees, which is not surprising when you consider that pensions are a form of long-term saving.

A recent survey from a leading employee benefits consultancy found that, of the respondents surveyed, 25 percent offer a supplemental retirement or long-term savings plan. Where this is a Defined Benefit (DB) scheme, the benefits tend to be generous, for example an accrual rate of 1/30th.

In stark contrast, DB schemes in the UK are almost extinct, and were far less generous, with 1/60th being the most common accrual rate. The vast majority of such schemes were closed to new entrants many years ago, then later closed to future accrual and more recently wound-up, to be replaced by a far less generous DC alternative.

A further difference between a reward package in the UAE and the UK is how it is structured. In the UAE, it will typically be made up of a number of allowances, in addition to basic salary, such as educational allowance, air travel or housing allowance. These allowances will rarely form part of a UK reward package.

A benefit common to both regions is group medical insurance. However, in the UK, this is not compulsory. A possible reason for not making it a mandatory requirement is the fact that in the UK there is the National Health Service – which is free to everyone resident in the UK and is funded from national insurance contributions paid by all employees.

We have all heard the rumours that pensions will be introduced on a mandatory basis in the UAE, but these are gaining traction now. Public inertia, and the government’s and regulators’ joint objectives all add up to the inevitability of pension compulsion. They include developing the capital market to contribute to national economic growth, protecting investors, raising financial awareness and providing opportunities for investing funds and savings according to a fair system that ensures the safety and accuracy of transactions.

There are many benefits of pension reform to employers. Compensation and incentive design are crucial in increasing productivity and morale, while reducing staff turnover, recruitment and training costs. UAE firms are scratching the surface in terms of employee benefit and pensions considerations, but there’s a fine line between turning the imposed cost of pension schemes to benefits for employers and employees.

Of course, pension products and associated consultancy and advisory services are already provided in the region. However, the amount of pension business currently being written is comparatively small when compared to other markets such as the general and life insurance businesses.

Group medical compulsion has brought only narrow profit margins to healthcare insurers and medical providers. When you consider the rigidity of the law and the competition in the marketplace this is no surprise. In contrast, pension compulsion, if introduced under a more flexible legal framework, will offer more scope to develop new products and innovative solutions, tailored to meet individual company requirements.

There are multiple challenges employers face in providing a pension scheme to their employees, but these differ in nature depending on whether a DB or DC scheme is offered. It’s widely known that, for DB arrangements, the major concern is their sustainability, due to the following factors:
i) People are living longer
ii) Salaries are rising
iii) Employees are remaining with their employer for longer periods
iv) Contributions are insufficient to meet the liabilities as they accrue

For DC plans, the challenges are fewer but still significant:
i) Poor investment performance
ii) Employees’ lack of investment knowledge, leading to unsuitable investment decisions being taken. More effective member communication can help here.

Challenges common to both DB and DC include:
i) Economic and demographic pressures.
ii) Pensions administration

It’s easy to understand why there is some reticence amongst employers to provide a pension plan to their workforce. Notwithstanding this, corporate pension schemes are an essential pillar to any developed or developing region’s economy. State assistance and means-tested benefits are unaffordable for most governments in the long-term and should not be relied upon.

04th Apr 2016, By Susan Turner