Authorities in the United Arab Emirates are eyeing major reforms to the end of service gratuity scheme that provides a severance payment for expat workers. The changes are a bid to improve on the country’s retirement saving system, with one major financial centre opting for a defined contribution-style plan.
The current end of service gratuity scheme offers expat employees a relatively small final bonus when their employment in the UAE comes to an end. It is usually paid from general corporate accounts, rather than from a separate savings scheme, and suffers from poor compliance and governance.
The scale of this unfunded issue was revealed in the latest Willis Towers Watson End of Service Benefits Survey for 2018. It found that, of the 300 companies that responded, around 90% said they paid the costs of the gratuity from company assets rather than funds set aside.
Around 29% of employers that do set aside funds use an insurance company product; but the largest group (37%) simply hold the funds in cash in a bank deposit.
Not much to retire on
“The situation is being looked at quite closely by the UAE government, as it tries to figure out what needs to be done,” said Michael Brough, senior director at Willis Towers Watson.
Updating the rules for the benefit system and providing better governance are likely to be part of the solution, however the real focus is on how to meet the needs of a changing workforce and bring the retirement savings system more into line with worldwide trends.
“The end of service gratuity is a relatively small benefit. The maximum you can get is two years of basic salary, which isn’t much to retire on,” Brough noted.
The current end of service payment is based on a simple formula. Employees receive 21 days of base pay for each year of service for the first five years. They are then entitled to 30 days of base pay for service after five years, though the overall total is capped at two years of base pay.
Given the growth in the UAE economy, which is encouraging workers to stay longer; and recent changes to visa rules allowing those with assets to stay well beyond their employment contract; the nation’s demographics are changing rapidly.
“People are staying longer in the UAE and living longer,” said Brough. “Many are thinking of staying five to 10 years and a lot of companies don’t have a pension offering. Rarely do people get to the maximum pay-out; but if the trend continues of people staying longer, they will be capped.”
Spread the word
As a result of these trends, and pressure from international bodies like the World Bank, the government is gearing up for change.
At the end of February, the Federal Authority for Human Resources (FAHR) will hold its first end of service benefit conference in Dubai. The forum is designed to discuss the challenges of retirement planning and the potential solutions that the financial services industry has to offer.
The goal of this conference is to raise the understanding among companies operating in the UAE on the need to strengthen their employee benefit systems ahead of potential regulatory changes.
“Moves are afoot to introduce new end of service rules and this event is designed to help determine the direction these changes might take,” said Sean Kelleher, chief executive of Mondial which is organising the event.
Kelleher pointed out that there are existing savings schemes run by corporations in the UAE with rules that are in line with the current laws covering end of service benefits, which state that an employee can receive “the highest of either their gratuity assessment or their savings scheme.”
“So, the law provides for a downside protection. In practice, the schemes we are aware of, and which have been in action for more than 10 years, do outperform the [end of service] gratuity target; but, then again, they have been blessed by bull markets for much of that time,” he said.
While the FAHR, with Mondial’s help, moves to raise awareness of the issue, other authorities in the UAE are moving faster.
Playing catch-up
The Dubai International Financial Centre (DIFC), a free zone which has its own laws and regulations, is in the advanced stages of implementing a shift from the gratuity scheme to more of a defined contribution (DC) system.
In a recent note to its tenants, the DIFC’s Strategic Pensions Work Group, which has been looking into the issue since 2016, said it had settled on an Expatriate Retirement Savings Regime (ERSR) using a master trust structure, domiciled in the DIFC and regulated by the Dubai Financial Services Authority (DFSA).
Employer contribution rates under the ERSR would match the accrual rates under the existing gratuity scheme for consistency and simplicity reasons.
All DIFC-based companies and employees are expected to change over to the ERSR scheme when it comes into force, and contributions into the scheme would only be invested with DIFC-registered fund managers.
Crucially, the plan proposes that the operating costs of the new ERSR should be recovered, where possible, through an annual management charge (AMC) that would apply to the employees’ ERSR accounts.
While waiting for feedback on its plans, the DIFC said its new pension system is expected to be ready for implementation on 1 January 2020, though it acknowledged there was still a lot of work to be done.
Growth tops priority list
Whether the DIFC’s move is likely to be replicated across the UAE is a moot point given regional rivalries, the state of the oil markets and the general outlook for slower economic growth.
The UAE wants to be the main financial hub in the region, so is expected to be keen to follow the worldwide trend towards mandatory DC savings schemes to help fund retirement, but any move that might make its economy less competitive could be seized on by its rival neighbours, like Qatar.
“The competitive issue is a big one. There’s a lot of pressure to keep costs down, especially where there are large blue-collar workforces,” said Brough.
“The state of the economy is key and if it’s not doing well, [the government] will be less inclined to do anything,” he said
Then there is also the practicality of changing such a major system. A new scheme for the whole country has to be developed, feedback needs to be gathered, further adjustment may be needed and then the communication of new plan has to happen.
As seen with other regulatory changes in the UAE, it could be a few years before anything really happens.
