The widespread Middle Eastern practice of giving employees a hefty gratuity when they leave could become the basis for a private pension system, finds George Mitton.

The goal of many expatriates in the Middle East is to save up and send money home. This practice does not help local financial services firms, which miss the chance to administer and manage savings. Nor does it benefit local capital markets, which are deprived of pension fund investment.

In Dubai, though, there are plans to establish a private pension scheme for expats. The Department of Economic Development (DED) has investigated the matter and received advice from the World Bank.

When and how the scheme will come into being is unclear, but it is likely that any pension scheme will build on the existing system of end-of-service benefits, a mandatory scheme in many Middle Eastern countries that entitles expat workers to a gratuity on retirement based on how long they have served.

But there is no need for financial services companies to wait until a mandatory scheme is unveiled. Some employers in the Middle East are already choosing to establish corporate savings plans on top of end-of-service benefits, providing a compelling opportunity for financial companies.

Most observers agree the end-of-service benefits system could be improved. Investment consultancy Towers Watson found in a 2012 survey that 80% of companies in the Middle East do not fund end-of-service benefits but simply pay the benefits out of cash assets when employees retire.

This is not good for employees, whose benefits are at risk should the company get into financial trouble.

“The concern is that if companies go belly up, you won’t get your gratuity,” says Nigel Sillitoe, chief executive at Insight Discovery, a research organisation that has examined end-of-service benefits.

Neither is it good for companies themselves, which must bear the liabilities for benefits on their balance sheets. These liabilities are linked to employees’ salaries and terms of service – a typical arrangement is one month’s pay for every year worked.

If employees stay a long time and are awarded pay increases, the cost of their end-of-service benefits rises sharply. In 2010, Towers Watson estimated that the combined end-of-service benefit liability of employers in the Gulf Cooperation Council was between $16 billion and $17 billion, and could rise to $75 billion by 2020.

Some employers have already set up external funds to meet their end-of-service benefit obligations. This is allowed under Articles 140 and 141 of UAE labour laws, which say employers can set up a provident scheme in lieu of end-of-service benefits as long as employees are no worse off.

It is not a perfect solution. Setting up a provident fund takes the assets off an employer’s balance sheet but not the liability. Nevertheless, in Towers Watson’s 2012 survey, 15% of companies said they provide for end-of-service benefits with an external fund.

That proportion could rise soon. The fact that the DED is examining expat pensions could provide an impetus for more employers to set up schemes. There is a precedent for this. In the mid-1990s, there were reports that the DED was considering making it compulsory for employers to provide staff with private medical insurance. A few employers chose to begin offering medical insurance before it was mandated, and this had a knock-on effect. By the end of the decade, nearly all employers in the UAE offered their staff private medical insurance, even though a law requiring this was never actually passed.

Simon Stirzaker was business development director at Alliance Insurance, one of the first medical insurance companies targeting the UAE market in the mid-1990s. He remembers it was a hard sell at first, but in time, medical insurance provision became a must-have.

Stirzaker is now senior manager of development and strategy for Royal Bank of Canada Corporate Employee and Executive Services (RBC CEES). He says the corporate savings market is set to grow, and not merely because of the DED’s involvement. With economic growth back to high levels in Dubai and house prices on the way up, the onus is on companies to provide attractive packages to retain staff. This is a shift from the last few years when many companies were actually trying to cut staff numbers.

“The market has been slow to grow over the past three years for the simple reason that employee retention has not been high on company agendas,” says Stirzaker. “But we are seeing salary increases coming back, a stabilisation in Dubai and rapid growth in Qatar. Employee retention is coming back to haunt human resources executives.”

Some companies have already created corporate savings schemes alongside end-of-service benefits. RBC CEES provides a corporate savings scheme to Kharafi National, a Kuwaiti infrastructure firm. The scheme rewards employees on top of compulsory end-of-service benefits.

In the UAE, the Jumeirah Group, a hotel chain, operates a similar system, while in Saudi Arabia, Sabic and Saudi Aramco have arrangements over and above end-of-service benefits.

Such schemes are an appealing way to reward staff because funds required by the employer are predictable; for example, 5% of an employee’s salary a year. The payments do not rise exponentially if an employee’s pay rises, as is the case with end-of-service benefits. Payouts from these corporate savings schemes can be made conditional on a number of years’ service, providing an incentive for employees to stay with the company.

“Corporate pension schemes are the most profit-and-loss efficient way of remunerating staff,” says Stirzaker – a rule of thumb that applies elsewhere, not just the Middle East.
Aside from RBC, Falcon Private Bank is said to be in the market to provide corporate savings plans in the Middle East, as is insurance firm Zurich.

However, one major provider, Friends Provident, has withdrawn from offering corporate savings schemes based on end-of-service benefits. Tim Hughes, of Friends Provident International, Dubai, says the move is part of a global policy to refocus from corporate schemes to individual policies.

Sources in the UAE say the company’s decision does not indicate a weakness in the market of end-of-service benefits, but is more likely to be a business decision driven by challenging circumstances. Friends Provident gained its federal insurance licence in the UAE in 2007 and began to expand while the financial crisis was at its most severe.

It is hard to predict when the DED will reach a decision on an expat pension scheme. Past experience suggests it would be unwise merely to sit and wait, though. Medical insurance companies that did that in the mid-90s would have lost out to their more dynamic rivals.

There is evidence that the provision of end-of-service benefits is evolving. As this market develops, financial services firms would be advised to get involved.

©2012 funds global mena