Abu Dhabi, UAETuesday 24 November 2020

The UAE’s gratuity system is in line for a shake up

A reform of the end of service benefit could address some of the risks associated with the payment, says an EY consultant

Philip Wheeler, Senior Manager & Pensions Actuary at Ernst & Young, says there has been discussion that the end of service gratuity regime could be overhauled. Antonie Robertson/The National
Philip Wheeler, Senior Manager & Pensions Actuary at Ernst & Young, says there has been discussion that the end of service gratuity regime could be overhauled. Antonie Robertson/The National

Employers must consider new ways of paying end of service benefits to help fund the retirement gap between the gratuity payment and an employee's retirement costs.

That is the message set to emerge from the Workers Incentives & End of Service Benefits Conference & Exhibition taking place in Dubai next Wednesday, the first event of its kind, under the patronage of the Federal Authority for Government Human Resources.

Organised by financial advisory firm Mondial, the event will examine the gap between the pension benefits expatriate residents in the UAE receive and what they really need to live on. It will also consider solutions to the problem such as employer-led pension products.

Philip Wheeler, senior manager and pensions actuary at Ernst and Young, says UAE expatriate residents could greatly benefit from "appropriate, cost-effective" savings products from their employers.

A recent study from financial services companies Old Mutual International and Quilter Cheviot found 59 per cent of UAE residents depend on their end of service gratuity payment to fund their retirement. The study highlighted the retirement gap for many, as the gratuity is considered inadequate to fund a retiree’s life after work because the lump sum payment only factors in the years of employment at a company, rather than the lifespan of an individual.

Employees leaving a UAE organisation are entitled to an end of service payment after completing at least one year of service with the tenure calculated on the number of days worked.

Here, Mr Wheeler outlines how the gratuity might evolve in the future.

Globally, the trend is for governments and employers to shift the responsibility for retirement saving towards the employee, and for employers to move away from providing employees with defined benefits due to their risky open-ended nature.

Philip Wheeler, Ernst & Young

What is the outlook for the UAE gratuity?

The UAE’s end of service gratuity is consistent with labour law gratuities provided in other countries in the Middle East. Globally, the trend is for governments and employers to shift the responsibility for retirement saving towards the employee, and for employers to move away from providing employees with defined benefits due to their risky open-ended nature. As a result, there has been discussion for several years that the end of service gratuity regime could be reformed in some way.

Will the current defined benefit (DB) system change to a defined contribution (DC) scheme soon?

Employers are currently able to provide a defined contribution end of service benefit as long as it exceeds the minimum (defined benefit) level described in the labour law. In practice, the majority of UAE employers provide the minimum level only, and this has remained the case since the end of service gratuity regime was first introduced in the UAE. Globally, research shows that employers tend not to enhance employee benefits unless there is a strong business case or there is a change in the law to require this. This implies that any reform to introduce a DC end of service gratuity would need to be triggered through a change in the labour law made by the federal government.

Why is the change needed?

There are some risks associated with the current end of service gratuity regime that a change in the labour laws could potentially address. For example: it exposes employers to an open-ended benefit promise, because the cost is dependent on future events such as when employees will leave and the salary increases they might receive up until that date. There is a risk that the benefit might not be paid because employers are not required to set aside funds beforehand. Employees are therefore reliant on the employer having sufficient cash to pay the gratuity amount at some future date of leaving.

There is a further risk that an employer could make unreasonable deductions from the end of service gratuity to be paid to a departing employee. Whilst employees have the right to seek redress through the courts in such situations, the cost and timescales involved might prevent employees from achieving a reasonable settlement. DC plans can mitigate these risks.

What hurdles need to be crossed for such a scheme to be introduced?

Key considerations for implementing a DC plan include a sustainable structure for benefits, contribution rates and charges; a robust vehicle to operate the plan coupled with a robust governance structure; cost-benefit and impact analyses to test the viability and credibility of such a plan; an appropriate regulatory regime; transitional arrangements that balance the needs of employers, employees and government and quality employee education, communication and empowerment programmes.

Who would manage a DC scheme?

Fundamentally, any organisation that manages a defined contribution savings regime needs to be trustworthy, transparent and efficient. Typically, this equates to a strong governance structure, a high degree of efficiency through automation, and a quality customer experience, coupled with robust regulatory oversight. This usually requires several independent organisations to operate an effective regime, especially where the potential number of employees is numbered in the millions.

What safeguards need to be put in place?

It is important to note the difference between the end of service gratuity regime - which provides a lump sum on leaving service, and a pension plan - which provides an income from retirement. For continuity reasons, we would expect any initial reform to the end of service gratuity regime to result in a structure that still provides a lump sum benefit on leaving service. Globally, there are several best practice safeguards that apply to defined contribution savings regimes for employees such as employer compliance (to register itself and its employees for the correct level of contributions), independence from the employer's finances and controls and transparency and regulation.

Are employer-led pension schemes a better alternative to the gratuity in terms of retirement provision?

The challenges of the gratuity regime can be tackled through reform by converting it to a funded, DC arrangement, but this would not turn it into a pension plan. An employer-sponsored pension plan would provide benefits in the same form required for retirement provision, but a wide range of further factors would need to be met for the pension plan to be considered best practice.

How could an employer-led scheme strengthen the workforce?

Globally, typical protection measures involve up to three levels of control:

1. The plan will have a clearly defined governance structure operated by managers whose prime responsibility is to act in the best financial interests of the employees.

2. Regular external audit of the plan to verify compliance with its governance structure.

3. Oversight by a dedicated state regulator with powers to monitor, investigate, take control and sanction the plan and their managers where appropriate.

Would a mandatory employer-led scheme ensure employees actually get paid their dues?

If set up appropriately and operated effectively, there is every chance that such a plan would result in employees receiving their end of service benefits. In turn this means the correct level of contributions would be paid at the correct time to the plan, the plan’s finances would be independent of the employer’s finances and the plan’s managers independent of the employer. [Also], contributions would be invested efficiently in accordance with the employee’s instructions, charges levelled by the plan would be low and driven by efficiencies and on leaving the invested amount would be paid directly to the employee.

What kind of a timeline is needed to switch to a DC scheme?

In other countries such as the UK, Malaysia and some US states, it has taken several years to introduce defined contribution savings arrangements for employees.

How serious is the retirement gap for residents in the UAE?

Globally, there is a lack of awareness by individuals of the amount of funds needed to provide an adequate income in retirement, and what that means in terms of the amount of regular savings required. Further, pensions are typically perceived as being complex and ‘tomorrow’s problem’, especially given pressures on incomes due to increases in the cost of living more generally. When this is coupled with an absence of relevant investment products, the scale of any retirement gap problem is likely to be substantial.

How can consumers be better protected from financial advisers selling unsuitable pension products?

Similar to other countries, this needs to be driven through regulation around charges, product and fee disclosure, customer education and advice, coupled with a robust enforcement and sanction regime. Globally, government regulation tends to be the ideal way to support the development of a quality savings and protection market for residents. Regulation can ensure the market understands what ‘best practice’ means, outlaw inappropriate products being sold in the future, and encourage financial education and awareness in individuals.

How much do residents need for retirement?

There are a range of online tools to project how much income may be needed in retirement, how much of this could be provided using existing savings and pension assets, and therefore how much would need to be saved between now and retirement to bridge the gap.

Updated: February 20, 2019 03:25 PM

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