Helping workers retire doesn't have to break the bank

Talk of a retirement pension system for Dubai has sparked much interest. But what kind of system would be the right one for expatriates in this country?

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News that the Dubai government is actively seeking World Bank advice on options for the provision of pensions for expatriates has ignited hopes of secure retirement benefits for foreign workers in the Gulf Cooperation Council (GCC) region.

But while it is encouraging to see that local governments are considering how to improve retirement incomes for all workers, study alone is not enough. Careful planning and a sound regulatory framework will be required to achieve the desired goals.

Labour law in the United Arab Emirates currently requires company payments of gratuity benefits, upon termination of employment, equal to 21 days of final pay for every year of service for the first five years, and 30 days final pay for each additional year of service.

One approach to help strengthen this framework could be to introduce regulations setting up a national defined contribution scheme to which employers annually contribute 8 per cent of an employee's pay (roughly equivalent to the current gratuity benefits) to his retirement account.

To succeed, pension fund administrators (PFAs) would be needed to manage the retirement accounts on behalf of the employees, independent of their existing employers.

As a result, the retirement benefits would be portable and employees would have the flexibility of switching employers without having to cash out their end-of-service benefits at termination of employment. Then, upon retirement, the funds in an employee's account could be used to purchase financial products to provide further retirement income.

The above scenario assumes that the employees have the necessary education to make important investment and retirement planning decisions and, hence, are able to bear all the investment risks associated with a defined contribution scheme. It also assumes that capital markets would provide stable returns to ensure the funds are intact at the time of an employee's retirement.

But it would be wrong to assume that employees already have or will quickly acquire the knowledge required to make savvy financial and investment decisions.

The past decade has shown us that the capital markets can be extremely volatile and may produce zero or negative returns even over a decade-long period. Such economic times would certainly wipe out the retirement savings of individuals, threatening their retirement income.

The day to day volatility of capital markets can also put individuals under substantial stress, thereby reducing their productivity and increasing health care costs.

Nonetheless, employers in developed countries such as the United States and Canada have been able to transition from defined benefit plans to defined contribution schemes because in such countries retirement planning is viewed as a three-legged stool: a government social security scheme, employer-provided retirement plans and personal savings.

As a result, people retiring during economic downturns may face decreasing account balances in their employer-provided plans and personal savings accounts, but can still rely on the government-provided pension and social safety net.

On the contrary, expatriates in the GCC region do not have any protection provided through government social programmes and, hence would be left extremely vulnerable during economic downturns under a pure defined contribution scheme.

One way to move past this could be the creation of a hybrid programme of defined benefit and defined contribution schemes.

Under such an approach the government could introduce a defined contribution scheme that may require the employer to provide a minimum guaranteed benefit, such as one equal to the currently required gratuity benefit. Employers would still be required to fund the end-of-service liabilities by making regular contributions to the defined contribution scheme.

Employees would be guaranteed at least the current gratuity benefits in the event of economic downturns when their individual account balances deteriorate. In addition, such defined contribution schemes could be made more attractive by offering an option of voluntary contributions to employees.

The effective implementation of this option would need regulations requiring proper actuarial valuations of gratuity benefits. Such actuarial valuations would enable employers to understand their minimum end-of-service obligations and make effective funding decisions to ensure security of this minimum guaranteed benefit.

As the UAE considers ways to improve benefits for foreign workers, they would do well to explore all the options and examine possible consequences on the lives of retiring expatriates. Involving stakeholders, experts and expatriates themselves will streamline this decision-making process.

Mohammad Ali Makani (FSA, FCIA) is a consulting actuary with the consulting firm Milliman in Dubai