Sharing the burden Sohail Jaffer is Deputy CEO at FWU Global Takaful Solutions Globally, there has been a discernible shift in recent years towards risk-sharing between the public and private sectors in the provision of pension cover, with defined benefit (DB) schemes increasingly being complemented or replaced by defined contribution (DC) programmes. This process is being driven by a mix of demographic and financial trends, with life expectancy levels rising dramatically at a time when governments worldwide are coming under increasingly pronounced fiscal pressures. Although these pressures may appear to be less immediate in some parts of the Middle East and North Africa (MENA) than in the EU or Japan, even in the wealthiest economies of the Arab world, governments are increasingly recognising the need to address the issue of their pension time-bombs. A Booz & Co analysis, published in 2009 but still relevant today, describes pension plans in the GCC as “extraordinarily generous to those they cover.” As a result of the attractive incentives offered by these schemes, roughly nine out of 10 male workers in the GCC retire by the age of 60, according to the Booz report, compared with one in 10 in the OECD. The drawback, however, is that these generous pension schemes do not extend to expatriate workers. As the Booz report puts it, “perhaps most damaging of all to the GCC’s future economic development has been the GCC’s policy of excluding productive non-national labour from its pension programmes.” This, says Booz, might be less of an issue in a region that did not pin so much of its economic fortunes on foreign-born workers. But three-quarters of GCC-based employees are expatriates, while in the UAE and Kuwait the proportion is 83% and 82% respectively. Pension systems in the GCC compared with Asia Pension systems in the GCC differ markedly with those in key Asian financial centres, such as Singapore and Malaysia, which offer government-sponsored provident funds to all local employees. By contrast, in the United Arab Emirates (UAE), for example, the current practice is for companies to provide expatriate employees with an end of service (ES) lump sum based on the number of years of service. This system, which has been enshrined in UAE labour laws for a number of years, is increasingly regarded as inefficient for the government as well as for employees. Given that the majority of expatriate workers in the UAE are estimated to send up to half their salaries home, this system is unsatisfactory from the government’s perspective because it drains much-needed resources away from the domestic economy. According to the Booz analysis, if the GCC expanded pension coverage to non-nationals, the contribution fund would in some cases grow three-fold, reflecting the number of additional contributors. This would help to add considerable depth to local financial markets. Expatriate workers’ dependence on employers’ end of service benefit (EoSB) payments, meanwhile, leaves them vulnerable in the event of the bankruptcy of their employers, especially given that in the majority of cases end of service liabilities are either under-funded or unfunded. This vulnerability became all too apparent in the economic downturn of 2009 and 2010. According to SEI, “across the region, corporate cash flows were tight and, in some cases, non-existent, resulting in corporate restructurings and bankruptcies. This left many employees as creditors to the firm or, put simply, receiving none of their EoSB.” Grasping the nettle of unfunded EoSB Research published by Towers Watson suggests that a rising number of companies in the Middle East are addressing the issue of unfunded EoSB. The number of companies indicating that they are now funding their EoSB, at least in part, rose from just eight in Towers Watson’s 2009-2010 survey to 24 in 2010-2011, a growth of 200%. “This is a significant increase in one year and falls into line with Towers Watson’s view, particularly given the projected sharp rise in ESB liabilities over the next 10 years or so that companies should be looking to fund benefits (at least in part) as far as possible,” Towers Watson notes. “Such funding, preferably under an external trust, may help to achieve greater security for the employees’ ESBs.” At a broader level, the public and private sectors in a number of leading MENA economies are exploring new solutions for ensuring that adequate retirement cover is offered to all local employees. In the UAE, for example, Dubai’s Department of Economic Development has been in discussion with the World Bank on the introduction of a mandatory pension system for employees not covered by the present scheme. Government-backed pension initiatives are likely to be especially beneficial for small and medium-sized enterprises that are the backbone of the economy in the UAE. SMEs will continue to spearhead economic dynamism and diversification in the UAE, according to SEI’s most recent survey, in which 80% of respondents indicated that they expect their headcount to grow in the next three years. About 34% of this increase is expected to come from smaller companies with fewer than 200 employees, while 37% will be generated by medium-sizes operators with a headcount of between 200 and 999. In the meantime, the private sector has been looking at initiatives that would provide added pension security for expatriate workers. For example, in February 2013 the NBAD Trust Co, a wholly-owned subsidiary of the National Bank of Abu Dhabi (NBAD) announced the launch of its Today Wealth Builder, specifically designed for companies employing expatriates. As the local press explained at the time of the launch, this is essentially a “packaged corporate structure underpinned by a range of investment fund options that employees can choose based on their risk appetite.” These schemes are individually tailored, with regular payments made either solely by the company or by both the employer and employee. Efficient pension provision: a competitive edge Employers contributing schemes of this kind are not motivated purely by altruism. In an environment in which the region’s financial centres, in particular, are competing intensely to attract top quality staff, the provision of generous and secure retirement programmes is increasingly being identified as giving employers a competitive edge. As NBAD Trust Services has said, “by offering employees a cost-effective and professionally managed savings solution, employers will be able to demonstrate that they have the long-term interests of their staff in mind. This will have a powerful and positive impact on their ability to recruit and retain high quality employees.” Competition for talent is likely to intensify rather than ease over the foreseeable future. According to SEI’s latest report, a recent survey by Robert Half, the 2013 UAE Salary Guide Report, indicates that 85% of executives are concerned about losing their top performers over the next year. The result, says SEI, is that “human resources departments are under pressure to consider retention strategies and rewards for employees that link compensation to length of service.” The importance of health insurance If the provision of more efficient pension schemes are increasingly regarded as a competitive advantage for employers, so too is the offer of group medical coverage, which is now seen by most companies as a prerequisite for attracting and retaining talent. The most recent Mercer Benefit Survey for Expatriates and Internationally Mobile Employees found that 98% of companies now provide medical benefits coverage to their globally mobile employees, up from 57% in 2005. Governments in the GCC are progressively introducing mandatory health cover systems. For example, the Advisory Council of Qatar enacted its new health insurance law in June 2013, requiring mandatory coverage for all Qatari nationals and visitors. According to Towers Watson, the Qatar government picks up some 73% of the country’s annual expenditure on health care of almost $2.8 billion. “The requirement for additional contributions to the mandatory health care system will help to reduce this expenditure and shift the burden more toward employers,” Tower Watson advises. In Dubai, meanwhile, according to new regulations recently rolled out by the Dubai Health Authority (DHA), companies employing 1000 or more employees are required to provide medical cover to all their staff by October 2014. Those with between 100 and 999 employees have until July 2015 to comply, and by June 2016 even those with fewer than 100 will need to have followed suit. Responding to demographic and fiscal pressures A number of MENA countries have other powerful incentives for overhauling their pension systems. According to a report published in 2012 by the Kuwait-based Markaz, the generous welfare system in the GCC is exasperated by the Elderly Support Ratio, which calculates the degree to which the youth population is able to support the aging and retiring. By global standards, this ratio is currently high in the GCC. But as Markaz warns, “a stark reversal is expected in just 40 years, when this ratio is expected to drop to the low single digits across the GCC. This essentially means that by 2050, Kuwait, for example, will have just three working age persons supporting one senior citizen; this will constitute a major strain on resources for the country.” Demographic trends across the broader Arab world are, however, even more unnerving, and point to the need for an urgent rethink of pension policies in scores of Muslim-majority countries. “The projection for an ageing population in the Arab world is alarming,” notes a recent report published by Milliman. “Its tsunami effect will be catastrophic because family or tribal support is disappearing. We are also moving towards a financial economy rather than a real economy, which means we are becoming more dependent on financial instruments for our survival. According to the UN’s recommendations, funded pension plans can be a panacea for this problem.” The Turkish blueprint A striking example of a MENA economy which will face growing demographic and fiscal pressures is Turkey, which is developing what may be a blueprint for private pension systems across the MENA region. According to UN projections, the share of the Turkish population aged below 24 will fall from 50.4% in 2000 to 35.7% in 2030. Among major economies in the Muslim world, only Egypt (where the share is forecast to plunge from 55.7% to 28.1% in the same period) is undergoing a more rapid ageing process. Turkey’s unfavourable demographic dynamic, combined with a low savings rate aggravating the perennial problem of the country’s current account deficit, has been an important driver of legislative change designed to promote the growth of private pensions. Under the revised pension law, which came into force at the start of 2013, the government contributes an amount equal to 25% of the sum paid by individuals into private pension schemes. At the same time, a range of tax incentives have also been introduced aimed at boosting domestic savings. With a private pension fund to GDP ratio of just 2%, according to PricewaterhouseCoopers, the long-term growth potential for the industry is self-evident. Already, the passage of the new law has led some private pension companies to double their target for the industry’s assets in 2023 from TRY143 billion (US$67 billion) to TRY300 billion (US$138 billion), compared with TRY19 billion (less than US$10 billion) in 2012. Aside from increasing the savings rate and helping to reduce Turkey’s current account deficit, this will underpin the expansion of the country’s insurance and asset management industries, supporting the growth of Istanbul as a financial centre. The potential of shariah-compliant pensions Dovetailing with MENA governments’ commitment to promoting more sustainable pension systems in recent years has been the increased depth, sophistication and adaptability of the region’s financial systems. More particularly, the recent expansion of the Islamic financial services industry worldwide has underpinned robust growth in the takaful (shariah-compliant insurance) sector. The investment policies and annuity principles of conventional pension system mean that these schemes are unacceptable with devout Muslims, given the payment of riba (interest) twinned with the element of gharar (uncertainty) arising from the unpredictability of life expectancy and therefore of annuity payment streams. There is, however, a growing recognition that the takaful industry is well-positioned to provide shariah-compliant solutions to those eager to reconcile their religious beliefs with the need to cater for a comfortable retirement. One product that is being explored as a means of avoiding all these elements is the Islamic equivalent of government longevity bonds, known as longevity sukuk, which pay declining coupons each year after a given age (typically 75) rather than any principal. According to Milliman, “the underlying spirit of takaful fits squarely in the government longevity sukuk concept through the mechanism of wa’ad (promise or undertaking).” Products such as these will provide an important building-block for shariah-compliant pension programmes. As Linklaters observes in a recent update on Islamic annuities, “the costs associated with increasing lifespans across the world is well known. The nascent Islamic pensions industry will only develop if shariah-compliant means of dealing with longevity risk are developed.” Conclusion: bright prospects for pension providers Shariah-compliant pension products will form a small but growing component of the market for defined contribution schemes. More generally, it is clear that the long term prospects for conventional as well as Islamic pension providers are bright, and that opportunities will continue to be underpinned by growing demographic and fiscal pressures throughout the MENA universe. In the GCC, meanwhile, expansion of opportunities for private pension funds will also support the growth of the asset management and life insurance industries. This will in turn make a key contribution to the expansion and diversification of the financial services industry in regional centres such as Dubai. Previously published in Financial Bridges, Winter 2013-2014, and Global Islamic Finance Report (GIFR), 2014

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...perhaps most damaging of all to the GCC's future economic development has been the GCC's policy of excluding productive non-national labour from its pension programmes

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