Gulf must pioneer on pension reform

Reuters Connect/CNBC

The end of service gratuity, or EoSG, has long been a staple in the Gulf.

This one-off payment, made to foreign employees at the end of their work contract, serves as a substitute for the pension benefits that they may miss out on when working in the region. Instead, it provides a one-time monetary benefit as they conclude their contracts.

The EoSG system is integral to the GCC’s employment framework, but it poses significant challenges.

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Schemes lack comprehensive benefits, fail to provide predictable payments, and are ineffective when it comes to pooling risk and financial safeguarding.

Employees find that the system often lacks transparency and feel left in the dark about their post-employment financial health.

The model also presents a range of disadvantages to employers. It imposes uneven cashflow requirements, creating financial strain and liquidity issues, particularly in times of economic uncertainty.

The risk of underfunding these liabilities looms large, often requiring rapid financial adjustments that hurt operational budgets. The complex accounting associated with the accrual of EoSG liabilities poses further challenges. 

Meeting interational norms

These shortcomings stand in contrast to the principles enshrined in social security norms internationally.

That is why global bodies such as the World Bank and the International Labour Organization have highlighted inefficiencies with the EoSG model and argued that it offers an inferior form of social protection. 

Globally, we have instead seen a shift towards what are called “defined contribution” (DC) workplace savings models.

In DC schemes, both the employer and employee contribute a regular percentage of the employee’s salary to an individual account specifically earmarked for the employee, with the final benefit amount depending on contributions made and investment returns achieved.

These funded long-term savings schemes mean that contributions are invested separately from the company’s assets. 

Over the past 20 years, funded DC systems have become the norm in leading financial centres such as the UK, Australia, Singapore, and Hong Kong.

They have proven effective in providing enhanced financial security through predictable savings growth.

DC systems increase transparency via clear account tracking, and empower employees, who have greater control over their retirement funds, all while integrating into the diverse operations of multinational companies.

Research has found that DC models have all involved some degree of tweaking over time to achieve iterative improvement.

Regulatory pressures and the need for economies of scale have meant the UK market has consolidated in recent years, and this year Hong Kong will replace its fragmented savings market with a new, centralised, digital offering, after years of operational challenges.

Creating a new standard

In the GCC, we have a unique opportunity to leapfrog existing models and set a new global standard in retirement savings. 

For the Gulf’s new pension and savings systems to succeed, they need to be intuitive and accessible.

Advances in technology, including user-friendly platforms, can simplify pension management for both employers and employees, encouraging long-term saving for the region’s diverse workforce.

These systems can be designed with the user in mind, offering straightforward overviews of pension funds and investment options without overwhelming users with complexity.

Reforming the pension system in the Gulf is not just an economic imperative. It would also mean a significant step forward in enhancing social welfare.

By adopting a DC model, we can offer more secure and transparent benefits for employees and alleviate the financial burden on employers.

This transition will attract global businesses, foster local investment and contribute to a stable and prosperous economic environment.

This presents an opportunity for the GCC to innovate and become a pioneer in pension savings.

By embracing change, we can establish significant new investment vehicles, secure individual financial futures, and strengthen the regional economy.

This is a chance for the GCC to lead with a model that not only secures financial futures but also bolsters the regional economy, setting a global standard.

Tim Phillips is the Middle East and Asia managing director for the global pensions fintech Smart. He is the author of End of service gratuity reform in the Middle East: Global lessons on the role of technology.