New UAE gratuity scheme could leave staff worse off

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One perk of being an expatriate worker in the UAE has long been that when you finally quit your job you receive substantial end-of-service benefits, commonly known as “gratuity”.

However, the country’s new, voluntary end-of-service benefit investment funds will make departing staff considerably worse off in cash terms than the current system, AGBI calculations suggest. 

What is more, it is the employer, not the employee, who decides whether to join these alternative schemes.

An employee’s gratuity, which increases substantially over time, is in lieu of formal pension plans. But it is dependent on the company’s own finances. If a business goes under or falls into difficulties, departing staff may not receive the benefits to which they are entitled.

These concerns led the federal government to introduce new rules, licensing four financial services companies to launch so-called defined contribution end-of-service benefits funds.

Under UAE labour laws, as an end-of-service benefit, employees receive 21 days’ basic salary for each year completed at their employer for the first five years of service, and then 30 days’ basic salary for each additional year of employment thereafter.

This is a defined benefit programme and, crucially, is calculated based on an employee’s final basic salary.

But in defined contribution schemes, employers make monthly contributions based on employees’ salaries at that time. Imagine, for example, a person who starts at a company on a monthly basic salary of AED10,000 ($2,725).

Each year, the employee is awarded a AED2,500 per month basic salary increase so that after five years of service their basic salary has increased to AED20,000 per month, or AED240,000 annually.

An employee’s gratuity is in lieu of formal pension plans. But it is dependent on the company’s own finances

After five years’ service, the person’s employer would have invested a total of AED51,745 (currently $14,000) on their behalf in a fund, plus any additional income the fund generates (we’ll come to that in a moment).

In the same employment scenario under the existing defined benefit scheme, that same person would get AED68,994 when they left, according to AGBI calculations, meaning that under the proposed defined contribution scheme they would be almost exactly 25 percent worse off.

“It will be difficult for the new defined contribution schemes to deliver bigger windfalls than the defined benefit programme in normal circumstances,” says Michael Brough, a senior director at the consultancy WTW in Dubai. 

“In a few years, defined contribution schemes will probably become mandatory.

“By then, hopefully there will be more fund providers and greater competition with lower prices, better products, higher net returns and more choice.”

Lunate Capital and Daman Investments, two of the four entities to receive licences to launch defined contribution schemes, declined to reveal the fees that their funds levy, although the charges on some of Daman’s funds will be up to 175 basis points (bps), or 1.75 percent, Brough says.

This is made up of 100 bps to Daman as the product provider and fund manager, 45 bps to the fund administrator and about 30 bps in additional costs and charges. The administrator is a third-party entity, an international financial services firm, which maintains the fund’s records.

“When a new defined contribution system is set up, you generally have high initial investment and administration charges that impact the early investors, which are necessary to meet provider establishment costs,” Brough says. 

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“Assets start from zero and grow to scale, when fees can start to reduce to the benefit of the investors. That’s traditionally how all defined contribution plans globally operate. It’s all about achieving sufficient scale.”

So what about the additional investment returns from these funds?

Daman’s funds invest primarily in “money market” instruments, which are low-risk investments such as short-term government bonds and interest-bearing deposit certificates.

Using the Dubai financial services company Al Ramz’s dirham-denominated Sky One Money Market Fund as a benchmark, this provides a gross annual yield of 4.83 percent.

So, under our imaginary example above, the employee would earn an additional AED4,284 over a five-year period, once annual fees of 175 bps are deducted. That would provide a total payout of AED56,209, which is AED12,965 – or just under 19 percent – less than through the defined benefit scheme.

While the federal government’s intentions are noble in terms of protecting employees’ financial interests and also reducing companies’ liabilities, staff at large, long-established companies will probably be hoping that their employer opts against joining a defined contribution scheme until the associated fees fall substantially.

Matt Smith is an AGBI senior editor