Such an opportunity lies ahead with the announcement last month that employers across the entirety of the U.A.E. would have the future opportunity to voluntarily fund future end-of-service benefit (ESB) liabilities. This can only be the start of a seismic shift across the whole Gulf Cooperation Council (GCC) to move away from the defined benefit volatile cost mechanism (ESB) that has been such a part of benefit obligations in the Middle East for the last few decades. With the lack of key detail currently available on how this will all work in practice, a few thoughts from the author on what could be done to get this working effectively.
Contribution rates should be simple to administer and communicate to local staff. The U.A.E. ESB has a targeted equivalent cost of 5.83% of Base Pay for the first 5 years of service and 8.33% of Base Pay for service over 5 years. Perhaps set a scale of 6% and 9% (for the 5-year service requirement). This will overprovide but help to mitigate the likely high Provider costs - see next point.
Secondly, a charges and fees cap needs to be considered in a similar way to the successful Polish model where a 60bps charge is the maximum that can be applied (50bps ongoing and a 10bps performance charge). The U.K. applies a 75bps charge on defaults to its mandatory auto-enrolment pension vehicles. One of the major criticisms of the DIFC DEWS arrangement is the excessive charges with the management charge alone published at 133bps, this is significantly higher than the U.K., U.S., and Poland. The 133bps is published as a management charge but also contains additional total expense ratio costs that take the true cost up to in excess of a whopping 150bps. The impact of this on small contributions and balances for the lower-paid blue-collar workers into a voluntary savings vehicle used to fund ESB is material.
|U.A.E. – Uncapped fees
|U.K. – Capped fees
|Poland – Capped fees
|Projected annual charges
|30k Salary (fees over 20 yrs.)
|Accumulated balance (Gross - no fees)
|120k Salary (fees over 20 yrs.)
|Accumulated balance (Gross - no fees)
You can see from Table 1. that an employee joining a pension plan on a salary of AED 30,000 according to the design in the assumptions and without any charges might accumulate a fund value after 20 years of AED 119,752.42. The impact of charges reduces this to AED 110,297.04 (Polish Plan), AED 108,725.51 (U.K. Plan – Default), and AED 100,603.22 (U.A.E. DEWS Plan).
For a higher salary, an employee joining a pension plan on a salary of AED 120,000 according to the design in the assumptions and without any charges might accumulate a fund value after 20 years of AED 478,572.87. The impact of charges reduces this to AED 441,188.15 (Polish Plan), AED 434,902.04 (U.K. Plan – Default), and AED 402,412.87 (U.A.E. DEWS Plan).
The employee takes only around 84% of the fund accumulated in both cases in the U.A.E. DEWS Plan and 16% is taken in fees and charges by the various Providers in this pension solution. The Polish Plan in contrast gives the employees 92% of the fund accumulated, an 8% enhancement.
Thirdly, the U.A.E. has an opportunity to create a financial services centre and needs to get a balance between delivering jobs and investment to the local U.A.E. market and enabling access to international investment with few limitations and restrictions. In practical terms, this could mean requiring a % invested in local markets. Poland has set a 30% requirement for investment in local Polish stocks, bonds, cash, and money markets and much of the developing world tries to direct 100% into local investments that unfortunately carry very high default and failure risk. The U.A.E. may want to look to offer choice rather than force investment in the U.A.E.'s still developing and perhaps currently limited local investment market. This can be achieved by offering access to a core range of Shariah-compliant investment funds across a wide range of asset classes.
WTW is developing a local pension that will include seven Shariah funds covering Global Equity, Sukuk, Money Market, Property, Gold, Infrastructure, and Multi-Asset. The total expense ratios or charges for the investment funds are expected to be less than 20bps with a passive fund manager. There is also a blended fund for Shariah and an automated de-risking Shariah Lifestyle investment strategy for those targeting a retirement benefit. An equivalent range of non-shariah options is also offered. This is offered in conjunction with National Bonds offered by the U.A.E., as a supplementary additional vehicle.
The provision of a Guaranteed Fund to provide security and certain guarantees largely for the Blue-Collar workers may also carry risks – these Guaranteed Funds internationally have had a chequered past with high-profile failures impacting both the developed world (e.g. Equitable Life in the U.K.) and developing world (e.g., CLICO in the Caribbean).
Finally, the U.A.E. might want to support an open and competitive environment by allowing both local and international equivalent savings vehicles to be offered in a free competitive market. Past service ESB obligations could be converted into an equivalent transfer value and moved across (with Members' consent) to either local or international equivalent vehicles with a suitable fee cap to protect against erosion of the transfer value. This is a particularly tricky area and needs to be well thought through to avoid the transfer scandals that have been seen in this area in developed markets like the U.S. and U.K.
It is an exciting time to be in the U.A.E. with these reforms being introduced and a huge opportunity for the ESB to be made better and for members to have better savings outcomes with the right protections in place. It feels as though this is merely the beginning of the journey towards a mandatory defined contribution system in the U.A.E. and wider GCC as we see elsewhere in the world these days. Bring it on!