“It’s past its sell-by date.” ... “It’s an iceberg.” ... “Few question how it will be funded.”
You don’t have to ask too many wealth management experts in the UAE about the country’s end-of-service benefit scheme before the negative opinions start to accrue.
Considering they represent the other alternative – market-based private savings plans – they perhaps would say all that and more.
But it’s undeniably the case that the severance pay set aside for every UAE worker – calculated on a sliding scale depending on the number of years worked and the means of your departure – has several issues that, in light of other reforms now being introduced to the local labour market, perhaps ought to be addressed.
The first one is how, and to what degree, they are funded. According to several studies and surveys, companies in the UAE are sitting on millions of dirhams of financial obligations owed to their employees who could potentially call them in at any time.
If CFOs aren’t making adequate provision each month, this could have a substantial impact on the balance sheet if several long-standing employees leave at the same time.
They need only look to Europe to see the problems of failing to set resources aside for these ever-accumulating obligations.
Across the continent, according to consultancy Mercer, around 35 percent of defined-benefit pension plans – in which a monthly payment linked to final salary and years of service continues to be paid for the remainder of a former employee’s life – now have more money going out than coming in.
In the UK, this figure is as high as 61 percent and is contributing to a pension “black hole” that in 2017 equated to a funding shortfall of £400bn ($516.6bn). According to the Financial Times, “the combined pension deficit of the FTSE 350 companies has now risen to 70 percent of their profits, diverting resources from projects that ensure long-term business viability”. That’s a fairly bleak picture.
We have been anticipating that regulations would be put in place requiring employers to make provision in their account for end of service accrual
In the UAE, there are slightly different, and on the face of it less catastrophic, considerations. The main one is that the end-of-service benefit isn’t a pension; it doesn’t have to take into account the lifespan of the employee once they leave.
As it is based on a fixed formula that every CFO ought to be familiar with, there shouldn’t be any surprises when an employee heads for the door. Once the cheque is handed over, that’s it.
That hasn’t seemed to have helped companies in the UAE sidestep the issue, of course. According to Willis Towers Watson - an advisory, broking and solutions firm - a fifth of the country’s companies face end-of-service liabilities of $15m or more.
Even more startling is a figure that suggests as many as 88 percent of companies across the GCC have no plan in place to fund gratuities due, opting to settle amount from funds as and when required.
Considering nearly two-thirds of employees now expect to stay in their place of employment for longer than five years – when the maximum gratuity threshold is reached – that is a rather large debt being amassed every year.
According to a report in Gulf News in December last year, the UAE’s government has been presented with a study recommending the establishment of a savings fund in each organisation rather than the traditional end-of-service gratuity for expatriates.
The plan would allocate a percentage of foreign employees’ salaries at government, semi-government and private sector firms and place it in investment funds, with the lump sum – and any gains accrued – paid to the employee when they leave their place of work. Employee participation would be voluntary and they could, should they choose, add more to the fund from their own salaries.
Sarah Anderson, senior associate at Hadef & Partners, a law firm that specialises in HR issues, says that talk of tightening accountability over contributions have been circling for some time.
“Failing to make adequate provision for end of service gratuity and/or under calculating the amount due is is a common problem amongst employers and we had anticipated that regulations would be put in place requiring employers to make provision in their accounts for end of service accrual. These regulations, despite reports, have not yet materialised,” she tells Arabian Business.
“Interestingly, we are aware that the DIFC is consulting on the proposal to introduce a mandatory pension which would replace end-of-service gratuity. However, these consultations are in their infancy and may not be well received by employees, who typically move around a lot and don’t want their money tied up in complex schemes.”
One private-sector solution that may address both sides of this equation has now been released by Zurich International, one of the largest insurance and wealth management companies in the region, in conjunction with Mercer, a leading investment consultancy.
Their new platform, called MySavings, offers employers an investment-grade option that can be built into their payroll in a number of tiers – from baskets of basic funds to self-selected stocks and bonds.
“End-of-service benefit was never designed as a retirement fund and often most people use it as a means of paying off debt and buying a one-way ticket back home,” says Peter Cox, head of international pension plan sales at Zurich.
End-of-service benefit was never designed as a retirement fund and often most people use it as a means of paying off debt and buying a one-way ticket back home
“In terms of companies putting money into it and the returns for employees, it’s past its sell-by date. It’s not a robust enough product, most are unfunded and it is becoming a major problem for the UAE government – especially as the employee cycle in the UAE is getting longer here.
He explains how MySavings aims to provide a simple solution via an employer, who people are likely to trust more than some of the commission-heavy retail investment companies in the market. Saving at source is automated and, as a result, contributors are then free to spend what remains without having to think about keeping some savings aside.
“What we’re offering is similar to a workplace scheme in the UK or the US, where the employer sets it up, gains access to a wide variety of funds and the cost benefits of being in a large pool,” says John Benfield, head of wealth at Mercer.
“But as there are no tax implications as in the UK, there are also no lock-ins, meaning that when you leave, you can close it and take the funds to your next place of work – with no penalties or redemption charges.”
There is also, adds Cox, the option of employers making a contribution, creating an attractive employee benefit that can be charted on each month’s wage slip – adding transparency and an element of financial education on the benefits of regular saving.
“In a country where there is no income or payroll tax, you can see this as the equivalent of being taxed at source, only this is all going back to you,” says Benfield.
The end-of-service benefit does, though, have its fans. One employer, who recently left his executive-level position after 12 years, said the gratuity payment was “a nice thing to receive at the end” and that if it was included in his payroll, “I am not sure we would have saved anything over and above. As it is, we managed to save all of it to supplement other savings”.
In a country where there is no income or payroll tax, you can see this as the equivalent of being taxed at source, only this is all going back to you
Not all employees are perhaps that financially literate, though, and with no index-linking or structured investment, the end-of-service benefit might leave many short-changed – especially if they are relying on it to fund retirement or key life events like starting a family or paying for a child’s education.
For UAE expats, saving is difficult and is often postponed as other, more immediate, lifestyle choices take precedence.
“I think we forget just how much people need to save for their futures,” says Zurich’s Cox.
“People are living longer and states are providing fewer benefits in retirement. But the length of time you save is almost as important as the amount – and the longer you put off saving, the more you have to put away each month when you do finally start.”
Although there is, he adds, no simple answer to the age-old conundrum of how much you need to put away, there are some general rules of thumb. In the UK, for instance, a popular figure is 17.5 percent of your salary needs to be channelled into a savings scheme every month.
Other metrics point to thresholds like having one year’s salary saved after five years of work, which will then need to build to 12 times your salary after 40 years working. They’re big numbers.
As Hadef’s Anderson says, “given the lack of obligatory pension in this region, employees should ideally be making their own retirement plans and they would be well advised to invest end-of-service gratuity upon receipt of this”.
The end of service benefit law has been in place in the UAE for more than 35 years now. It is payable to any worker at the completion of their employment, either through resignation or redundancy, who has completed one or more years of continuous service. The total amount of severance pay should not exceed two years’ worth of wages.
The sum owed is calculated using the following formula:
Monthly wage divided by 30 and multiplied by 21 days wages and the number of years worked for each of the first five years of service. Any full years after the fifth is calculated on the full 30 days’ wage.
The two-year cap isn’t usually hit until more than 20 years of work are competed.
Subscribe to Arabian Business' newsletter to receive the latest breaking news and business stories in Dubai,the UAE and the GCC straight to your inbox.