Pensions Play Key Role in Building Strong Economy
By Richard Dean,
Boring things, pensions. In a world of sexy finance – day trading, IPOs, takeover arbitrage – pensions are the maiden aunt. They're dull, they're high maintenance, but deep down you're glad they're around.
Here in the Gulf, though, they're not around. And that's a pity, because pensions really do play a critical role in building a strong economy. They help the man-on-the-street save for his retirement. They help companies reward and retain their best staff. And, perhaps most important, they generate a massive pool of long-term capital, bringing strength and stability to the stock market.
So, if we accept that pensions are a good thing, how does the Gulf stack up against the rest of the world? Not well. Research from HSBC shows that in the UK, pension funds are equivalent to about 66 per cent of the economy. Compare that to the Gulf, where pension funds are negligible.
Why the lag? Typically, in Western economies, three sources pay into a pension: the individual, his employer and the government. Let's look at those in turn to see why it's not happening here in the Gulf.
First, individuals. Expatriates make up the bulk of the population. Many expect to spend their retirement in their native country, so they save money back home, not in the Gulf.
Second, companies. They pay into the gratuity system instead of pensions. In ballpark terms, employers must pay staff – when they leave – one month's salary for every year of service. We know that many firms fiddle this by paying low basic "salaries" in favour of "allowances" which don't figure in the gratuity calculation. By and large, though, they do pay something.
Third, governments. Western governments recognise that pensions are a good thing, so they offer tax breaks to encourage people to save. But we don't pay income tax here in the UAE, so there's no tax to break. We already have the money in our pockets, to save or spend as we wish.
Given this, maybe it's unfair to compare the UAE and UK pension markets. But that doesn't mean we can ignore the issue: far from it. Here are three reasons why the region must embrace a formal pension system sooner rather than later.
THE MAX FACTOR
The current gratuity system is deeply flawed, mainly because long-serving staff are at the mercy of their employer. Imagine a guy – and there are many – who's been working for his company in the Gulf for 15 years. Just before he's due to retire and claim his hard-earned gratuity, the company goes bust. Sadly, the guy gets nothing, because under the present system, there's no separate gratuity fund. It's all on the company balance sheet.
The classic example of what can go wrong is Robert Maxwell, the British media magnate who died in 1991. Back then in the UK, the lines between the staff pension fund and the company balance sheet were blurred, as they are today in the Gulf. Maxwell used the staff pension fund as his personal bank account – and when his empire went under, the staff were left with nothing.
Following that, the UK tightened up its pension laws, and company pension funds are now ring-fenced. Normally, they're managed by a specialist, independent fund manager. So even if the company folds, the pension fund is safe – and staff can enjoy the retirement they've worked so hard for.
The Gulf needs a similar system to protect hard-working staff from failing companies.
Boring things, pensions. At the risk of repeating myself, this is exactly the point. Pension fund managers are long-term investors. They take a 10, 20 or even 30-year view of investing. They buy and hold stocks for years, and that makes for greater stability in financial markets.
Today, Gulf stocks markets are dominated by retail investors, who buy and sell on a whim. That makes for volatile markets – and volatile markets don't do their job as well as stable ones. (Remember, the main role of a stock market is a place where real companies can access capital to invest and grow, thereby creating prosperity, jobs and higher living standards for all.)
A thriving market in occupational pensions, then, will contribute to the region's long-term economic goals.
DEMOGRAPHIC TIME BOMB
The days of the two-year Gulf posting are fading fast, particularly in the UAE. Expatriates buy homes here, educate their children here, and many will die here. As such, they need to plan for a retirement in the Gulf, not the country of their passport or birth. It's no good having a great retirement fund in India or the UK, if (as seems likely) Gulf currencies appreciate sharply over the next couple of decades. As any good financial adviser will tell you, retirement savings should mainly be in the currency of the country where you plan to retire.
So much for expatriates. What about the national population? Today, retirement is funded by a combination of government schemes, private wealth and younger family members. By and large, this system works well, particularly in an affluent country like the UAE. With oil above $100 a barrel, there's little danger of the government system coming under pressure any time soon. But for young graduates entering the workforce, retirement is 40 years away. Maybe a formal pension isn't such as bad idea after all.
So much for the imperative. What are the prospects for change? HSBC is optimistic. It predicts that from virtually zero today, occupational pension plans will be offered by a majority of employers in 2020. Of course, HSBC has a vested interest: the world's local bank is also the world's local pension fund manager. But progress is slow.
Three year's ago, the bank's Middle East spin-doctor, Steve Martin, was plugging the case for pensions. Today, his successor Tim Harrison is doing the same. HSBC has made some inroads in the intervening period – earlier this summer there was a bit of media hoopla when Dubai-based Al Hathboor Group signed up. But the bank's own research acknowledges, as I just mentioned, that we're still at "virtually zero".
In the future, it hopes the Middle East pension industry will follow the medical insurance industry. Back in the mid-1990s, hardly any Gulf companies offered their staff medical insurance. Now it's compulsory in many countries. If they're right, companies like HSBC will make a tidy profit. But they won't be the only ones to benefit. The regional economy will benefit as a whole, and I for one hope they succeed.
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