With unrealistically large future liabilities, pension systems across the MENA region face a future crisis, yet governments in the region are doing little to tackle the issue. Faced with social unrest their top priorities are more immediate issues such as jobs and development. In addition to the impending pension crisis among nationals, swathes of expatriate workers are also neglecting to save for retirement. MENA Fund Review spoke to Yazan Abdeen of ING Investment Management, Jahangir Aka of SEI Investments and Lynda O’Mahoney of Hawksford about the current situation and potential future of pension sytems in the Middle East and North Africa
PENSION SYSTEMS in the Middle East and North Africa are at a crossroads.
With unrealistic future liabilities many countries in the region could face serious problems ahead that may lead to drastically reduced pensions, higher taxes, or cuts in services such as education and healthcare to pay for these inflated systems.
If governments were to act now, crises could be avoided. But with shorter-term issues high on the agenda, such as maintaining social stability, creating jobs, food security and building infrastructure, it is unlikely the issue will be tackled.
Analysis of pension systems in the MENA region shows how unaffordable they are in the long term, according to Yazan Abdeen, senior portfolio manager, ING Investment Management. Workers across the region get an average of 80 percent of earnings before retirement compared to an average global level of 57 percent, he says.
Also, pension systems in the region rarely impose any cap on the level of earnings eligible for a pension. This means that families earning double the average salary or more represent around 75 percent of those receiving a state pension.
This is a structural problem, one of badly designed schemes, that determines pensions by final salary. It is both open to manipulation and is overly generous.
So why aren’t governments tackling this issue? The answer is, because right now there is no will to do so. Populations across the region are young and so at present pension liabilities are relatively small. This will of course change over time. Eventually countries in the MENA region will catch up with these promises and be forced to “face the music,” says Abdeen. “Today, because of the structure of demographics in the region, you don’t have to answer for that, but that does not mean this problem does not exist.”
Other un-tackled and un-talked of issues also exist. Only around 30 percent of the region’s nationals are actually covered by pension systems and they work predominantly in government and public sector roles.
In most cases, people working in the private sector have no cover (the Emirates and Qatar are different in this respect). The effect is that for most people in the MENA region, their pension is their children or good investments.
Effectively, just 30 percent of the region’s nationals are covered by pensions, and they represent a promise level of 80 percent of GDP, according to Abdeen.
While issues are being stored up for the future that could be seriously destabilizing in some countries, wealthy governments in the region are somewhat exempt.
“The rich governments don’t have a really big issue because they will be able to seed these pension funds with whatever liquidity they need to cover certain promises,” says Abdeen. “I’m talking about governments like Saudi Arabia, the UAE, Qatar and Kuwait for example, because the surpluses they have from oil revenues and the reserves they have accumulated over the years create that buffer zone for them.
“The problem will lie in countries that have a high level of population like Libya, like Egypt, like Syria, these are countries that are anyway in political turmoil and have turned over their governments and their presidents and today they want answers to their existing questions regarding employment and their wellbeing today. But in the future they will have to make other revolutions related to how pensions are taken care of.”
The Arab Spring has helped to sideline any talk of the pension issue. It has, in a way, formed the third part of the value triangle, according to Abdeen. The first part was solid and interesting capital spending programs across the region. The second part was the healthy demographic structure. The Arab Spring has forced governments to create the third part, which is change for the benefit of their citizens. They have been forced into this position to some extent by the sudden realization that governments in the region can be overthrown by the people.
“What has happened is that naturally the governments that want to maintain peace and stability in their countries have taken fast action in terms of curing people’s problems now and unfortunately because the pension issue does not affect people today because of the nature of demographics, I don’t think there was a lot of effort put on that front,” says Abdeen.
“They are more focused on generating better job opportunities, increasing budgets for education, for agriculture and for infrastructure spending.”
It is not too late for governments in the region to tackle the issue, according to Abdeen. Pension systems need structural change and greater levels of transparency. Contributions also need to be increased to help met future liabilities.
“According to calculations, for governments to be able to acknowledge the promises they have in their pension systems people will have to increase their contributions by more than 35 percent,” says Abdeen.
The chances of these changes happening any time soon look slim, given the other social issues faced in much of the MENA region. And even if the pension liabilities issue was solved, the second problem of what to do about the remaining 70 percent who are not covered by pension systems would remain an issue.
While local pension systems could face long terms issues, expatriate systems are almost non-existent. There are no government funded schemes nor legislation in place.
For many expats, they are storing up problems for the future by failing to save and, by virtue of living abroad, opting out of any state pension scheme in their home country.
In the UAE there is the End of Service Benefit scheme. Under this the employer must pay an amount to expatriate employees on the termination of their employment.
Although employers should be accruing for the payment, they are not compelled to put funds aside during the employment period.
The system worked well until companies began to have issues with corporate cash flow, according to Jahangir Aka, senior executive officer, SEI Investments. This saw companies folding with employees owed an end of service payment, but no money in the firm to pay them. Employees, or ex-employees, then became debtors to the company.
“Companies lay off employees the most when they are in trouble,” he says. “And any company that is in trouble; by definition doesn’t have the cash lying around to be able to pay out the gratuities”
The second issue about the End of Service Benefit system was that historically companies would invest the money back into their own working capital, effectively giving themselves a loan. If a business was growing at 20 percent the end of service money was too. This was fine during the boom years, but not so fine when the economy began to flatten out or hit negative growth rates.
Currently though, many expatriates still fail to save for the future. According to Lynda O’Mahoney, business development manager, Middle East, Hawksford, “This is quite a problem in the region, particularly in the UAE, where the standard of living is higher than most other GCC countries. For a number of reasons, many Western expats are not saving sufficiently. For some expats the cost of living has increased dramatically since they moved to the region. Many expat packages have been significantly tightened which reduces the level of disposable income. That said, we are still very much in a fast car, Friday brunch and nice holidays environment.”
More often the people who are saving are lower earners who send money back to their home countries as soon as they receive it.
“In many cases, this money is used to educate the next generation who will go on to get better jobs and be in a better position to provide retirement income to their parents,” says O’Mahoney.
In recent years, where companies provide some form of expatriate pension scheme, there has been a growing awareness of the need for expert advice when it comes to asset management.
“Corporates are more open to discussing their needs with international providers who have the experience, particularly in pension fund management, and who understand the sensitivities of the region and the need to protect the company assets in order to honour their end of service benefit liability,” says O’Mahoney.
The demograhics of the region, both of expatriates and nationals, are also driving greater pension fund investment.
“In the next 25 to 40 years, pension funds will be unable to meet their obligations unless the current system is changed,” says O’Mahoney. “GCC policy makers will need to undertake reforms that will make their pension systems sustainable for the long term. Furthermore, by excluding non-nationals, who make up more than three quarters of the region’s workforce, GCC countries also miss a significant opportunity to strengthen their financial markets. If the GCC expanded pension funds to include non-nationals, the contribution fund would in some countries be greater than three times larger than its current size.”
The creation of long term pension fund investment in capital markets in the region would have a strong stabilising effect, according to Aka.
“If you take Western markets, the reason why we end up having a core baseline in terms of our stock exchanges is because our pension funds are so large and they do maintain positions in the market,” he says.
“So if you had a governed pension fund industry it would become a nice source of long term money for regional capital market stability as well.”
The development of a stronger pension system would have a significant impact on the local and international asset management industry.
If a UAE expatriate pension system, as the government there is currently discussing, is brought in and legislation states that it is mandatory for employers to contribute a certain amount which is to be invested in equity of local companies, this will both contribute towards more active local stock exchange markets, and also support the expansion of the local private sector and benefit the broader economy.