Pension reforms for expat workers in GCC

The current framework for End-of-Service Benefits (ESB) for expat workers is proven to be inefficient for all stakeholders. This is not just in Bahrain but also in the wider GCC markets. The labour law contains a requirement for employers to pay expat employees a lump sum upon leaving employment. Yet, very few companies actually set aside specific funds against these liabilities, while expat employees themselves consider such benefit to be much far less than adequate as a pension income.

Therefore, new soft reforms, that prioritize the preservation of the expat labour rights, are proposed to change the End of Employment scheme, whilst avoiding cash deficiency employers might face anytime with respect to the current unfunded strategy.

Dubai’s DIFC have accumulated substantial financial assets through altering their approach to this expat benefit. The reforms will therefore build a new layer of pension infrastructure in Bahrain, funnelling funds to local capital markets and expanding the country’s asset management industry.

There are several factors coming together substantiating the case for a new national workplace savings framework for Bahrain. Modernization of the ESB arrangements that are almost 50-years old by now is one of these. The pension reforms debate that has been ongoing the last few years in some GCC countries is another factor. And the increased awareness about voluntary and supplementary savings to protect against contingencies or difficult times such as Covid-19 is a third point.

To avoid any confusion, we do not mean nor aim to reform the ESB by integrating expat workers into the national pension funds managed by governments for local citizens, because many of these funds are already struggling with actuarial deficits; but rather by restructuring these benefits with new notions in line with innovative pension thinking and the asset management industry.

The ESB (also referred to as leavers’ indemnity) is a benefit paid to expatriate workers when they leave the service; such scheme is also enforced in all GCC countries. The payment amount is calculated based on the employees’ wages when they leave employment and the number of years the employee has worked. This means that substantial amounts can become payable to staff.

Under Bahrain’s labour law, the employee is entitled to half a month’s wage for the first 3 years worked and a full month wage for each subsequent year worked. For example, an expat worker who has worked for 5 years with a salary of BD1000 ($2,636) per month is due (3*0.5) + (2*1) = 3.5 months’ worth of salary, i.e., BD3500. Therefore, it is crucial that such amount is accounted in the firm’s balance sheet as it constitutes as a liability. A company with 50 employees with a similar status to the example given above, the company would owe BD175,000 in liability. Not only is the amount substantial, but the cost to the employer is always to some degree undefined due to the benefit being dependent on the employee’s monthly salary when they leave.

Although companies account for liabilities, very few companies set aside specific funds. Granted that the liability is present in the company’s balance sheet, yet it is calculated as part of the working capital. Such unfunded approach to the ESB puts both employees and firms at risk; if the company needed to reduce staff numbers, the firm will end up facing cash shortages. Even if the liability was accounted for correctly, there is no guarantee that the company would have sufficient funds to be able to make payment of ESB benefits. In the case where the company’s performance has been poor, the likelihood of having little or no access to liquidity from the bank is increased.

In an ideal world, this benefit will be fully funded and segregated from the employer’s balance sheet wherein each company would hold sufficient financial assets to cover their ESB liability; those assets would be segregated from the company’s balance sheet and not available to creditors.

However, the proposition of funding ESB liabilities often raises major public objection mainly from business firms, stemming from the belief that funding ESB will reduce their working capital and lead to business deterioration.

Realistic reformative measures that could be reinforced in Bahrain’s labour and pension sectors include more than one viable option. The first option is to retain the current ESB yet require employers to fund them. Although this option might appear unreasonable whereby employers cannot be expected to fully fund the whole amount to be paid for ESB liabilities immediately, various funding solutions could be considered. The first solution is to only require that a portion of ESB liability to be paid; this could be interpreted as 25% of the total liability, or the liability of 25% of employees with the largest accumulated benefits.

The second solution would be to ring-fence and restrict access to current accrued benefits and require that benefits that are accrued in the future must be funded; thus ensuring a gradual approach to the process. In either way proposed, a sufficient notice period is to be given to employers.

The second and better option of reforming ESB is to replace the current ESB structure with a Defined Contribution vehicle, in line with global pension thinking. This involves replacing the current method of calculating benefits with a contribution that is a percentage of the employee’s monthly salary, going to an Employee Saving Scheme. This arrangement will ensure that benefits are fully funded on an ongoing basis, while employers will know the exact total cost to be paid and free their balance of such chronic liabilities. Many big businesses in Bahrain and across the region already have been running employee savings schemes for decades and are familiar with its workings.

While achieving a win-win for employers and employees, this remedial approach also has the potential to create demand in local equity and funds, and channel a great domestic liquidity for infrastructure and growth projects. The writer made some lobby efforts with colleagues to put forward this concept and the law amendment it entails to some government agencies in Bahrain in the year 2015, but those authorities did not see the time was right then.

Dubai’s DIFC is a striking example to the success of implementing a saving scheme for expats’ End-of Service benefits in the year 2020. The DIFC asserted a pathway for modernizing these benefits, through transitioning away from the traditional calculation of ESB into a new system of individual accounts of employee workplace savings, funded with contribution from the employer. Employees too can choose to contribute to these accounts and choose how their funds are invested.

As a result, in just one year, the scheme accumulated a total of $127 million in new investment assets. This was just the beginning, not the full roll-out at DIFC or the emirate of Dubai itself. The success of implementing a new expats’ saving scheme was previously predicted and discussed in a study conducted by Fintech Robos under “With $170 Billion, the GCC can Triple the Size of Asset Management and Establish GCC Infrastructure Bank -The Power of Thinking Big for Pension Funds”. Executing such a plan will promise the creation and development of a new and thriving pension industry that will exponentially grow the financial and investment assets of Bahrain’s economy in the next 10 years.

About the author: Ebrahim K Ebrahim is Founder of Fintech Robos and Chairman of the Arab Pensions Conference