An ageing population means its time to rethink pensions in the Gulf

Pension reform during much of the 20th century was heavily focused on allowing the elderly to enjoy financial security after their working lives had ended. Western nations, as well as regions such as the Gulf Cooperation Council countries, spent decades building up increasingly comprehensive pension systems that typically provided significant incomes for those enjoying a well-deserved rest after decades of work.

But changes in demography in richer countries is altering assumptions that were once held to be self-evident. The mathematics of pension provision have fundamentally challenged the old model of government retiree incomes. And the process is continuing, making pension reform a more urgent part of policy debates around the world.

The reasons for this shift are as obvious as they are difficult to meaningfully change. Modern pension systems were typically established in relatively young and growing populations facing a fairly short post-retirement life expectancy. In other words, many people contributed to pension funds where the number of pensioners was much smaller and the period during which they benefited was a fraction of an average working career. Modern science and improving living standards have up-ended this.

Fertility rates have been drifting down, pushing up the average age and cutting the proportion of working-age people, those who contribute to the pension system. Life expectancy has risen, stretching the number of years people spend in retirement. Ageing people face higher health care bills and may require other support.

Not a concern for the Gulf given its young population? Wrong.

The same transition is playing out here also, albeit along different timelines. While the Gulf’s population is youthful, its average age is rising thanks to higher life expectancies while family sizes are gradually drifting down. The World Bank recently projected that old-age dependency ratios in the region will quadruple from less than five percent in 2015 to more than 20 percent by 2050.

How do we cater to these growing needs without compromising pension security?

The response to this challenge in most parts of the world has been parametric pension reform. By tweaking parameters of the pension system — retirement age, contributions, indexation, benefit levels, and so on — governments can extend pension payments without fundamentally altering the scale of their provision. But given the drift towards an older population, this becomes an ongoing process of recurrent tweaks every couple of years.

Is there another way?

Yes. By undertaking paradigmatic pension reforms, governments can put in place a system that is funded and self-adjusting, capable of ensuring that people can build savings for their retirement in line with their earnings during their careers. A simple way of thinking about this new system is the World Bank’s three-pillar model, the first of which is a government pension that is designed to ensure an acceptable minimum for all.

The bulk of pension savings is undertaken through occupational pension programs, which both workers and their employers contribute in line with an employee’s income. The money is typically placed into individual accounts, managed in line with the contributor’s wishes and converted into an additional pension, or annuity, at retirement. Another pillar is voluntary pensions, which many countries support through tax incentives.

Paradigmatic pension reform is no simple undertaking and has often been used due to a lack of alternatives, for example, when the old pension system has been nearly exhausted. But the framework of a three-pillar system also offers food for thought for countries that are under less immediate pressure to overhaul pension provisions. Even when introduced gradually, it can bring many direct and indirect benefits while adding resilience to a country’s social insurance system.

First of all, it can help embed a savings culture that allows people to better plan their financial futures. Encouraging people to contribute to their pensions regularly changes behavior. Making decisions about the management of savings boosts financial literacy. Regulating the second and third pillars in line with the World Bank model adds comfort as savings are managed by professional asset managers subject to prudent person rules, designed to ensure appropriate risk management, diversification, and returns.

While company savings schemes exist in the Gulf, they are often run by in-house committees who lack the financial expertise to ensure that their pots of money are protected and profitably invested. This would appeal to those who want to remodel the outdated end-of-service benefit practices for expatriate employees. A funded system can protect their retirement security but also ensure more capital is invested into driving growth across Gulf economies.

By putting in place provisions for dedicated pension funds and management companies, governments can enable necessary diversification across the financial sector. These funds would benefit from a continuous influx of contributions and quickly grow into substantial institutional investments. It is collective savings firms such as these — insurance funds, pensions funds, and other asset managers — that dominate Western financial markets. Given their trustee responsibilities, they are required to safeguard pension savings and ensure they are efficiently invested. They play an important role in pooling and allocating capital across their economies.

This is a major consideration in this region, which is in the middle of an economic transition, designed to put in place an increasingly diversified economic model. Having more professional asset managers — not to mention more capital — involved in this exercise can only be positive. While the time for paradigmatic pension reform in the Gulf may not be today, gradually adopting elements of this model can deliver a wide range of benefits to the region’s working people and its broader economy.

• Jarmo Kotilaine is an economist and strategist focusing on the Gulf region. He writes on issues ranging from economic development to changes within the corporate sector