The GCC’s Pension Funding Challenges and Silver Linings

The effect of demographics on the economy has been one of increasing concern for countries with ageing populations. The poster child for this issue is Japan although an increasing number of countries in the Western Hemisphere are beginning to take notice as well. The main issue is that declining population growth rates and in some cases negative population growth rates are severely challenging the historical funding of retirees with tax revenue collected from a working population that is greater in number.

This crisis has not been satisfactorily resolved in any of the countries facing these challenging, with the most popular government solution of extending the retirement age so as to delay pension payments to pension consumers, i.e. retirees. Other approaches include phasing in retirement payments over time. As you may expect, these solutions are unpopular with older generations.

The other main approach of closing the near global retirement crisis is to increase taxes on the pension producers, i.e. the currently employed. This alienates the younger generations who view such a strategy as simply working so others can benefit.

As always it is instructive to try and learn from others. What are the demographics in the GCC? Will they change in ways similar to the rest of the world? How will this impact the economy?

There are currently two marked differences between the situation in the GCC and of the economies that I mentioned above. The first is that the population growth rate remains strong, some might say too strong. The second is the relatively low levels of income tax revenue. Public pension funds are funded via revenue that is far more fixed in quantum given the current near total absence of personal and corporate income tax.

Widening the scope out to investigate second order issues, the increase in longevity in the GCC countries brought about by vastly improved healthcare systems in the recent past as well as greater education towards healthier lifestyles is an extremely positive aspect of the modern-day GCC. However this increased longevity changes the calculus of retirement as longer lifespans lead to greater pension requirements at a time of life when health care costs increase markedly.

Another important issue with respect to funding pensions in the GCC is the growth rate in the cost of living. In fast growing economies the cost of living will grow much faster than the global average. This creates further challenges as maintaining quality of living levels for pensioners requires either greater contributions or better returns on investment for the pension funds.

Is there any silver lining in this morass of grave news? Well, I’m not sure increased longevity is necessarily bad news, so let us restrict it to funding pensions. For the GCC there are three silver linings.

The first silver lining is that the countries of the GCC are young. Any funding deficits that might exist will be small relative to those found in countries with older pension schemes. The second is that the younger generations are vastly greater than the retiring generation, making any extra funding necessary relatively small as it is spread across a wider base.

The final silver lining is peculiar to the GCC. The region has a relatively large percentage of the population who are expatriates and are therefore not necessarily covered by the local governments’ pension schemes. This is key, as local pension plan funding needs are therefore small relative to the GDP generated by these economies.

These silver linings do not mean that pension planning can be ignored. What it does mean is that the challenges the GCC face are different than other emerging markets or even mature markets. The UAE’s approach so far has been exemplary. The next step is to either boost contributions, improve returns on investment or manage the expectations of our younger generations with respect to financial quality of life at retirement.

If we don’t we will face a much more acute problem than that faced by current mature economies which are pushing retirement from around 60 years old to around 70 years old, and we might have to issue the first pension check about a week before the retired employee retires from life.

This article was originally published in The National.