What the new UAE end of service gratuity regulation will mean for you

Under a new law coming into effect in July, companies will have to set aside enough to cover all their end-of-service liabilities. Here, Aon Hewitt explains what this means to employees and employers.

The new regulation obliges companies to have an evaluation of their liability for their end of service and then they have to match the accrual that they have on their balance sheet. Jeff Topping / TheShow more

The majority of companies in the UAE are aware of their end of service liabilities and have some funding in place to cover it. That’s the good news, according to Martin McGuigan, partner and head of rewards consulting for Aon Hewitt Middle East. But the problem is, he says, a company’s liability changes over time. And only “a very small proportion” of companies carry out an evaluation to top up their liability accordingly each year. However, that is about to change, with a new regulation coming into place on July 1. Mr McGuigan explains what it is and what it means for employers and employees.

What is the new regulation?

The new regulation obliges companies to have an evaluation of their liability for their end of service and then they have to match the accrual that they have on their balance sheet to say here’s what we owe our employees and here’s how much money we have set aside.

Will this be a problem?

The problem will be two-fold. One, a number of companies don’t set anything aside and they fund it as an expense as and when people leave because they are using what should be the employees’ money as working capital. And the second problem is because of the way the system is set up. For your first five years you get paid 21 days of pay and for your next five years you get paid 31 days of pay. Somebody who starts on Dh10,000 a month and gets paid 5 to 6 per cent increases every year in terms of their salary (is due more for their final salary with each increase). But if the company only accrues (the final payment based on the original salary) without doing a top-up for what they are owed, even for one employee, then you have a gap by the end of 10 years of Dh40,000. This doesn’t sound much but if you employ, let’s say 1,000 people, then that suddenly becomes a big hole of Dh40 million. So what this new legislation is saying is as an employer, you need to make sure that gap between what you have saved up and what you owe is constantly topped up so there is no gap.

What’s the solution?

Companies need to bring in a defined contribution pensions scheme. What that would do is every month instead of putting your money onto the company’s balance sheet, your money would be paid into a fund that you would control held by a third party.

What if companies can’t fill the gap?

That’s a very good question. If you look at the financial press, BHS [in the UK] went into liquidation and the reason it went into liquidation is because its accountants said it was no longer a going concern because it didn’t have enough money to fulfil its pension liabilities. So what it owes its pensioners has effectively closed that company down. This is an accounting regulation, so what they will have to do is take a hit on their profit and loss accounts over a number of years to fund the gap.

What does the new regulation mean for employees?

Firstly it takes away the risk of them having all their eggs in the one basket with their jobs, pensions and savings all with one company. Secondly, under the current UAE end of service rules if you are a long-serving employee at the end of your service you cannot be paid more than two years’ salary. Now it doesn’t take that long for your money to get up there, let’s say 20 years. But what happens under that regime is that your money can’t grow. And actuaries will tell you if you are hoping to retire at 65 and live to the age of your early 80s, you need to have more than 12 years of your final salary saved up in assets to fund your retirement.

Aon has a defined contribution pensions system it will launch by the end of the year to companies in the UAE to replace the end of service payment. But it is aimed at offshore companies, those based in free zones, not onshore companies. Why?

The reason for that is in offshore legislation each one of the free zones has its employment law and allows companies to opt out of the end of service arrangements, conditional that they give the employees something of equal or greater value. The problem for the onshore companies is the labour law is not clear. So the risk for the onshore companies is I give you this and put money into it on your behalf every month. Then at the end of your end of service period you come back and say no, I want my end of service as well. That is a risk the onshore companies are not willing to take. And that is why we need to have a joined up legal point of view on this for the government.

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