The unmet need for Shariah-compliant pensions

Photo credit: wk1003mike

There is a palpable momentum building for more Shariah-compliant pension funds as residents of Organisation of Islamic Cooperation (OIC) countries improve their financial literacy, the uptake and awareness of Islamic finance continues to grow, and the need to take better care of ageing populations intensifies. However, pension provisions are still low and their benefits are not fully understood in these countries.

GLOBAL AND OIC PENSION MARKET

The pensions market reached an estimated $35.4 trillion in assets in 2015. The largest markets are the United States ($21.78 trillion), the United Kingdom ($3.2 trillion), Japan ($2.75 trillion), Canada ($1.53 trillion), and Australia ($1.48 trillion).

In contrast, the pensions market in Organisation of Islamic Cooperation (OIC) countries is a lot less developed and there is no single estimate of the total amount of pension assets in all OIC countries. However, for the six-member Gulf Cooperation Council (GCC) countries alone, public pension funds have been estimated to be worth $397 billion.

OIC representation among the largest pension funds in the world is low, with only three of the top 300 pension funds in OIC countries: Malaysia's Employees Provident Fund ($161.71 billion), the Malaysian government’s retirement fund, KWAP ($28.34 billion), and Kuwait's Public Institute for Social Security ($60.99 billion).

NEED FOR SHARIAH-COMPLIANT PENSIONS

Most conventional pensions are not Shariah-compliant as they involve interest and/or generate returns by investing in sectors which are prohibited in Islam, such as food and beverage companies that produce alcohol, pork, or other non-halal products, Shariah non-compliant entertainment businesses, and conventional banking and insurance.

This, coupled with the increasing awareness and uptake of Islamic finance especially in key Islamic economies such as Malaysia and Indonesia in Southeast Asia and the GCC countries, makes the issue of providing Shariah-compliant pensions more urgent.

A 2013 report valued the demand for Islamic pensions at between $160 billion and $190 billion. This latent demand is in stark contrast to the $145.51 million (pdf) held in 64 Islamic pension funds in 2014. 

According to Luc Metivier, Chief Executive Officer at Bahrain-based Takaud Savings and Pension, state pension systems face a huge stress, with many governments, including in the GCC, facing deficits and hence increasing the challenge for them  to pay pensions out of their budgets.

“Employees and citizens understand they will have to count much more on themselves and shall save for their retirement, otherwise they will not have enough money to live decently, betting only on the state pension system,” said Metivier.

The more urgent need for OIC countries to start providing Islamic pensions is compounded by their need to take care of their ageing populations—due to a combination of declining fertility rates and increased mortality rates—even as these countries carry a “youth bulge”. For example, in Malaysia, a key OIC economy and prominent Islamic finance jurisdiction, the proportion of people aged 65 and over is projected to increase by 6.4 percent by 2030.

As the recent uptake for Malaysia’s Employees Provident Fund’s (EPF) Shariah-compliant pension scheme shows, demand for such pension plans is strong. In the first five days after the scheme was opened in early August,  at least 150,000 existing EPF members registered for it, resulting in an uptake of a quarter of the scheme’s allocated $24.9 billion.

Safder Jaffer, Managing Director and Principal at actuarial firm Milliman, believes the growing call for Islamic pensions runs alongside the overall demand for retirement savings. “As awareness of the need for retirement savings takes root, there has been a concurrent demand on Shariah-compliant saving platforms. This extends to the way in which assets are accumulated and the way in which these holdings are eventually drawn down as income,” said Jaffer.

KEY ISLAMIC PENSIONS PROVIDERS

At the country level, Malaysia’s EPF Simpanan Shariah is the only standalone, fully Shariah-compliant state-owned pension scheme in the OIC.

At the market level, there are numerous private pension providers of Islamic products across the OIC and in some non-OIC countries.

In Malaysia, Affin Hwang Asset Management, AIA Pension and Asset Management, AmFunds Management, CIMB-Principal Asset Management, Kenanga Investors, Manulife Asset Management Services, Public Mutual, and RHB Asset Management all offer Shariah-compliant private retirement schemes.

In Pakistan, a number of voluntary pension providers offer Shariah-compliant schemes, including MCB Arif Habib, NBP Fullerton Asset Management, Al Meezan, UBL Fund Managers, ABL, and HBL.

In the United Kingdom, Al Rayan Bank, together with Carey Pensions, provides the Islamic Pension Trust, a Shariah-compliant scheme that works on an automatic enrolment basis. In addition, the UK-based National Employment Savings Trust (NEST) occupational pension scheme offers a Shariah-compliant workplace pension that uses an investment strategy mirroring the Dow Jones Islamic Titans 100 index.

GAPS AND OPPORTUNITIES

Addressing the gaps in the market, Jaffer sees two key areas for improvement. “Looking at the OIC region as a whole, pension savings as a proportion of GDP are considerably below other parts of the world. The journey from an under-provision to adequate provision offers fantastic potential,” said Jaffer.

“The market needs to develop Shariah-compliant products that are understandable and meet consumer needs. This will require innovation,” he added.

“Some states are moving to state pension parametric reform and others are also entering into systemic reform, following the World Bank model of three pillars: State Pensions System, Corporate level, and Individual Level,” explained Metivier. 

Some OIC countries, such as Kazakhstan, engage in parametric reforms, such as increasing the normal retirement age, which consist of changes to their current pension systems’ parameters.

Others, such as Malaysia, are undertaking systemic reforms, which involve either using a new type of pension system as a replacement or addition to incumbent systems. Malaysian state pension funds such as the EPF are becoming more aggressive and professional in their approach to investing social security funds in order to secure pension adequacy.

In the GCC, the market is slowly moving in the right direction. “Many providers have made concerted efforts to build awareness of Shariah-compliant pension platforms, as well as the need for pension provision more generally,” said Jaffer. 

All reforms, coupled with demographic trends, create opportunities for pension providers to provide products that cater to the corporate and individual pensions markets.

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