ACA chair Stewart Hastie: The legislation together with TPR guidance will need to bring clarity to trustees and sponsors
Government measures on surplus flexibilities are big enough to make run-on in pursuit of surplus a “viable alternative to buyout for many schemes,” the industry says.
This morning (29 May), the government set out its plans to lift restrictions on how defined benefit (DB) scheme surpluses are used – pledging to introduce a statutory override for trustees of schemes to modify their scheme rules; change the threshold at which trustees were entitled to share surplus with the sponsoring employer to full funding on a low dependency basis; and amend section 37 of the Pensions Act 1995 to clarify trustee requirements.
WTW head of corporate pension consulting Bina Mistry said: "The government is addressing three of the main hurdles that schemes must clear before they can make payments to an employer: what the scheme rules say, how well funded a scheme must remain after the payment, and the requirement – over and above general fiduciary duties - for trustees to be satisfied that the payment would be in members' interests.
"This package of measures looks big enough to make run-on in pursuit of surplus a viable alternative to buyout for many schemes and presents opportunities for both members and sponsors to benefit - the proposals finally seek to correct the long-standing asymmetry, whereby shortfalls must be plugged but surpluses are trapped."
Isio director Iain McLellan agreed: "These proposals mark a significant shift in DB scheme regulation. For two decades, the focus has prioritised securing existing accrued benefits above all else, including future benefit accruals and discretionary increases. The industry in keen to embrace these changes and the opportunity to support growth and greater innovation.
"Trustees have generally been positive but have consistently raised the importance of clear guidance being provided to support their decision making on using any surplus. So far, The Pensions Regulator (TPR) appears keen to engage with explicit reference in its recent Annual Funding Statement that it views schemes having a surplus policy in place as best practice."
LCP partner Steve Hodder said that, while some schemes had already put in place arrangements to use some of their surplus funds where circumstances allow, the new legal framework would make this much easier and is likely to lead to far more trustees and sponsors considering how best to use their scheme's surplus.
He said: "We welcome the government's ambition in avoiding unnecessary layers of caution in their plans for DB surpluses.
"Of course, it is paramount that member benefits are protected. However, the surpluses of DB schemes today are very real and robust as demonstrated through recent market volatility. Regulators have devoted considerable time and energy in developing a low dependency measure for scheme funding, and that is the right yardstick to allow trustees to consider if their scheme is now able to productively use its excess assets."
Arc Pensions Law partner Sonya Fraser said trustees and employers should welcome the potential for greater flexibility around the use of surplus and agreed the government had avoided adding additional complexity.
She said: "Members should be reassured that a statutory power to do this will be vested solely in trustees, although it is unclear whether the proposed changes will maintain or strengthen the legal hurdle to get there. The clear statement that there will be no restrictions on the use of extracted surplus will also be welcome for employers, as the alternative risked adding yet another layer of complexity."
Legal & General head of UK institutional and wholesale asset management Mark Johnson also welcomed the government's consultation response and its stated intention to remove barriers to surplus extraction, while maintaining stringent funding safeguards to protect member benefits.
He said: "While we believe a majority of schemes will continue to target risk transfer to an insurance company, running on for longer will increasingly become a realistic option and, thanks to measures enabling surplus extraction, will provide sponsors and trustees with greater choice, for example through opportunities to enhance DB and DC member benefits and investing in the UK growth agenda.
"The Pension Regulator's latest Annual Funding Statement shows that schemes are better placed than ever before to meet the needs of their members and can shift their focus from deficit recovery to endgame planning. It doesn't need to be a question of transferring liabilities to an insurer or run-on - a scheme can do both. Importantly we think that clarity will be a catalyst for trustees to utilise their surplus and as an opportunity. This could include exposure to productive assets just as many insurer's hold a portion of in their Matching Portfolio. We believe for those ultimately targeting buyout, preparing their market approach and transacting at an optimum time will remain high on trustees' agendas."
Clarity needed
XPS Group said the focus was now on "getting the details right".
Senior consultant Tom Froggett said: "We need a clear blueprint for trustees and employers who are seriously considering running on, so that they can develop with confidence the strategic and operational frameworks to deliver the benefits of running on to members and employers as well as having robust safeguards to protect member benefits."
The Association of Consulting Actuaries (ACA) – an organisation that has long been vocal in its support for surplus release reform – agreed the details would now be key to get clarity for trustees and sponsors.
ACA chair Stewart Hastie said: "The legislation together with TPR guidance will need to bring clarity to trustees and sponsors to conclude how and when surplus release is appropriate."
Tax reform
Hastie said the ACA would also like to see the government bring forward tax reforms as well.
He explained: "We also would like to see the government bring forward the necessary pensions tax reforms to increase flexibility on how surplus is used – for example, making it easier to use DB surplus to fund current employee pensions in another trust; and paying lump sum benefits to members of DB schemes that could be more meaningful and less risky than increasing lifetime pensions."
Hymans Robertson head of corporate DB Sachin Patel agreed.
He said: "While the government's response today was relatively light on tax detail, we believe this area warrants further focus.
"Allowing one-off lump sum payments to DB members to be treated as authorised payments, free from punitive tax charges, would significantly enhance the appeal of surplus distribution, without adding material future liabilities to pension schemes. There's also a real opportunity to incentivise schemes to run-on by offering tax incentives on surplus funds reinvested into pensions, UK productive or growth assets. These reforms could help align member benefits, employer sustainability and national economic priorities."
Safeguards
The Society of Pension Professionals (SPP) welcomed reforms to make it easier to return surpluses to employers that wish to do this but said it was also pleased to see the government's commitment to safeguards in its response.
SPP DB committee chair Jon Forsyth said: "For many the focus of surplus extraction will understandably be on the potential for member benefit improvements and release of surplus to sponsors, but we are also very pleased to see the government's commitment to maintaining stringent funding safeguards to protect member benefits, and that extraction will remain subject to trustee discretion and actuarial certification."
Release consent
Barnett Waddingham partner and head of DB endgame strategy Ian Mills said he believed it would be "unlikely" trustees would permit surplus release at levels below that of buyout.
He said: "In a world where almost every scheme now has an ambition to reach buyout funding, and many have already done so, it would be an almighty turn of face for these schemes to instead release surplus before they get there. If it was the right target level of funding before, I don't see why it isn't still.
"So, whilst the rules will permit surplus release at a lower level, we expect many trustees to continue to prioritise getting their scheme fully solvent first. Whilst this will delay the release of surplus, it is only a delay. The amount of surplus ultimately released is effectively the same."
Mills added: "Most of the industry focus has for many months now been on what the surplus release rules should be. This now appears largely settled, although we are still waiting for some of the finer details. However, the key question that sponsors and trustees are going to have to grapple with is whether surplus release is the right approach for their scheme. Strategies will need to be redesigned and reoptimized to reflect the new world."
PPF protection
Insight Investment head of solution design Jos Vermeulen said plans to permit DB scheme sponsors to extract surplus, subject to agreement from scheme trustees, would help unlock the full potential of the £1.2trn in these schemes, which includes £160bn of surpluses.
But he said that, despite pension schemes' resilience and overall good health, trustees may still be reluctant to release any surplus.
Vermeulen said a straightforward way to reassure trustees and members would be to increase the protection provided by the Pension Protection Fund (PPF) to 100% of scheme benefits for all pension schemes – something he said was "fundamentally different" to the opt-in 100% PPF underpin that was considered and rejected by the government.
He said: "That model is clearly flawed and its dismissal in today's announcement is therefore no surprise.
"An alternative approach of a universal 100% underpin would likely increase the amount of surplus released and the associated benefits. The costs and risks of doing so would be minimal, and insignificant when set against the potential positive impact of such action."
TPR and PPF react
Commenting on the government's consultation response, a PPF spokesperson said: "We welcome the government's recognition of the role the PPF could play delivering a small, focused government consolidator for the defined benefit market. We will support the government as it considers this further, and engage industry stakeholders, so any future solution suitably complements existing commercial providers and delivers good member outcomes."
TPR welcomed the publication of the Department for Work and Pensions' response – saying it would shortly issue guidance to support DB schemes in considering the best options for their members over the longer term, some of which may be useful for endgame planning.
