The Society of Pension Professionals (SPP) has published a paper on surplus release.
The paper - DB Surplus Release: risks, rewards, and responsibilities - detailed the risks and rewards of surplus release for defined benefit (DB) schemes, including figures from the Department for Work and Pensions (DWP), policy changes and pension sharing benefits for members and employers.
The paper said while some figures have showed the low dependency aggregate surplus of DB schemes reached £160bn, new DWP figures suggest the amount that could be released in the next decade is around £11bn.
A potential change in skillset and mindset, and more "regulatory scrutiny" is potentially needed across the industry to ensure the success of the new flexibilities in surplus release.
However, some proposals come with risks including where employer covenant is weak, schemes being too small to run cost-effectively, and employers needing to exit the scheme to remove management burdens, as well as trustees being "too wary" to release surplus.
In addition, potential policy changes could have "unintended consequences", including decisions where members receive higher incomes than their expectations receiving more scrutiny.
Members can benefit from surplus release but trustees will need to consider how to begin surplus release for older and younger members, and to treat different groups fairly including for pre-1997 increases, as well as considering timing of surplus distributions, agreeing a level of surplus release every three years, and communicating any enhancements.
Risks to members include "regret risk" for trustees who decide to run-on, "perceived unfairness" for different groups, and managing expectations for members receiving an uplift as well as tax implications including for annual allowance for active and deferred members.
Employers can benefit from using surplus to meet ongoing scheme running costs, being able to transfer these between schemes, using it as a source of "free cashflow to support commercial activities", while risks include having to make future contributions to a scheme if funding levels go down, "reputational risks" of making decisions, and accounting implications for the company.
To ensure security for members, schemes need to consider funding and investment buffers, with trustees needing to be "very confident" it can provide the support of a financial buffer or seek additional covenant protections, including to protect against the "residual risk in the surplus release strategy in a scenario where the covenant fails".
They also need to target the right investment return to generate more surplus, while a good hedging strategy needs to consider which funding measures to include, if it should focus on funding ratio or total surplus value, and if it will use leverage, as well as consider liquidity if they can commit to longer-term run-on.
The SPP added longevity risk "can represent a more material proportion of overall risk" if schemes are well-funded, while company accounting can also impact investment strategy, with longer term investment or run-on needing to be considered against its funding levels.
Schemes also need a "robust decision-making framework" when considering surplus release, including how often these decisions will be made, agreed funding levels and ways of calculating, and how to respond to lower funding levels than planned.
Possible conflicts of interest could arise between employers appointing their own trustee boards and exerting pressure on them, trustees having "subtle incentives" like a surplus release plan that extends the tenure of a professional trustee, as well as conflicts between advisers.
The forthcoming legislation from The Pensions Regulator, which covers notification of payments to an employer, any benefits to members, and enforcement and engagement powers, may not cover all scenarios, including weak covenant, lack of extra security, or employer's ability to support schemes.
In addition, a volatile funding position, insufficient allowance for risk, data uncertainties, pressure from employers, small schemes having extra costs, and compromising long-term objectives, mean more advice might be needed.
SPP covenant committee member and surplus release working group chair Alex Beecraft said while decision factors on surplus release vary across schemes, most will have "considered over the last decade to reduce risks for members", with risks needing to be "managed, monitored and mitigated to improve outcomes".
"This SPP paper serves as a useful tool to quickly, yet comprehensively, identify the risks, rewards and responsibilities associated with surplus release. It should prove useful to a wide range of industry professionals, policymakers and other stakeholders, and support the DB industry's transition from a culture of wealth preservation to one of wealth creation."
