Mark Johnston: Long-term success will depend not only on strong funding, but on strong governance
According to the Department for Work and Pensions (DWP) , around three-quarters of defined benefit (DB) schemes are in surplus on a low-dependency basis, collectively holding approximately £160bn in surplus assets. While this represents a welcome development, the DWP also cautions that these funding levels can be volatile and could change in the future.
This is prompting a re-evaluation of the traditional pension scheme endgame. While full insurance buy-out remains a common goal, more schemes are considering alternatives. Chief among them is the option to "run on" continuing to manage the scheme beyond technical solvency to retain flexibility, control and potentially deliver better long-term outcomes for members and sponsors alike.
Why running on deserves a second look.
Historically, buyout was the natural destination for DB schemes, offering security and finality. But with so many schemes in surplus, could retaining the scheme and its assets add more value? Could a well governed run-on strategy enable trustees to manage the surplus prudently and use it to support wider objectives?
This change in thinking is prompting new discussions around legal frameworks, regulatory expectations, member communications and strategic oversight. Schemes must assess whether they have the governance strength to meet the challenges of running on in a surplus environment. It is also important to reflect on previous surplus cycles.
In earlier decades, some scheme sponsors used their surpluses to justify contribution holidays or even extracted funds, only to see markets turn and deficits return. Those short-term decisions, made in optimistic times, had long-term consequences. That history underlines a lesson: today's surpluses are hard-earned, and circumstances can change quickly. As attractive as a run-on strategy might be, it must be supported with cautious planning and a long-term view.
Governance will be the defining factor
Strong governance is central to any run-on strategy. Schemes need robust frameworks to manage risk, monitor covenant strength and adapt to shifting conditions. Decisions must be made on a solid foundation, not on the assumption that today's surplus will last indefinitely.
An important part is documenting how the surplus was achieved, whether through funding discipline, investment outperformance, or sponsor contributions. Without this transparency, future decisions about how the surplus is used may lack credibility and resilience.
Also, even the best governance structures must operate in an environment where not all variables are within their control. The legal and regulatory landscape surrounding surplus management is still evolving. While The Pensions Regulator (TPR) has issued guidance on long-term funding and surplus use, it remains uncertain how this will be interpreted in practice, particularly for larger or more complex schemes.
Trustees and sponsors must stay agile and informed, ready to adjust their strategies as the regulatory picture becomes clearer. Good governance means preparing for the unknown.
Recommendations for good surplus management
Managing member expectations is paramount. When a scheme is in surplus, members naturally want to understand what it means for them. Trustees must explain why a surplus is being retained, how it protects member benefits and under what conditions it might be shared.
Transparent and consistent communication is essential as it can build trust and engagement, reassuring members decisions are being made in their best interest.
Schemes considering a run-on strategy should focus on five key principles:
- Covenant strength: Every decision should be underpinned by a robust covenant assessment.
- Incremental surplus release: Any release of surplus should be gradual, always maintaining a healthy buffer.
- Backstop protections: Triggers should be in place to pause or reverse surplus distribution if conditions deteriorate.
- Ongoing monitoring: Governance frameworks must be dynamic, able to track surplus levels, funding health, and covenant strength in real time.
- Communication: Open engagement with members and sponsors builds trust and reduces the risk of misunderstanding.
Turning today's surplus into tomorrow's advantage
The rise of surpluses is opening the door to broader conversations around financial wellbeing. For instance, surplus assets could be used to address inequalities in retirement outcomes, such as gender disparities or intergenerational imbalances. They could also support wider workforce wellbeing or even aid defined contribution (DC) schemes within the same corporate group. These ideas highlight the potential for well-funded schemes backed by strong sponsors.
What is certain is this surplus era presents an exciting opportunity. But it also calls for caution, discipline and a forward-looking mindset. These are unprecedented times, and those involved in managing schemes must remain mindful of just how many "1 in 20" events they have already had to manage in recent years. The 2022 LDI crisis for instance triggered by the UK mini-budget exposed vulnerabilities across even well-managed pension portfolios.
As schemes consider run on or proceed to buy-out, long-term success will depend not only on strong funding, but on strong governance, and the vision to turn today's surplus into tomorrow's advantage.
Mark Johnston is client director at Vidett
