Don’t lose sight of members in surplus debate

It’s been an exciting week, if you enjoy pensions policy announcements. And who doesn’t?

Most notably, chancellor Jeremy Hunt built on his landmark Mansion House reforms by setting out plans to require schemes to disclose how much they invest in UK assets – although exactly what he means by this is unclear at the moment.

The pensions sector has immediately cast doubt on these plans, as we reported this week. I fully expect the words ‘fiduciary duty’ to feature prominently in many responses to the forthcoming consultation.

However, there is another aspect of the Mansion House reforms that has been niggling at me for the past couple of weeks, and that is defined benefit (DB) scheme surpluses.

In the black

It wasn’t that long ago that having a funding surplus was a pipedream for many DB schemes.

At the end of 2020, approximately 60% of private sector DB schemes were in deficit on a section 179 basis, according to the Pension Protection Fund (PPF).

Now, DB pension schemes in the public and private sectors are looking exceptionally healthy. The PPF’s most recent data shows an aggregate private sector funded ratio of 114%, while the LGPS is enjoying an aggregate funding ratio of 104%, according to Isio.

It’s no wonder, then, that people are starting to think about what to do with all this extra money. The government wants to relax rules about accessing surpluses and has already reduced the tax levied on employers receiving money back from their schemes. Some are now getting excited by new flexibilities proposed by policymakers that could allow more schemes to run on and invest in UK growth assets (whatever the chancellor decides these are).

Before we all get too excited by these potential changes, we have to remember that surpluses are almost entirely theoretical. As Douglas Adams probably never said: “Surpluses are an illusion. Pension surpluses, doubly so.”

The monthly data we regularly use in our articles is based on models and assumptions, and even full triennial valuations are only a snapshot of a scheme’s funding position – and these, too, are based on certain assumptions. Major events affecting financial markets can easily swing a scheme from surplus to deficit in a very short period.

Even when these surpluses are deemed to be real, employers can only benefit once a scheme exceeds the funding level needed to secure a buyout, and members can only benefit when the trustees believe it is prudent – and within the scheme rules – to augment or increase payments to members.

Anna Rogers, senior partner at Arc Pensions Law, put it far more succinctly when talking to Samantha Downes for our article on surpluses.

She stated: “Until all liabilities are covered, it is not surplus, it is a reserve. The surplus is money that may yet be needed in the future. We have had years of this debate. The money is there to provide a pension for [the scheme’s] members.”

Sharing is caring

When members see their scheme has more money than it needs to meet its pension promises, it is only natural for those members to want to benefit from this apparent ‘extra money’ through one-off or permanent uplifts.

Currently, scheme rules often dictate that surpluses must be paid to the employer, but if trustees are given more powers then it may become difficult to justify doing anything other than paying out to members – particularly if existing benefits have been increasing at a rate lower than inflation.

There is, of course, space for negotiation. Perhaps a surplus, if healthy enough, can be split evenly between the employer and the members. From an employer’s perspective, it has ultimately been shouldering the funding risk for the scheme so why shouldn’t it benefit from any excess?

Another alternative is that trustees could push for surpluses to be recycled into defined contribution schemes, either through one-off payments or – preferably – permanent increases to employer contributions. With the government apparently unwilling to consider statutory increases to the auto-enrolment minimum contribution levels, employers could generate some goodwill among staff by upping their payments into retirement funds.

Much like surpluses themselves, what happens to them is theoretical – at least for now.