More funding surplus disputes ahead

The pension industry should brace itself for more disputes over how funding surplus is used, an industry expert has warned. 

Professional trustee Ray Pygott said the industry will ‘inevitably’ see more disgruntled pensioners take action after the BP Pensioner Group recently announced it has begun a legal process against senior members of BP management and directors of the BP Pension Fund Trustee, following concerns around the value of members' pensions.

The dispute centres around decisions made by BP and the Pension Fund Trustee in 2022 and 2023, which led directly to an 11% fall in the value of the pension in real terms, according to the BP Pensioner Group.

Ray Pygott, a professional trustee at Capital Cranfield, who was speaking in a personal capacity, said: “Inevitably, we will see more disputes arising and there will be a need for give and take on both sides.

“The situation will differ depending on the fact pattern for each scheme including the surplus level, and the scheme’s rules and maturity. For those schemes that are close to buy-out, there will be a one-off opportunity to benefit from any surplus and attitudes may harden compared to ongoing schemes where other considerations are involved.”

The BP dispute recently hit the headlines when Nick Coleman, member of the BP Pensioner Group, warned that other companies looking to dispose of their closed defined benefit (DB) pension schemes are copying BP, which delinked inflation from its pension scheme payouts two years ago.

Speaking at the Work and Pensions Committee in November, Coleman outlined that BP’s DB pension fund has £20bn worth of assets and 60,000 members with an average pension of £18,000 a year. 

He said the pension fund has always paid pension rises in line with inflation but stopped that two years, despite its surplus. The sum accounting surplus for all UK DB schemes is around £441bn, according to the PPF 7800 Index. Coleman warned that BP is making a ‘grab’ for its pension surplus.

Pygott expects that sponsors will act now to protect their position. 

Pygott said: “It is likely that sponsors will act now to protect their position, which will likely involve making more use of contingent funding mechanisms, such as escrow or asset-backed contributions, as schemes approach full solvency funding, and also agreeing on a policy now on how to deal with surpluses should they arise in the future. It is easier to agree on a future policy now as part of a funding negotiation rather than have a more difficult conversation when the balance of interests has shifted.”

Pygott added that the result of the BP pensions dispute will help shape who owns the funding surplus.

He said: “We are taught that the love of money is the root of all evil. Others profess that being treated fairly and with respect is what makes people content. These beliefs are about to be put to the test as they play out in the pensions arena over the use of funding surpluses.

“Who owns the surplus? Lawyers will tell you what the legislation and the rules say - but that is only the start.

“Sponsors, which have generally paid huge additional contributions over the years, may now argue that the surplus is theirs. For example, they might argue that ‘if only the trustees had listened previously and had agreed to a more relaxed funding practice, we probably wouldn’t be in this position now’. But trustees have a duty to act in the best interests of the beneficiaries of the scheme – which predominantly means their members.

“The Trustees may therefore argue that if there is excess money, then surely the members deserve this in the form of enhanced benefits, especially as high inflation has recently eroded the value of pensions.” 

A brave new world

Problems surrounding DB pension surpluses have only become an issue since October 2022, according to Anne Sander.

Sander, who is a client director at ZEDRA said: “A little over a year ago we weren’t talking much about surpluses in UK pension schemes. Most defined benefit schemes were underfunded, or if they were close to fully funded, they were looking to buy out.

“The accepted philosophy was, and for the most part still is, that securing members’ benefits through insurance policies as soon as possible is the right thing to do.  Few schemes had any material surpluses built up.

“That changed dramatically in October 2022 when, despite pension assets falling, the value being placed on pension liabilities fell to a greater extent resulting in almost overnight surpluses. And so, the conversation about what to do with the surplus became real.

“If surpluses continue to grow, and that is not a given, then the potential for disputes over how those surpluses should be used are likely to grow. The Mansion House proposals aimed at encouraging pension schemes to allow surpluses to grow so that they can continue to invest in “productive finance” muddies the water further.” 

Funnelling DB surpluses into DC

Some experts have suggested that DB surpluses could be used to boost the pensions of defined contribution (DC) savers.

Sander said this may sound like a good idea, but it will require changes to the law in order to make this a practical option for most sponsors. 

She said: “Using DB surpluses to boost DC savings is a great idea but will need legislative changes to make it a practical option for most sponsors. The challenge is finding a mechanism that will allow that to happen. 

"Unless the DC benefits are being built up in the same scheme as the closed defined benefits, it may be difficult and will currently present tax issues to the sponsor to move the surplus from an existing DB arrangement into a DC arrangement. Setting up a new DC section within an existing DB scheme may also not be ideal, particularly given the DC governance requirements that make running small DC arrangements unattractive and potentially expensive. 

“Most pension scheme trust deeds don’t allow surplus to be removed from a scheme until there is a scheme wind up, presenting a further challenge to using DB surpluses to boost DC savings.”