Since 2011, almost 7,000 articles in Professional Pensions have included the word “deficit”. “Surplus” featured in only a quarter as many. But, despite the adage that “good news is no news”, articles about surpluses have enjoyed a narrow lead over the past 12 months.
Funding positions have improved to the point where The Pensions Regulator (TPR) thinks one in four schemes could afford to buy out their full benefits (though the insurance sector could not digest all these liabilities in one go). In WTW’s experience, most schemes are in surplus on TPR’s proposed Fast Track “low dependency” measure. In other words, they have already reached the sort of position that policymakers expected them to work towards over the coming years.
With surpluses no longer a hypothetical “nice problem to have”, we should ask whether the legislative framework is right when it comes to distributing surplus - how, when, and under what conditions. A Department for Work and Pensions (DWP) call for evidence published the morning after the Chancellor’s Mansion House speech puts this on the agenda. Crucially, Laura Trott, the pensions minister, recognises that this is not just about divvying up surpluses that exist today; her foreword talks about helping schemes invest to “generate further surpluses”.
A detailed WTW paper Six changes to seize the DB pension surplus opportunity, published at the start of July, anticipated many of the DWP’s questions and highlighted a few more that we think should be asked. This paper proposed six changes which, we think, would encourage more schemes to run on and take some risk for longer, with the aim of creating surpluses to benefit employers, defined benefit (DB) members and employees in defined contribution (DC) schemes.
First, while surpluses can often be used to pay for DB accrual, it can be harder to allocate them to DC, especially where DC provision is outsourced. We would like a straightforward legal route for transferring assets to another pension scheme used by the employer, subject to trustees’ agreement and to the transfer not taking the DB scheme below 100% “low dependency” funding.
If deficit contributions have held down employee remuneration – including DC contributions – surpluses can work the other way. Limiting use of surplus to paying for increases to DC contributions is tricky; policy should not penalise employers whose DC contributions are higher to begin with. But we floated the idea of only allowing contributions above statutory minimum levels to be financed this way – something on which DWP is now seeking views.
Meeting today’s pension costs should usually be the most frictionless way for employers to benefit from surpluses they helped create. But this may not always provide resources quickly enough – for example, if undertaking a large capital investment. Currently, only refunds of surplus on a buyout basis can be sanctioned by trustees. The second and third changes we proposed were lowering that hurdle to a low dependency basis and reducing the 35% tax rate.
Fourth, the DWP’s paper notes that there is currently little incentive for trustees to drive funding to a higher level than needed to pay promised benefits and asks what might change that. Making it easier to use surplus to improve benefits must be a large part of the answer, but employers are understandably reluctant to sign off pension increases with an uncertain ultimate cost stretching decades into the future. One-off sums might be easier to negotiate, but - unlike lump sums from DC schemes – these are currently “unauthorised payments” and would therefore trigger tax penalties for pensioners. That should change.
Fifth, while the Regulator says significantly mature schemes might be able to hold 20-30% in growth assets, trustees’ legal advisers may query this if regulations say funding levels must be “highly resilient” to adverse changes in market conditions. In its annual report last week, TPR said the funding Code will be updated to reflect “final regulations” – hopefully a further hint that the regulations consulted on last summer will change.
Finally, we think DWP should widen their review of the legislative landscape to cover TPR’s objectives – for example, should these include something about members’ wider interests (rather than just protecting accrued pensions), or about the adequacy of workplace pensions?
Others have made more radical proposals; if that is the yardstick, we won’t try to rival those arguing for almost all DB schemes to sever their ties to the sponsor by 2026! It would also be unrealistic to expect closed schemes to go back to the days of investing primarily in growth assets, even if the Government were not worried about how this would affect the gilt market; there is now much less time until pensions need to be paid.
But with £1.4 trillion in DB schemes, even modest and deliverable changes to investment strategies can have meaningful effects. Making it easier, and acceptable, for more schemes to target further surplus, rather than buying out asap, could affect how tens of billions of pounds are invested.
