DB schemes: A time for opportunity

The following article is an extract from our latest DB outlook.

The impact of the recently published Pension Schemes Bill is only just beginning, with changes influencing DB and DC schemes, master trusts and superfunds. The bill marks a change in UK pension policy, building upon an earlier objective of multiple governments to maximise pension participation – by both extending into seeking to optimise investment returns for individuals and in leveraging the UK’s large pool of pension assets as fuel for domestic economic growth.

Looking at DB schemes, the part of the bill focused on surplus release mechanisms is driving conversation. In recent years, we have seen many DB schemes’ funding levels increase, often to the point of surplus. The bill introduces a resolution-making power that will allow trustees to modify scheme rules to share surplus funds – perhaps unlocking capital that can be injected into the domestic economy.

Surplus detail? 

The detail of how surplus extraction will be governed remains in draft, and in the coming months trustees, corporates and their advisers will collectively learn the ‘rules of the road’ as final regulation is expected to be published in 2027. But what do we know today?

Firstly, we know that where scheme rules do not allow for surplus sharing, trustees will be granted power to amend these. Secondly, we know that the threshold for measuring when surplus can be shared will change from a buyout basis to a ‘low-dependency funding basis’. Thirdly, we know there will be measures in place that aim to manage risks to both members and employers, including a requirement for actuarial certification for surplus release. Finally, we also know the government will not mandate how extracted surplus is to be used.

Perhaps it is the last point that is really driving the conversations we see at trustee tables. How the surplus could be used – for example to enhance member benefits (where the government has indicated that it will make it easier for one-off payments without incurring large tax bills), or to be returned to the employer (where the authorised surplus payment tax charge has been reduced from 35% to 25%), or to be transferred into a DC pot (where we also expect legislation and market innovation[1] to make this easier to implement tax efficiently).

How to extract? 

Another critical question is: what is the mechanism for surplus extraction? For example, little and often or lump sum? How does the mechanism one chooses ensure we retain fairness – to prevent one layer of membership not getting all the benefits out of a surplus position, while another layer retains the risk of not settling the liability sooner.

The conversations on ‘whom’ and ‘how’ will keep going – and we believe this is good news for the industry. These conversations allow trustees and corporates to consider what surplus extraction means for them – but one thing can be sure – what is right for one scheme will be different for another.

The conversations also drive innovation, especially around the question of how schemes can best invest assets to run on for longer and (perhaps) access surplus. So this brings me back to the title of this piece ‘a time for opportunity’.

Today is just that. An opportunity to pause, discuss and consider the right way forward. Perhaps retaining the status-quo is right, perhaps a change in direction is needed – but the Pensions Schemes Bill provides the industry with an opportunity to consider these points. It’s one we should all embrace.

The above article is an extract from our latest DB outlook.

 
[1] See our press release: L&G facilitates DB surplus transfer to DC schemes