Rising to the challenge

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

Every scheme is in a unique position. Yet integrating funding, investment and covenant matters will continue to be central for trustees seeking to make the best decisions for their members. The strategy conversations we are having with clients are evolving to meet the new challenges; we believe the following key areas will be hot topics for 2026:

Funding and investment strategy alignment

Trustees are now required to document their long-term plan for either buyout or run-on. A wider range of uses for surplus than previously expected will be a major influence on strategic planning for many schemes. A key decision is the intended duration of any run-on arrangement and whether a buyout is targeted at the end of that period.

Running on (rather than buying out at the earliest opportunity) can offer several potential advantages:

• Provide additional or discretionary benefits to members
• Retaining control over member experience and benefit options
• Use surplus to fund employer DC payments or return surplus to the employer
• Allow illiquid assets to mature without forced sales
• Position for a more favourable buyout in future

An investment strategy designed to maintain or grow surplus must be compatible with the new funding code’s low-risk investment strategy requirements for mature schemes, balancing liability matching with the pursuit of returns. Notably, the regulator has clarified that the requirement for low-dependency investment does not extend to surplus assets.

Running on will mean a plan for surplus is needed

If a scheme, once it is mature and well-funded, runs a prudent investment strategy with appropriate risk buffers built in, then it can expect to target surplus unless one of its risk events happens. Trustees will then need to have a plan for any surplus generated. A crucial factor here is the minimum funding threshold, above which surplus can be used or refunded. While the government is inclined to allow refunds above the low-dependency funding level, trustees and sponsors may wish to set the bar at the buyout level, possibly with an added buffer for safety.

Trustees and sponsors must agree on safeguards – actions to be taken if funding dips below the agreed threshold. This could involve halting surplus utilisation or taking specific steps to seek to strengthen investments or employer support. Early warning triggers are extremely useful in this context, and can be adapted for surplus upside and downside events.

Wider factors relating to the value proposition of running on for surplus generation include understanding scheme rules on surplus use, tax implications and systemic risks over the scheme’s time horizon such as technological and climate change.

Employer covenant and risk underwriting

The strength of the employer covenant underpins trustees’ appetite for risk, investment strategy, and the robustness of run-on arrangements. Trustees must assess the sponsor’s willingness and ability to support the scheme, and build this into surplus sharing plans. Sharing surplus as regular payments of a known size may be appealing for the sponsor for planning purposes.

However, this essentially creates additional liabilities, and therefore is likely to impact a scheme’s ability to take risk. A contingent approach may be more flexible. but will need to be very clearly documented to ensure expectations are very clear on all sides.

Reducing reliance on the sponsor covenant

For those schemes without the covenant strength to support long-term run-on. the new freedoms may ignite interest in downside risk management, to support run-on. Capital-backed journey plans and self-insurance may see a wider range of use cases. Replacing the covenant may also become more attractive if members benefit from, for example, consolidating with a pension superfund.

Operational and governance considerations

Effective scheme governance is critical for running on successfully. Trustees must already assess their own expertise, seek advice where necessary, and ensure robust policies for cost management and adviser/provider oversight. Running on whilst distributing surplus extends the discussions needed around intergenerational and cross member fairness of distributions or benefit changes.

Recent regulatory change – that is encouraging DB pension schemes to run on and target value for members and their sponsors – is opening up more choice for trustees. Whilst this is welcome, it creates further work for trustees to assess the options. For those considering long-term run-on, it is our view that good governance, clear policies, effective delegation, and ongoing collaboration will be essential to achieving the best outcomes for both members and sponsors.

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

 

Risk management cannot fully eliminate the risk of investment loss. Assumptions, opinions, and estimates are provided for illustrative purposes only. There is no guarantee that any forecasts made will come to pass.