A pension surplus is of little use to an employer – it should stay that way!


This is how the DWP introduces the question of surplus funding  in its consultation on options for defined benefit schemes.

Incentives for employers to invest for surplus are currently quite weak. Employers have little to gain from any surplus, their access to which is strictly limited, and they are entirely responsible for any deficit that might emerge if investment does not perform well. Any deficit would have to be filled by additional employer contributions and would have to be reported on the company Balance Sheet. This could affect the company’s market capitalisation, and the company’s ability to borrow and attract the investment needed to grow.


 Nor are surpluses helping Trustees

There are similar issues with incentives for trustees. There are many varied drivers that lead trustees to decide how much risk to take with pension scheme investments. Scheme trustees are concerned with ensuring members get the benefits they have been promised and will want to limit risk that could threaten members’ interests; they may therefore prefer contributions from the employer to relying on uncertain investment returns. There is little incentive to invest to drive funding to a higher level than is needed to meet the pension promises.

For businesses which are running both a DB and defined contribution (DC) fund, there is currently limited ability to transfer surpluses to help bolster DC funds whilst protecting the member benefits for the DB funds.

The Government is calling for the views of the private sector on how surpluses should be dealt with , starting their questions by asking ” How many DB schemes’ rules permit a return of surplus other than at wind up?”

My answers are in bold.

The Pensions Regulator and Pension Protection Fund have detailed analysis. They will have better intelligence on this than the private sector as they aggregate data from all schemes

According to an analysis of FTSE 350 companies by Barnett Waddingham, the actuarial consultancy, their schemes have £50 billion of assets in excess of 105 per cent of the funding levels regarded by The Pension Regulator as enough to leave a scheme self-sustaining if the sponsor were to fail

What should be the conditions, including level of surplus that a scheme should have, be before extended criteria for extracting surplus might apply?

At present, the rules allow it only after a scheme is in wind-up after securing all promised benefits, for example by handing all liabilities to an insurance company through a so-called buyout. There is also a penal rate of tax at 35 per cent on any money paid out.

So Trustees are not incentivized to run-on a pension. Once a scheme is ready to buy-out , it is logical for the trustees and employers to wind up the pension scheme after outsourcing the payment of the promised pensions to a third party

This is driving sponsoring employers and Trustees to seek buy-out as a quick and easy way out of a no-win situation. 

Would enabling trustees and employers to extract surplus at a point before wind-up encourage more risk to be taken in DB investment strategies and enable greater investment in UK assets, including productive finance assets? What would the risks be?

Where a scheme has announced it will not continue to accrue future pensions, the liabilities of the scheme are finite and the trustees  primary purpose is to meet the pensions promised in full. It is not to speculate with the fund behind these promises to deliver employers a surplus.

There are situations where a scheme may be used to increase contributions to related schemes (for instance a DC plan insider the same trust as the DB plan) but this is uncommon.

It’s legitimate for trustees to look to improve DC benefits from DB assets but this can only happen where there is clear daylight in funding and then only with the regulator’s permission.

Similarly the restoration of contentious benefits lost (such as on some pre-97 accrual) can only occur where doing so will not put at risk the core benefits not under contention.

Finally, where scheme allows discretionary increases to be made, these can only be made where doing so could not put reasonably in doubt , the payment of the core benefits promised in scheme rules.

Gaming a pension fund so heads the employer gets a surplus and tails the PPF gets the deficit is speculation and should play no part in DB funding.

Would having greater PPF guarantees of benefits result in greater investment in productive finance? What would the risks be?

Improving the guaranteed benefits of the PPF to mirror the benefits of the “scheme rules” of the DB scheme falling into it, would require an extra obligation on the PPF that would need funding. A proposal from LCP is that schemes looking to stay open or improve existing member benefits (including DC) could do so without “gaming” by paying a super-levy. This is a good idea, providing the trustees paying the levy consider their scheme well run.

This would allow such trustees to invest for growth and move some of the fund into productive assets. Here the risk to members would be minimal (amounting to the opportunity cost of the super-levy not being invested).

As with any investment for growth, there is a risk that such an investment might fail, but a good scheme would seek to mitigate such risk through the choice of asset/fund managers

What tax changes might be needed to make paying a surplus to the sponsoring employer attractive to employers and scheme trustees, whilst ensuring returned surpluses are taxed appropriately?

We don’t see any reason for changing the tax  position on pension scheme surpluses. The tax-system should not incentivise  employers taking surpluses.

In cases where an employer sponsors a DB scheme and contributes to a DC pensions scheme, would it be appropriate for additional surplus generated by the DB scheme to be used to provide additional contributions over and above statutory minimum contributions for auto enrolment for DC members?

Yes (see above), though we understand that this can only be done if the DC members are in the same (hybrid) trust as the DB members. We shouldn’t allow money to be extracted by the employer for onward payment into another workplace scheme. There is considerable risk that the money would not get paid across or paid across at a much diminished rate (relative to the surplus).

Could options to allow easier access to scheme surpluses lead to misuse of scheme funds?

They could. Pension liberation schemes , from Maxwell to ARC have sort to release money due to pensions by foul means

I have produced other blogs in answer to this open consultation and call for evidence

Should the PPF become the consolidator of last resort

On superfunds as a  consolidator 

About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
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8 Responses to A pension surplus is of little use to an employer – it should stay that way!

  1. Derek Scott says:

    “The Pensions Regulator and Pension Protection Fund have detailed analysis. They will have better intelligence on this than the private sector as they aggregate data from all schemes.”

    In the past when TPR presented aggregate UK data to the likes of EIOPA in Frankfurt, they put their protect-the-PPF blinkers on and talked down any scope for investing in growth.

    Can TPR be trusted to do differently now?

    Talk of surpluses and deficits in this context seems to miss the point that employers (and trustees) in many cases are arguably being asked to overfund at gilts relative discount rates, directing capital into holding or gaming government debt and away from investing more in growth and employment.

  2. jnamdoc says:

    We are in danger of accepting the “profit is bad” reflex, especially when to corporates. More open mindedness required ? Its the application of profit that should concern us – we’d be less concerned if its helps support pay increases, or – god-forbid – even as dividends to shareholders that they can spend and re-cycle.

    Its not at clear that “it is logical for the trustees and employers to wind up the pension scheme after outsourcing the payment of the promised pensions to a third party”? That’s a convenient narrative if you’re an insurer, and it suits TPR’s objective of protecting the PPF at any cost, but its very poor Policy (not that we have one) on a whole economy basis leading to a neglectful mis-allocation of capital.

    The additional risk capital that insurers actually bring to the issue is really quite limited (say less than 10% of any actual buy-out). The Schemes come laden wit excess capital, provided by the over-funding from corporates over many years (and as has been shown, sadly at the cost of accrual to members). Thus – on an economy or system wide basis – the additional covenant support provided to the members from a Buy-out is poor when compared to the collective strength of sponsoring employers they leave at the alter.

    The 35% tax charge is from Trust law, and is designed to stop tax avoidance (converting income into capital repayment). There is not really much basis for it given corporate tax relief on the way-in would have been limited to current rates – so say 19-25%. But worse, its excess capital we’re talking about, and excess capital gets lazy and becomes abused (by the custodians of it for their own ends / empires /fees) when it has no purpose nor a need to pay its way. And in periods of high inflation and cost of living challenges, the lazy capital should be recycled in more productive ways.

    Govt at last is thinking about pensions and pension funding in the wider context.

  3. Charles McDowall says:

    The DB pension is a deferred salary and should be treated as such. The use of bonds and lower risk higher certainty investment for DB schemes in run-off seems entirely aopropriate. However they do need to ensure they do not get caught in a bond turning into equity or similar haircut. The idea of government taking part is to concentrate risk into the wrong hands.
    Whilst the ‘surplus’ remains a very variable difference between two large uncontrolled variables, it remains a slight of hand yo repay it to the sponsor, ‘investments go up and down’.
    Only when the assets and liabilities are FIXED can the fund wind up. And the last fix is the admin to pay the last benefit, and liquidate the scheme. So nothing is gixed until the fat lady has sung all commitments met.
    THE UNLEVEL PLAYING FIELD IS THE POWER OF THE TRUSTEES AND SPONSOR VS the members who ate kept apart and have no way of getting together except by word of mouth and social mediea

    • jnamdoc says:

      And that is the challenge of pension funding. One section of the population wanting absolute certainty on their age related income for life, regardless of the cost or risk to those who have to provide it.

      For now the democratic deficit, whereby the elderly vote counts more than the youth vote, holds sway, and regulations and political attitudes direct schemes to sell off their investments and give the money to the Govt in return for a gilt. But the gilt is only a promise from future generations to work and pay. If we starve those generations of investment, growth, education and of capital, why (or how) do we think they will be able to pay?

      If you can start to view a pension surplus as an over allocation (indeed a mis-allocation) of that promise forced upon the youth, and as something instead to be recycled and invested into the economy and in future generations, then you can see the recycling and investment as being something that actually increases the likelihood that the gilt (ie the promise to work and pay) will be serviced.

      That the process of the recycling may be via refunds to sponsors is just the mechanics of distribution. We (or Govt on our behalf) can influence the application of such refunds. Already, by applying a 35% tax on that recycling, Govt can determine how (at least) 35% of pension surplus refunds are spent (say, on public services etc), and it could easily introduce rules or incentives requiring that the remaining 65% should in some way be used to support staff or even have to be distributed to the broader shareholding base.

      Where there is a will, there is a way.

  4. Dr Robin Rowles says:

    How corporates look at these things these days can possibly be seen in BP plc’s attitude to its DB Pension Fund. The fund is currently in surplus and could easily have afforded the RPI increase this year, except that the Trust Deed requires that the approval of the Sponsor is obtained when the rise in annual pension payable would be greater than 5%, approval that BP plc refused! So it is interesting to note that it is reported in the financial press that BP are considering a buy-in/buy-out of the DB Pension Fund, a prospect that is obviously made more advantageous when the current surplus is taken into account… #bppensioners

    • Derek Scott says:

      The “surplus” tends to become insurer’s future profit in such buyouts.

      Employers’ reactions are also to be expected given the accounting standards they’ve been stuck with since 2001, IAS 19, I mean.

    • jnamdoc says:

      That’s the very point of the consultation on surplus.

      The regulations are so onerous and bring such one sided jeopardy for corporates that the likes of BP would rather give up on many £bns of surplus, handing the whole bloody mess to an insurer, rather than coming to an agreement with the Trustees on a fairer allocation of the evident surplus. Shame on the Trustee too for passing the buck on this.

      How bad must these Regulations be where when presented with the gift of excess, we get to point that neither Trustees or employer feel empowered enough to decide on a wiser use of excess capital, opting instead for the choice of Solomon.

      So, hopefully we can see this consultation on the use of surplus capital as the beginning of the end of the madness of mass overfunding and pre-packaging of schemes off to insurers, and an awakening of govt to the latent potential with the excess pools of capital.

  5. Henry heskeh tapper says:

    Very sorry that I have to agree. We will look back in anger

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