Surplus to requirements: Government's positive shift in Defined Benefit schemes

Overview

The long-awaited government response to its Options for Defined Benefit schemes consultation has finally landed.

Overall, the direction of travel is encouraging for DB scheme sponsors and members as well as UK industry against the current backdrop of a healthy funding position for many DB schemes.

The government has confirmed that the required legislative changes will be included in the Pension Schemes Bill 2025 and underlying regulations.

Summary

• In short, there are no massive changes in direction in the government’s thinking and many of the legal obstacles will be removed, subject to appropriate safeguards:
• Rather than a power to actually pay out surplus, the statutory override will be for trustees to modify their scheme rules to allow for surplus sharing. Trustees know what’s best for their scheme;
• The legal requirement to have passed a resolution under section 251 of the Pensions Act 2004 before 6 April 2016 will fall away;
• Trustees and employers will decide how surplus is used, but benefit improvements for members are likely to be part of any package of measures, before enhanced DC contributions for other employees or cash is paid to the employer;
• The tax regime is still being considered but as the government reduced the tax payable on surplus from 35% to 25% last year it doesn’t look like it’s going down again anytime soon;
• The threshold for extraction is likely to be full funding on a low dependency basis rather than buyout and an actuary will need to certify funding adequacy;
• Trustees need to act in accordance with their duties to scheme beneficiaries (note not just members). The confusion caused by section 37 of the Pensions Act 1995 will be clarified;
• Details on the funding threshold will be set out in regulations which are subject to further consultation. tPR will provide welcome guidance to help trustees make appropriate decisions;
• The idea of the introduction of a 100% PPF underpin has been dropped as being unaffordable and open to moral hazard risk;
• The government is still considering how a defined benefit consolidator would work. The need for a consolidator targeting “run-on” rather than buyout which services particular segments of the DB market (e.g. closed schemes less able to secure buyout, small schemes and underfunded schemes) has been recognised. Any consolidator would be run by the PPF.

Comments

Although the government won’t be prescriptive on what released surplus funds can be used for, because trustees will be in the driving seat members are likely to see improvements to their benefits as part of any package. 

It will still be up to sponsors to come up with a compelling proposition to trustees, because it is trustees who will decide whether to modify scheme rules under the new statutory resolution power and accordingly whether there is any distribution, alongside what will be welcome guidance to be put together by the Pensions Regulator together with the DWP.

Interestingly, the government is leaning towards low dependency as a minimum funding measure before surplus may be released, rather than buy-out, increasing the impact of the reforms because more schemes will be “in scope”.

Encouragingly for sponsors, the government is sending a clear signal to the industry that conversations in trustee meetings about use of surplus and the potential for surplus extraction are acceptable conversations to be having.

It will be important for trustees as the reforms develop that they feel supported in what may be difficult decisions to come, particularly as their scheme’s endgame strategy could start to feel like it is shifting under them, away from buyout. However, if handled properly, with appropriate safeguards for members that may be less of a seismic shift than it once was.