A good problem to have? Dealing with scheme surpluses

And given the aggregate deficit of defined benefit schemes within the PPF 7800 Index is estimated to have increased during October 2014 to £164.9bn, it is not one likely to make headlines either. But like deficits, surpluses can cause a real headache for pension scheme trustees.

Typically, employers are fearful of surpluses, because they can be hard to retrieve without complicated tax charges.

One way to take advantage of a surplus is for employers to reduce future contributions into the scheme. However, the continuing closure of DB schemes to both new members and future accrual means the ability of employers to use surpluses to meet other contributions is becoming more limited. 

It is sometimes harder to predict a surplus than might be imagined. The assumptions used in a scheme funding assessment by their very nature relate to future events, so there is no absolute certainty that the current value of the scheme's assets, together with any agreed future contributions, will be adequate – or indeed, too much. And market volatility means today’s surplus can be tomorrow’s deficit.

Pension scheme surpluses can prove a source of tension. The employer may feel the surplus would be best used reinjected into the business − especially if there is a shortage of money.

However, the trustees may feel strongly that the surplus belongs to the pension scheme beneficiaries and that any extra in the scheme should be converted into an increase in employer contributions.

So how can pension schemes overcome this conflict? The best course of action is to look at the employer covenant, the employer’s legal obligation and financial ability to support the DB scheme now and in the future, to assess its current strength.

This will help trustees decide upon the appropriate level of risk to take when considering whether to allow surplus to be paid back to the employer.

There is legislation allowing trustees to authorise a payment to the sponsoring employer if the scheme is fully funded above a ‘full buyout’ level, and trustees must carefully consider if that option is in the best interests of scheme members.

The Pensions Regulator recommends trustees should consider any request for an authorised payment to the employer in the context of their scheme's investments and investment strategy, weighing up the potential benefits and detriments of each cause of action.

It remains a sad fact that for many DB schemes a funding surplus would be a nice problem to have. However, regardless of the funding situation in the scheme, the strength of the employer covenant remains a good starting point for trustee discussions around scheme funding.

Helen Forrest is policy lead for defined benefit at the National Association of Pension Funds