The amount available to be extracted from defined benefit (DB) pension schemes is likely to be much smaller than some previous figures have suggested, according to a new report from the Pensions Policy Institute (PPI).
The Pension Schemes Act has introduced new powers for DB trustees to return surplus to employers or members, but the final rules are subject to future consultation.
The government has previously suggested up to £160bn could be released from pension schemes in funding surplus, citing data from the Pensions Regulator (TPR) relating to the estimated aggregate funding position of DB schemes on a “low dependency” basis. Subsequent figures unearthed by the Society for Pension Professionals (SPP) have shown that this figure could be as low as £11bn.
“While it may be possible for some schemes, expectations around widespread surplus across the private DB market may not fully reflect the realities of extraction.”
Shantel Okello, Pensions Policy Institute
However, the PPI’s analysis indicated that funding resilience, scheme rules, fiduciary duty, and other influences could all restrict the ability or willingness of trustees to return surplus to employers or members.
Shantel Okello, PPI policy researcher and lead author of the report, said: “While it may be possible for some schemes, expectations around widespread surplus across the private DB market may not fully reflect the realities of extraction.
“Our modelling has identified significant variations in funding resilience and investment risk, with endgame strategies for individual schemes and differences in liability measurement also critical to understanding the true scale and accessibility of surplus extraction.
“At a critical juncture for this area of policy development, we are delighted this new report delivers new independent insights to the evidence base to support informed decision-making.”
Considering the variables
The PPI’s report explained that rising long-term interest rates have reduced the present value of liabilities, boosting surplus positions. At the same time, investment performance, changes to longevity assumptions, and historic sponsor contributions have all reinforced these funding gains.
“Confidence in both the resilience of the funding position and the strength of the sponsor covenant over the long term is critical.”
Claire Altman, Standard Life
However, “the sustainability of these outcomes continues to depend on scheme-level decisions”, the institute emphasised.
For example, a “sustained reduction in long-term yields” would increase liabilities and reduce surplus buffers, unless schemes were fully hedged.
“This sensitivity is particularly relevant for mature schemes with long-duration liabilities,” the PPI report stated. “In such schemes, relatively modest downward shifts in discount rates can translate into material increases in liabilities. Where hedging is incomplete, or where asset movements do not align fully with liability movements, this can lead to a meaningful deterioration in funding level.”
The PPI also highlighted the different types of liability measures, each of which paints a different picture of the DB funding landscape. Section 179 and technical provisions methods have shown “widespread surpluses” for some time, the institute said, but buyout-level funding is typically weaker.
According to the Pension Protection Fund, DB schemes are on average just 95.8% funded on a buyout basis, with many schemes still “materially underfunded” on this measure.
Surplus extraction attracting more attention
Recent surveys have shown that more and more trustee boards are open to releasing surplus to repay sponsoring employers, boost member benefits, or both.
Legal & General and the Pensions Management Institute recently reported that more than half (57%) of pension schemes were actively considering how they might extract surplus. A separate poll by PwC from December put this at around four in five schemes.
Claire Altman, managing director for pension risk transfer and individual retirement at Standard Life, which was a co-sponsor of the PPI report, highlighted that a “surplus on paper does not necessarily translate into guaranteed member outcomes”.
“What matters is how resilient that surplus is under stress and how it fits with a scheme’s long‑term endgame,” Altman said. “For schemes considering run‑on, this raises important questions. Confidence in both the resilience of the funding position and the strength of the sponsor covenant over the long term is critical.”
Despite the increase in interest in surplus extraction, bulk annuities remain the most popular option for endgame planning, as shown by multiple surveys.
A survey of 350 pension schemes carried out by consultancy giant Aon found that three-quarters of schemes plan to move to an insurance solution once this becomes achievable.
Of those schemes that have agreed on an endgame option and are not deliberately keeping their options open, 74% said bulk annuities were the preferred choice.
Members come first at all times
Trade bodies for insurers and pension funds have also supported the PPI’s report. Rob Yuille, head of long-term savings policy at the Association of British Insurers, said the primary purpose of a pension scheme – to pay pensions – should “stay forefront to any debates about surplus extraction”.
“The same shocks that threaten a surplus can also threaten a sponsoring employer,” Yuille added. “This is why trustees need to look carefully at the scheme’s risks and choices, and regulations should set clear and specific tests before surplus can be taken.”
Tiffany Tsang, head of DB, LGPS and investment at Pensions UK, said judgements over releasing surplus would need to be “finely balanced” with “close scrutiny”.
The comments echo those of the SPP. In November, the society argued that stakeholders such as sponsors, trustees and regulators would all need to scrutinise endgame strategies to ensure that decisions were made in the best interests of members and employers.
It also warned that extending the life of DB schemes would lengthen the regulatory time horizon, which could have “resource implications” for regulators and policymakers.
