Ongoing surplus release: should I

Our “Could I?” blog last week set out issues for trustees and employers to consider when deciding whether they could run on and use surplus.  In this blog, assuming that the answer to “Could I?” is “yes”, Karen Mumgaard from Slaughter and May and Paul Brice from BESTrustees look at the factors which might influence trustee and employer thinking in answer to the question “Should I?”. 

Consider the options

Guidance from the Pensions Regulator highlights a number of endgame options and that trustees should consider them all.  These include superfund transfers, transfer to a master trust willing to accept DB assets and bespoke solutions similar to the one adopted in relation to Stagecoach. 

There is also the option of running on and allowing both members and employers to benefit from any surplus.  This allows trustees to continue to use discretionary powers and potentially augment benefits and, from an employer side, can enable DC contributions to be met from DB surplus or employers to use the funds to invest in their business. 

If trustees and sponsors are considering “running on” to use surplus, this will require detailed consideration of a wide range of issues, including: 

• If the proposal is possible under the scheme rules or if they will need to pass a resolution under the provisions in the Pension Schemes Act 2026.  In addition, if there are proposals to make payments to members or augment benefits, who has the power to do this?  
• Will surplus be refunded to employers in a single payment or paid in a series of instalments over time? 
• If several payments are planned, the parties will need to agree appropriate dates, any payment triggers and (if experience does match assumptions) any triggers for termination. They also need to be aware that the proposed process for surplus release requires actuarial certification each time a payment is made. 

• What is proposed for members? Benefits must be authorised under the Finance Act 2004 which means that, for example, it is not generally possible to make a one-off increase to a pension, but it is acceptable to permanently increase it (albeit this carries a funding risk and may be rejected by the employer). 

  Changes are being made to allow surplus lump sums to be paid to members over minimum pension age.  They can also be awarded to younger members, and deferred until minimum pension age, with revaluation applied.  The payment is explicitly not be a pension or lump sum under the Finance Act 2004 so trustees will need to look carefully at scheme rules to see if they will have power to pay it or if an amendment is needed.  

• Are the proposals within the trustees’ tolerance for risk?  Trustees need to ensure the funding position and covenant support remain at a level they are happy with.  Where a refund is made in instalments, they must monitor both funding and covenant carefully. 
• Will any additional security be put in place for the scheme in the event that experience does not match assumptions and the funding position deteriorates and what are the terms for the realisation of any security? 
• If it becomes clear that members would be better off if the scheme were bought out, could surplus-sharing be brought to an end and on what terms? 
• What are the tax implications?  This will depend on what is actually being done and both trustees and employers should consider getting tax advice.  
• What are the accounting implications for the sponsor?

Administrative and governance arrangements 

Once it has been decided to use scheme surplus, there are a number of administrative and governance issues that need to be considered by both employers and trustees, particularly where a refund is being made to an employer. 

The kind of things that need to be considered include: 

• What does the Pensions Regulator guidance say and has it has been complied with?   Detailed guidance is expected by April 2027. 
• Have all parties considered whether there are any conflicts of interest and have these been managed in accordance with the scheme rules, articles of association and/or appropriate policies? 
• Has the scheme actuary provided a valuation certificate in the required format? 
• When will any payments be made?  Currently they must be made within 15 months of the actuarial certificate, but from April 2027, this will change to 5 working days. 
• Do instructions need to be given to asset managers to disinvest funds and, if so, when? 
• Are governance arrangements as between trustees and employer clear?
• Have the terms of any policy on surplus extraction been checked? Are the proposals in line with it and have any conditions been complied with? 
• Do the trustees have clear records of their decision-making processes and the considerations they took into account should issues arise in the future? 
• What documentation is needed?  Who is drafting it, who will bear the costs, when will it need to be executed and by whom? Trustees should ensure that they have the power to enter into any proposed agreements.   
• Is the administrator able to set up appropriate structures to implement the agreed proposals in so far as they relate to benefits or contributions? Will implementation be within the scope of any existing fee agreements? Are roles and timings clear? Have appropriate steps for member engagement, clear communication and disclosure been followed?
• Are advisers able to provide advice or other information required on a timely basis?  Where the proposals were initiated by the employer, who will bear the costs of this advice? 
• Have responsibilities for matters such as tax been clearly allocated? This includes consideration of the tax position of the employer, trustees and members. 
• Has someone been tasked with giving the required 3 months’ notice to members and ensuring that it complies with relevant statutory requirements? 
• If any surplus is paid to the employer, notification must be given to the Pensions Regulator within 1 week.   Check someone is tasked with providing it. 

Funding and funding support

In the future, for surplus to be released to the employer, the scheme must be funded at least at low dependency and be as likely as not to remain so over the next 3 years. 

It is for trustees to determine the right level for surplus release. Initial guidance from the Pensions Regulator says they “should consider the size of the financial buffer above low dependency… [which] would protect the scheme from downside scenarios”. The Regulator has also signalled that it is unlikely to object to “situations in which the scheme is likely to remain fully funded on a low dependency basis and there is no realistic risk of employer insolvency... subject to [the trustees] having considered any other relevant matter”, although this is a fairly high bar.

From all perspectives – member, employer and trustee – a poor outcome from a decision to run on and release surplus based on a funding position less than buy-out (or only marginally ahead) would be a combination of downside risks crystallising from which recovery could prove extremely difficult, if not impossible, to achieve. 

For example, consider a geopolitical event which leads to higher prices for commodities used by the employer or materially weakens demand for its products. At the same time, this impacts investment markets, weakening the scheme’s funding position. The nature, duration and extent of this shock might weaken the covenant materially, and lead to underfunding.  This could create “regret risk” for members, employers and trustees if surplus was refunded and illustrates the need for both trustees and employers not to “act in haste and repent at leisure”.

Any “Should I?” analysis is likely to require varying levels of stress testing, both in relation to scheme- or sponsor-specific risks and broader systemic risks.  Consideration of risk needs to include both individual events and correlated risks, including “domino effects” impacting both scheme and employer. It will also involve individual investment, actuarial and covenant advice, and joint advisory working on the associated scenario analysis. 

Assuming that the outcome of stress-testing is satisfactory and supports a decision to release surplus, as downside outcomes may be progressive over time, it is essential to consider and agree mechanisms to manage this risk.  This will involve consideration of a range of issues including: 

• What guardrails are in place to pause or limit the structure if appropriate? 

• How will any underfunding be corrected?

• How can any arrangement be terminated? 

Simply being able to meet “Day 1” criteria for a running on / release of surplus arrangement – “Can I?” – is only part of the decision-making process.  The “Should I?” decision may require in-depth, forward-looking analysis, combined with the agreement of protective guardrails, so that regret risk for all parties is appropriately mitigated.

Conclusions

Meeting the basic tests for entering into a run on / release of surplus arrangement is just one part of the trustee and employer decision-making process.

It is not just about creating “upside” for the parties: depending on the strength of the employer and the scheme’s funding position, any “Should I?” analysis should consider downside risks, both systemic and scheme-specific, and whether administrative and other arrangements are in place to manage the structure.  In addition, it is essential to have in place appropriate guardrails, risk-management and termination/exit provisions.

Running on and surplus release offers opportunities for both members and employers in the right circumstances.  However, there is scope for material regret risk for all parties if arrangements are entered into without thinking through and managing the risks. Just because you can, does not necessarily mean that you should! But if you can and you should, then surplus release might be just right!