ARTICLE
5 February 2025

Unlocking UK Pension Potential: Surplus Sharing And Investment

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There has been a lot of commentary around the potential for increased surplus access since the Mansion House proposals in 2023 and the Labour government has now announced its own plans...
United Kingdom Employment and HR

A five-point explainer on the defined benefit pension landscape and the UK government's proposal for more flexible surplus access.

There has been a lot of commentary around the potential for increased surplus access since the Mansion House proposals in 2023 and the Labour government has now announced its own plans to relax restrictions on access to surplus for defined benefit (DB) pension funds.  Here we provide a brief, five-point explainer on the topic.

01

Private sector DB funds have been on a de-risking journey

DB pension funds hold a mixture of assets including higher risk assets which seek to generate growth and lower risk assets that provide income to pay pensions. DB funds have been reducing exposure to equities and other growth assets in favour of UK government and corporate bonds over the last two decades, partly driven by funding regulations and many schemes closing to new members.

02

Many funds have targeted an insurance transaction as their ultimate destination

When a pension fund has built up enough assets to meet all the expected pensions, trustees and corporate employers can transfer their assets and responsibilities to an insurance company and formally wind-up the pension fund – referred to as a 'buyout'. In preparation for an insurance transaction, a pension fund's assets are typically invested in a way that is as low risk and readily realisable as possible. This allows the insurer to accept the assets as payment of the premium and then reinvest the assets in a way that is consistent with their stakeholder objectives and insurance regulations. For most trustees and employers it is a question of when, not if, a pension fund will undertake an insurance transaction (or similar). That is because the ongoing costs of running a shrinking pool of assets eventually become uneconomic. This is a key part of the industry narrative around the benefits of asset pooling and consolidation.

03

Any funding surplus can most easily be released after an insurance transaction

The current regulation means that any surplus assets relative to the cost of a buyout can most easily be released once an insurance transaction has taken place and a fund has wound-up. It is estimated that DB funds which can afford to buyout collectively have £97 billion in surplus assets relative to the cost of insurance. This figure increases to a £163 billion surplus when assets are assessed against a 'low dependency' measure – i.e., when a fund has enough assets to be able to adopt a low-risk, secure portfolio, but not quite enough to be able to insure in full. This means there is a significant amount of 'trapped surplus' within UK DB pension industry that could potentially be put to better use1.

04

The government is proposing to make it easier to release surplus while a fund remains a going concern

The previous government launched a consultation in February 2024 which considered options to improve access to surplus while keeping member benefits secure (this consultation also considered the merits of a public consolidator in line with our observation under point 2). The current government has now announced its own plans to relax restrictions on access to surpluses. This could include legislative changes enabling all DB schemes to change their rules to permit ongoing surplus extraction where there is trustee-employer agreement. Full details will not be published until Spring, when the government intends to respond to the February 2024 consultation.

05

This flexibility should encourage more pension funds to increase investment in growth generative assets

The ability to access surplus assets more easily on an ongoing basis will incentivise more funds to defer insurance and run-on for a period, reversing the immediate de-risking trend and increasing investment in growth assets to generate surplus – at a time when the UK's economic and policy agenda is focussing on growth and investment.

We have been campaigning on surplus sharing flexibility as, in our view, this is a win-win-win for members, employers, and wider society – see our paper: Six changes to seize the DB pension surplus opportunity. Many DB funds have already taken the decision to defer insurance to build surplus and we believe many more funds will welcome the increased flexibility around surplus distribution that the government's announcement promises.

Footnote

1. Source: The Pensions Regulator, January 2025 (data as at 30 September 2024).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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