Part 2: So, you’ve got a surplus…
…and want to share it - is your Trustee governance up to the job?
The previous blog in this series examined the factors that DB pension scheme trustees may wish to consider when deciding whether to pursue a “return of surplus” policy.
This blog examines what implementation of that policy could look like in practice, noting of course, that there will remain some unknowns until the relevant statute is in place.
It is our view that, on balance of probabilities, the most likely profile for a scheme that implements a return of surplus policy will be one that:
Already has a material surplus (definitely compared to Technical Provisions and low dependency basis, and probably against solvency)
Has a strong sponsor (otherwise buy-out is likely to be more appropriate)
Is a medium- to large-sized scheme as these are more likely to have sufficient resources (e.g. to meet adviser costs / increased governance burden) and to be worthwhile for the sponsor to spend time on
Below a certain size, it is inefficient from both an economic and governance perspective to run-on, so smaller schemes are unlikely to find it beneficial to pursue return of surplus (as an aside, my colleague, Ian McKinlay, recently wrote a blog on this very topic).
Early in the process of getting a return of surplus policy in place, the Scheme Trustee (at a minimum) will want to have:
An idea of what benefit it wants for members; for example, granting additional discretionary benefits (whether as a one-off payment or an ongoing process of benefit increases);
Indication from the sponsoring employer of what it will want to receive in return and;
Indication from the relevant advisers that they would be prepared to offer advice that concurs with the above.
As noted in our previous blog, there are still regulatory and legislative hurdles to come before the details of return of surplus are ironed out, with statute and guidance likely to follow after this year’s expected government consultation. Any additional requirements for Trustees to enact before returning surplus will be clarified in the statute and accompanying guidance.
What does Return of Surplus mean for Scheme Governance?
A Scheme that is running on with the aim of returning a surplus as a long-term policy is likely to require a different governance set-up to one that is not.
Well-funded schemes are often heavily allocated to matching assets with a strong focus on reducing risk wherever feasible. Running a scheme with a “return of surplus” strategy, on the other hand, is likely to need to add back risk into the investment strategy. It may be thought of as akin to an insurance company; retaining a “capital buffer” and dividing up the surplus balances created according to an agreed policy.
Risk appetite, which determines the target size of surplus and investment strategy, should be articulated and agreed upfront, to help avoid the temptation to “chase” excessive returns. The rules for the distribution of the surplus assets (above the agreed buffer) should also be determined upfront – how is the surplus divided between member and employer, should there be a mechanism for “smoothing” e.g. to target similar levels of surplus returns each year, within the confines of the buffer constraints?
It will also be important for the Trustee to have a plan for what to do in a crisis – such as the surplus disappearing due to material investment under-performance or changing longevity assumptions. For example, should investment risk/return appetite be reconsidered, at what stage should the employer be approached to help plug any gap?
The following steps may be taken as a “starter for 10” for changing the governance set-up to help address the above questions on an ongoing basis:
Memorandum of Understanding between the Trustee and Sponsoring Employer:
Who does what and when
Key “return of surplus” objectives
Trustee / Employer working party
Include considerations of communications to members and other stakeholders, for example, shareholders and unions (where applicable)
Changes to committee structures, which is considered in further detail below.
Importantly, a return of surplus strategy requires a different approach to both investment strategy and investment governance, as a greater degree of coordination across investments, funding, administration and management of expenses may now be required. The Trustee’s Board and Committee structures should reflect this.
There will be a higher need for forward planning as schemes continue to run down over time (save for the very few DB schemes open to new members), as the return of surplus strategy and investment strategy will need re-thinking as a scheme begins to approach the size at which it would be better off buying-out (or perhaps consolidating in some other way).
Strong oversight will also become more important: the pension scheme’s in-house team (where available) or otherwise the Trustee, in coordination with its advisers, will need to develop a new set of relevant KPIs for the return of surplus strategy, and report on these regularly.
One of the biggest challenges that could face a Trustee undertaking return of surplus is that of crisis response. Regular reporting that alerts trustees to any “red flags” across investment and funding, and provides the right information for dynamic decision making will be very valuable to the scheme.
Lastly, return of surplus “best practice” will develop over time, and it will benefit schemes to keep on top of this and evolve their own approaches as they go.
Conclusion
Taking a step back, one of the greatest challenges for our industry is simply that people are retiring with inadequate pension provision, so taking actions to help alleviate that is a good thing, subject of course to any actions being appropriate for a scheme’s individual circumstances and the terms of the regulations, once these are set.
To be able to run a return of surplus well, trustees need to consider whether their governance model is the right one to meet the challenges:
Working groups in the set-up phase (trustee, employer, in-house team, plus related advisers)
Forum for interaction with sponsoring employer on an ongoing basis
Coordination and oversight of the ongoing strategy: investments, funding, sharing surplus, cost management
Regular reporting
Crisis plan
Getting the governance structure right should help to ensure that scheme members can enjoy the advantages of a return of surplus policy, whilst also having the security of their promised benefits protected.
How Avida can help
Avida supports pension organisations navigating strategic and governance transformation across all segments of the UK market — DB, DC, and LGPS. We help clients assess their current governance structures, benchmark them against best practice, and design fit-for-purpose models that reflect future scale, complexity, and regulatory demands.Our team of senior industry experts has deep experience guiding clients through transitions such as insourcing, scaling operations, board redesign, and fiduciary oversight.
Whether you’re preparing for LGPS consolidation, rapid DC growth, or defining your DB end-game strategy, Avida provides independent advice and hands-on support to help you manage change with clarity and control.
