Most trustees are comfortable with employers taker a larger share of any DB surplus than employees, if a scheme runs on, according to new research.
In a widespread survey of professional trustees Isio found that over two-thirds believe that the minimum member share of a surplus to justify a scheme running on is 40 per cent or less – with the remainder effectively being available to the employer.
However, it also found that more than half of these trustees would only be comfortable to return surplus funds to employers in schemes that are overfunded on a buy-out basis and also have a buffer.
Isio surveyed 83 professional trustees, managing over 800 pension schemes with over £350bn in assets regarding this issue, which is increasingly become a question for discussion following the improved funding position of many DB schemes.
The survey asked trustees about the minimum share of surplus that would need to be used to improve member benefits to justify running on.
Nearly a third of trustees (30 per cent) have not yet considered this, but of those who have, more than two-thirds (68 per cent) are comfortable that a member share of 40 per cent or less of the surplus would be sufficient to justify running on over the medium to long term after insurance first becomes affordable.
On average, trustees appear willing to reflect the fact that employers take on 100 per cent of downside funding risks with a higher employer share of surplus, aligning with the position that Isio expects most employers to take.
However the survey made clear that trustees are only willing to start releasing surplus once schemes are very well funded
Whilst more permissive legislation for releasing surplus from ongoing surplus would be welcome, in practice only around 30 per cent of trustees said they would be comfortable to start returning surplus to an employer in a scheme that is not yet fully funded on a buy-out basis.
Isio suggests many schemes can do this today using their Purposeful Run On (PRO) framework, which maintains a buffer above 100 per cent funding on a buy-out basis after each surplus distribution.
Over half of professional trustees surveyed would like this buffer to be 5 er cent or more.
Investment strategy
Investment returns outperforming insurance pricing discount rates is a key source of expected surplus generation. Isio asked professional trustees what a typical investment return target should be for schemes planning to run on for at least five years beyond the earliest opportunity to purchase a full scheme buy-in.
The survey showed that over half (55 per cent) of trustees would ideally target an investment return ranging between gilts plus 1 per cent per annum and gilts plus 1.5 per cent per annum, with almost a quarter (24 per cent) preferring a more conservative investment target of gilts plus 1 per cent per annum or less.
A cautious approach to investment strategy is understandable given the de-risking journeys that many UK DB schemes have been on.
However, Isio’s modelling suggests that a target of between gilts plus 1.5 per cent per annum and gilts plus 2 per cent per annum will typically give a better balance between targeting sufficient expected upside for members and employers while maintaining a very low probability of moving into a technical provisions deficit.
Minimum scheme size
Many market commentators argue that there is a minimum scheme size for run on to be practical for members and employers, as running costs are a higher proportion of assets for smaller schemes, leading to a greater drag on expected surplus generation.
Isio’s research revealed that over half (56 per cent) of trustees surveyed who had already formed a view, believe that schemes with at least £100m of assets are viable for run on. This figure increases to three quarters (75 per cent) of trustees who would consider run on for schemes with at least £250m as assets. Interestingly, nearly a quarter (23 per cent) of respondents felt there is no minimum asset size for schemes looking to run on.
Isio believes that run on strategies may be attractive for very well-funded, immature schemes smaller than £100 million due to the faster improvement in insurance pricing from retirements and ageing. It also expects that employers with US parent companies sponsoring small schemes may push for run on due to the unfavourable accounting treatment for buy-out under US GAAP.
Regulation
Trustees also want more guidance from The Pensions Regulator. To date it has been extremely rare for trustees to release surplus to sponsors before schemes enter wind-up.
Isio asked professional trustees to choose up to three changes that would be most effective in making it more common to release surplus from ongoing schemes. Over 70 per cent of professional trustees cited balanced and comprehensive guidance from TPR as being effective in removing behavioural barriers to gradually sharing surplus between members and employers.
This was significantly more than the next highest scoring change, with less than half (48 per cent) of trustees prioritising the introduction of a statutory override to allow surplus to be returned to sponsors irrespective of restrictions in scheme rules.
Isio director Matt Brown says: “Most professional trustees have an open mind to different ‘end games’ and see the employer’s views as key for deciding an approach.
“Employers that favour running on will be encouraged that most professional trustees would be comfortable for the member share of surplus to be less than the employer share. It can be easier to agree the sponsor’s preferred approach if it is raised early, so it is important for sponsors to model and quantitively assess different options.”