The Department for Work and Pensions has consulted on draft regulations intended to make it easier for well-funded defined benefit pension schemes to release surplus to employers while maintaining appropriate protections for members.

Arc Pensions Law has responded to the consultation. We welcome the additional flexibility offered to trustees and employers, including the proposed ability for ongoing schemes to release surplus without being funded on a buyout basis. However, our response emphasises that surplus release is not simply a financial or actuarial exercise. Trustees must also understand the scheme’s legal benefit structure, the scope of their powers and the fiduciary considerations relevant to any proposed payment.

The draft regulations require trustees to take “appropriate advice” before exercising a surplus release power, but the proposed definition focuses primarily on financial matters and the valuation of assets. We suggest that the requirement should expressly include legal advice.

Before releasing surplus, trustees will need to establish that the threshold conditions are met, including crucially that the correct benefit liabilities have been identified and valued, and that the proposed use of surplus is consistent with their duties. Issues such as GMP equalisation, past benefit changes and the implications of the Virgin Media judgment may affect the correct liability value and, consequently, the amount of surplus available.

If surplus is distributed on the basis of an incorrect or understated liability value, the consequences may be difficult to reverse. The regulations and accompanying guidance should therefore make clear that satisfying the statutory funding test is necessary but not sufficient to justify a payment.

We support the proposal to base the funding test on full funding on a low dependency basis. This appears to strike a reasonable balance between making the flexibility practically useful and preserving appropriate protection for members. However, robust actuarial assumptions, covenant analysis, legal advice and careful trustee governance will be essential when setting and applying that basis.

Our response also supports the proposed three-year forward-looking assessment, which provides an important safeguard against relying solely on a scheme’s funding position at a single point in time. However, we suggest that the proposed “at least as likely as not” threshold requires clarification. If the policy aim is that the funding level is “expected to be maintained” then the bar should be higher than 50/50. We recommend the conventional legal formulation “on the balance of probabilities” which means more likely than not, even if by a narrow margin.
Trust law is principles-based but it is not unclear. Decades of case law about pension scheme surplus mean the fiduciary process is well-understood by lawyers. Trustees have a lot of freedom in decision-making as long as they follow a good process. That includes taking into account the history and circumstances of the scheme, what the rules say about surplus on winding-up, the source of the surplus, past dealings with surplus, and member communications and expectations. Sharing surplus with members will not be compulsory but we expect in practice it will be the norm. The new and extended ability to pay authorised member lump sums, including deferred lump sums for younger members, will be helpful.

What’s next?

The proposed regulations have the potential to provide trustees and employers with a useful additional option for managing surplus in well-funded DB schemes. Their effectiveness will, however, depend on clear guidance which flags the full range of legal, actuarial and covenant considerations involved.

Trustees will need to follow a robust process and maintain a clear record of their reasoning. The actuarial certificate will support that process, but it cannot replace careful consideration of scheme-specific factors, fiduciary duties, member outcomes and the employer covenant.

Arc Pensions Law will continue to engage with the development of the surplus flexibilities regime and its implications for trustees, employers and members.