Surplus release rules open door to run-on
Isio welcomes the DWP’s draft regulations which set out the broad framework to permit the release of surplus to employers from well-funded defined benefit schemes. The changes keep trustees front and centre in the decision-making process ensuring that members’ rights are protected.
We consider that the proposed combination of actuarial certification, trustee involvement and regulatory oversight should provide a robust framework that delivers a shot in the arm to DB schemes.
It sets out a principles-based approach leaving room for the Pensions Regulator to develop guidance that helpfully navigates trustees through the process.
We think there are areas where the draft regulations could better accommodate how we anticipate surpluses being used in practice. Making it easier to set up regular surplus release programmes subject to appropriate buffers could be facilitated more easily by some changes to incorporate flexibility into the release process.
A low dependency test is the right measure to establish if the scheme has adequate funding to be paying out surplus. It follows that it should be used in tandem with assessments of employer covenant and other safeguards. We expect trustees to buttress the caution that is baked into these figures by applying buffers to ensure there is ample headroom to accommodate future funding volatility.
Trustees’ role – We fully support the central role that trustees will have in determining when to release surplus. We expect the forthcoming guidance from The Pensions Regulator will help steer trustees through the decision-making process, with a focus on having appropriate safeguards so that surplus release does not materially reduce benefit security (rather than seeking to negotiate large member enhancements).
Member notification requirements – We have some suggestions for improving the process put forward by DWP for the member notification. This is currently geared towards one-off payments, which would result in repetitive communications and appears unwieldy. In practice, we expect to see surplus frameworks being agreed that may result in a longer series of releases if certain tests or requirements are met. Such approaches would be better served by adding more flexibility into the proposed notification process.
Member payments – We welcome the creation of a new type of lump sum payment to members above normal minimum pension age and to deferred members. Making the authorised member surplus payments practical to award and administer for members that are yet to retire is key. Our response to HMRC’s consultation on this topic welcomes that the payments will be treated as pension income rather than pension benefits.
We think there are several areas where changes to the draft regulations would enable the legislation to operate more effectively:
- Condition 5 should be amended to differentiate between member surplus payments and employer surplus payments, rather than reference separate legislation. The practical application of this legislation should also be considered in respect of AMSPs. For example, will the same notification and payment timescales apply here too – we believe a lighter touch is needed for member payments.
- We think it would be appropriate for schemes to be able to make surplus payments to members even when winding up. We think condition 4 should be removed to allow such payments even after winding-up has been triggered.
In a similar vein, it raises numerous issues relating to how the new payment will interact with the usual rules around pensions, early/late retirement factors, whether it can be taken as a pension commencement lump sum and whether it will be possible for members to transfer it. We would want to avoid situations where schemes are left with modest separate pots for small lump sums.
Certification requirements – The proposed three year look forward is an appropriate look-forward period, but as described in the draft regulations appears to place actuaries in an awkward position because it is unclear on the level of analysis required to satisfy the requirements. The proposed specification for “on each and every day over the next three years” may be construed as introducing a requirement for stochastic modelling.
We think the regulations should be amended to clarify that the test should be carried out on a deterministic basis that uses actuarial assumptions which are consistent with the scheme’s expected future funding position. This should be sufficient for the actuary to certify that the scheme meets the low dependency funding requirement at the specific point relating to the refund and would be expected to do so in three years’ time. This would also be broadly consistent with the approach undertaken for Schedules of Contributions and Recovery Plan certification.
Surplus as employer contributions – Beyond this consultation, but still relating to the use of surplus, we think it would be helpful if legislation could facilitate surplus use specifically to fund future contributions in a separate pension arrangement. Allowing surplus funds to be passed directly as contributions into another vehicle sponsored by the employer, be it a defined contribution (DC), collective DC (CDC) master trust, stand-alone trust (including other DB schemes) or to a group personal pension, would make it easier for employers to reallocate historic pension contributions to current employees. We understand that legal views differ on whether this is possible under existing legislation and clarification that it is possible would be welcome.
Iain McLellan