Trustees and treasury teams responsible for the UK’s £1.2trn defined benefit corporate pension sector were left disappointed by the Chancellor of the Exchequer’s Mansion House speech after she failed to announce any reform to corporate defined benefit (DB) pensions.

Although Reeves unveiled sweeping reforms to the Local Government Pensions Authority, LGPS, and Defined Contribution, DC, schemes, urging these sectors to accelerate consolidation into megafunds, she gave no details of reform of the corporate DB sector.

Corporate defined benefit pension funds, in surplus for the first time in years, have been seeking guidance on how they can use their surpluses. The industry has been pushing for the government to make it easier for schemes to free up excess assets for the benefit of both the corporate sponsor and scheme members.

According to The Pensions Regulator (TPR) of the 5,000 DB schemes in the UK over 3,750 are now in surplus on a low dependency basis with a further 950 schemes approaching surplus. Tipped into surplus for the first time in decades, DB funds must decide whether to wind the pension fund up. This involves handing it over to insurers who promise to pay employees’ retirement payments at a fixed level under so-called bulk annuity arrangements. Alternatively, they can run it on, continuing to operate the pension for the benefit of the business and wider economy.

Private sector DB schemes and surplus assets

“Notably left off the menu at the Mansion House dinner were private DB schemes and the potential to use surplus assets productively,” argue Mairi Carlin, Louise Pettit and Amy Davies from law firm Burges Salmon.

“It’s disappointing that the Chancellor missed the opportunity to use the Mansion House speech to provide the DB sector with clarity around the proposals to make it easier for pension scheme surplus to be returned to sponsors,” says asset manager Brightwell CEO, Morten Nilsson.

“As it stands, the current regulatory and legislative regime incentivises trustees and sponsors to pursue insurance buyouts as soon as possible and more needs to be done to support those well-funded schemes with strong covenants who want to run-on. Schemes that run-on can invest in a wider range of assets for longer, retaining value for the benefit of members, sponsors and UK plc. The government shouldn’t overlook this important part of the market.”

Nikesh Patel, Head of Client Solutions UK at Van Lanschot Kempen adds, “from what we know so far, it seems that the Mansion House speech does not consider how to incentivise corporate DB pension schemes to efficiently utilise surpluses sitting with some of the largest UK employers.”

He continues: “This would be far more effective in accelerating economic growth, and more beneficial to a much wider range of UK companies and UK asset classes, than further LGPS pooling – noting too that this pooling falls short of the Canadian model and, will still leave most of the eight pools unable to match the reach of their international peers.

Patel estimates that in aggregate, well-funded UK DB pension schemes have, conservatively, around £300bn in surpluses today on an insurance buyout basis. Held by many of the largest employers in the UK, these pension assets could materially direct investment back into the UK.

“Over the next ten years, our calculations suggest that this surplus number could grow to £1trn, a large proportion of which could be put towards investing productively in a portfolio of long-term, diversified, public and private UK-focused assets, without additional risk to members’ savings.

“In fact, by putting DB surpluses to work, the Treasury could solve two pensions headaches with one stone: channelling capital into UK companies and protecting the retirements of younger generations.”

The potential

Choosing to run on the pension in a well-managed, low-risk way, could benefit corporate treasury by creating a source of funding to the business, and generating value for members.

Returns from investing the surplus could be invested in the company or used to offset borrowing costs. Having a pension surplus on the books can support the corporate’s credit rating and become a source of funding or be used to offset borrowing costs especially as debt has become more expensive.

Holding onto the pension fund could also allow companies to offer discretionary benefits for members or increase inflation protection, supporting employee retention in competitive businesses.

Treasury is also perfectly qualified to apply the same financial controls it deploys to run the business to managing the surplus. Trustees just need a blueprint, or code of practice, around surplus extraction and guidance on how to best manage the assets. In terms of financial rigour, the company and trustees can do things like set clear investment plans for pension schemes, put in checks and balances and rules around monitoring and assessment.

“For many years schemes have been a drain on liquidity but now there is an opportunity. Well-managed, a pension fund in surplus can be a positive source of cash for the business rather than a drain,” concludes Wayne Segers, Partner and Head Pensions Solutions at pensions consulting and administration business, XPS Pensions Group.