The rise of large surpluses is a nice problem to have, but alongside the many opportunities that an era of scheme pension surpluses opens up, DB scheme sponsors need to also be wary about the potential for this money to end up trapped or unproductive.
LCP’s latest corporate report highlights that better funding levels mean that surpluses are now here or much closer than they have ever been. This means new considerations for scheme sponsors about their ultimate strategy, including how accessible the surplus is, what that means for their end-game, making decisions such as whether to de-risk, and deciding if contributions are still needed.
LCP is urging sponsors to work closely with trustees to agree a mutually acceptable end-game objective. They should take advice on how and when their scheme rules permit refunds of surplus and ensure that they have up to date estimates of their funding position and a simple way to monitor it. This will help them to maximise opportunities.
According to the report, other issues that sponsors need to have front of mind are:
- There has never been a more important time for sponsors to be investing in line with their long-term strategy, with higher gilt yields, capped inflation and Covid-19 impacts reducing liability targets.
- Some schemes will need to make difficult decisions around LDI as high gilt market volatility means that their efficiency is reduced. They will need to think about whether to accept lower LDI hedging or fewer growth assets in the new world following the gilts crisis.
- While using index-linked gilts is the most common approach that schemes use to hedge inflation, for schemes with long time horizons, looking at investments that will reflect inflationary changes such as ground rents and long lease property could mean better protection at better value.
- There may be strong public and member pressure to grant higher pension increases in some cases due to high inflation and against the backdrop of the cost-of-living crisis.
- With the new funding code expected next year, sponsors need to understand the possible impact on their first valuation under the new regime. There is still uncertainty, but higher funding targets and shorter recovery plans are likely outcomes for many.
Phil Cuddeford, Partner at LCP, commented: “Scheme surpluses are a nice problem to have but sponsors need to work out the direction of travel for their scheme with their trustees in order to negate any risks.
“There are so many issues for sponsors to keep on top of, whether it’s responding to the new world of less efficient LDI, higher for longer inflation and interest rates, the prospect of tougher new rules on pension scheme funding or exploring new options for end-game. For the sponsor who is on the ball with oversight of their pension scheme, this is also a time of great opportunity.”