Pension Scheme Surpluses and the UK Economy: unlocking growth?

Suzanne Burrell looks at the latest announcements by the government regarding proposals to make it easier for pension schemes and employers to share surplus funds.  The detailed consultation is expected in the spring.

Rachel Reeves' recent speech on the government's proposals to boost economic growth included reference to the announcement made on 28th January that the proposed reforms to legislation governing how UK pension schemes can apply surplus funds would go ahead. This insight considers the proposals and what this means for pension schemes and employers.

The Chancellor has announced that legislative reforms will enable surplus funds to be released from defined benefit pension schemes “where it is safe to do so”. Details will be set out in the government’s proposed consultation on pensions reform; expected to be published in the spring.

The government has outlined two broad goals behind the proposed reforms. The first is to enable pension schemes to use surplus funds to invest in productive asset allocations. This could potentially include infrastructure projects such as the announced expansion of Heathrow Airport which also forms part of the Government proposals. The second is to enable employers to more easily access surplus funds to boost wages, pension benefits or to enable the employer to invest in its business. The focus in DWP’s press release seems to be on the second goal rather than on trustee investment strategies.

What will be interesting once the detail of the reforms is known, is how the right balance will be struck, both between the interests of employers and pension scheme members but also within different populations of pension scheme member. During the 2024 consultation, concerns were raised by various stakeholders over the need to ensure that the trustees’ overarching fiduciary duties were maintained. This was something which we flagged in our consultation response based on responses to our survey.

Pension Scheme members are entitled to increases on the part of any defined benefit pension which relates to employment from 6 April 1997. Many pension scheme members who were employed before 6 April 1997 see that part of their pension being eroded by inflation. This has been particularly marked in recent years while inflation rates were running high.

However, for employers and trustees, there is the question of how employees who were moved away from defined benefit pension schemes into defined contribution pension schemes, or who saw increased contribution rates and reduced accrual rates, can share in any surplus allocation. For many such employees, they might have been moved to a new pension scheme, meaning that scope for them to benefit from pension scheme surplus is limited and will only occur if employers decide to use surplus funds to increase contributions into their other pension schemes.

What will be interesting is how the Chancellor’s reference to release of surplus being “safe to do so” is translated into legislation. Changes to the Scheme Funding regime saw the introduction of an obligation on defined benefit pension schemes to set a long-term funding objective. Theoretically, the changes to legislation could include a restriction meaning that funds can only be released where a scheme is fully funded, either on a long-term funding basis or by reference to buy-out costs. Pension Scheme Trustees are only likely to agree to sharing surplus with a scheme sponsor where appropriate guardrails are in place to ensure that security of members’ benefits is maintained. This is something which is likely to vary in scope depending on the scheme’s and employer’s circumstances.

The DWP press release envisages that surplus funds will be released from pension schemes to be invested within the scheme sponsor’s business. However, where a scheme sponsor is part of a wider international group, there is may then be pressure to then release dividends from the scheme sponsor to the overseas parent. How this particular issue is addressed in the legislation remains to be seen.

Background to the Reforms

The proposed reforms were initially announced by the previous government and background to the 2024 consultation can be found in our previous article. The 2024 Consultation explored legislative changes to allow occupational defined benefit (DB) pension schemes to return surplus funds to scheme employers or other beneficiaries. 

Particular points in the 2024 consultation included:

• Proposals by the DWP to simplify the process of extracting surplus funds from DB schemes and establish a new public consolidator vehicle managed by the Pension Protection Fund (PPF).
• Legislative Proposals: The consultation sought views on whether to legislate to allow scheme trustees to apply a statutory override or require the scheme employer's agreement. It also considered the potential safeguards needed to protect scheme beneficiaries' rights.
• PPF Consolidator: The proposal includes establishing a consolidator scheme by 2026 to accept schemes unattractive to commercial consolidation providers. This would provide additional protection for scheme members' benefits in the event of employer insolvency.

The announced reforms also follow a recent consultation on consolidation in the defined contribution (DC) pension market. Alongside reform in the DB market, plans are afoot to encourage consolidation in the Local Government Pension Schemes and with the Defined Contribution Market.

Rachel Reeves' Mansion House speech in November 2024 emphasized the need for reforms to boost investment, increase pension pots, and tackle waste in the pensions system. The Pensions Review revealed three workstreams: scale and consolidation in the UK workplace market, cost versus value in the DC workplace market, and UK investment and growth. The surplus proposals align with the third of these workstreams.

Conclusion

Rachel Reeves' speech and the anticipated proposals represent a significant shift in the UK pension landscape which was initiated by the last government. This follows on from the proposals around consolidation in the DC pension market underscores the government's commitment to creating a more efficient and effective pension system.

The practicalities of these reforms, as outlined in the 2024 consultation, highlight the need for careful consideration of legislative changes and safeguards to protect scheme members. The consultation in the Spring will be one to look forward to.