Six changes to seize the DB pension surplus opportunity

UK private sector defined benefit (DB) pension schemes hold around £1.5 trillion in assets, and these schemes are better funded than ever. Many are on a path towards a very substantially de-risked asset portfolio, as part of their journey plan towards buying out with an insurer.

There are two major consequences of this direction of travel. First, neither employers nor their current or past employees stand to benefit from the opportunity presented by well-funded DB pension schemes. Second, the aggregate effect is contrary to the Government’s desire for UK pension savings to support economic growth by investing more in productive finance.

Some fundamental changes are needed to the pensions regulatory regime; otherwise the opportunity presented by strongly funded DB plans will be missed. Making it easier for employers, DB members, and employees saving through defined contribution (DC) schemes to benefit from surpluses, albeit with appropriate checks and balances in place, would encourage more employers and trustees to retain growth assets in their pension portfolios with the aim of making the surpluses more persistent. This would also benefit the wider UK economy.

We estimate that most pension schemes are already in surplus on the Pensions Regulator’s proposed ‘Fast Track’ low dependency basis; this is a conservative funding basis, which assumes very low future investment returns. Many more are close. The opportunity for the UK to take advantage is therefore one that exists today; equally, unless the pensions regulatory regime changes in the very near future, the opportunity will be missed.

The key to realising this opportunity is unlocking ‘trapped surplus’: with appropriate checks and balances, it should be easier to access surpluses when they arise. This would give employers and trustees a reason to invest in assets with higher expected returns. By extending schemes’ time horizons and delaying the journey to buyout, it would also facilitate investment in less liquid assets such as UK infrastructure projects.

We propose six changes the Government should make:

These changes could reasonably be expected to result in DB schemes directing tens of billions of pounds into higher return seeking assets.

Beyond DB, the expansion of Collective DC (CDC) via multi-employer, master trust and decumulation-only arrangements should provide further opportunities for boosting retirement savings and for them to be invested in higher returning assets. This will become increasingly important as nearly all private sector DB schemes have a finite investment time horizon. We have played a leading role in bringing CDC to the UK market, working with Royal Mail, and we support the Government’s plan to bring forward draft legislation later this year to make all forms of CDC a reality so that as many people as possible can benefit. It is our view that decumulation-only CDC arrangements will have the broadest reach.

Download our full white paper below.