Release of surplus from UK defined benefit (DB) pensions: draft regulations

Actuarial assessment

• The draft regulations reduce the funding threshold for surplus release from the existing buyout basis (the cost of buying annuities to cover accrued benefits, plus the costs of winding up the scheme) to the low dependency funding basis.
• Trustees considering release of surplus must first obtain an actuarial assessment of the scheme’s funding level on the low dependency funding basis. The assessment may be obtained at the triennial actuarial valuation for funding purposes, or at another time.
• Note that this actuarial assessment is a separate stage in the process to the provision of an “actuarial certificate” (please see below).

Asset valuations and appropriate advice

• The DWP is introducing more flexibility in the new regime, by dropping the retirement to use audited asset values and instead only requiring trustees to inform the actuary of the value of the scheme’s assets at the effective date.
• Before informing the actuary of the asset values, the trustees must take “appropriate advice” from a person they reasonably believe:
  • To be qualified by their ability in and practical experience of financial matters; and
  • To have appropriate knowledge and experience of the management of scheme investments and liabilities.
• The DWP comments that investment advisers may be able to give appropriate advice for this purpose.

Trustee proposal for payment of surplus to an employer

• Where the actuarial assessment shows that the scheme is more than fully funded on the low dependency funding basis, the trustees may agree a provisional amount of surplus to be paid to the employer.
• The DWP expects that when deciding what surplus can be released, trustees and the employer should consider the appropriate level of financial buffer to retain above the minimum low dependency funding level.
• The DWP also comments that, at this stage, trustees may wish to consider using surplus to enhance member benefits.
• Before deciding the provisional amount, the trustees must take advice from the actuary and must consult the employer, on both the amount of the proposed payment and the intended payment date.

Notification to members

• As at present, trustees must notify members of the decision to pay surplus to the employer, at least three months before the proposed payment date.
• Under the draft regulations, the notification must include (where applicable) that the trustees have decided to award improvements to member benefits.

Actuarial certificate

• As explained above, the provision of an “actuarial certificate” is a separate (and later) stage to obtaining the initial “actuarial assessment”.
• To proceed with the proposed surplus release, the actuary must be satisfied that the value of the scheme’s assets will be greater than the value of the scheme’s liabilities on the low dependency funding basis on the date of the actuarial certificate, taking into account:
  • Material developments between the actuarial assessment and the date of the actuarial certificate, which the actuary considers affect the assets and liabilities;
  • The amount to be paid to the employer;
  • Any future benefit increases connected with the payment to the employer; and
  • The known future value of any authorised member surplus payment (please see below).
• The actuary must also be satisfied that, for three years from the date of the actuarial certificate, the value of the scheme’s assets is “at least as likely as not” to be greater than the liabilities on the low dependency funding basis.
• If the actuary is satisfied that the above conditions are met, s/he may give an actuarial certificate (which must contain prescribed information).
• The Financial Reporting Council (FRC) has announced that it will develop technical guidance for actuaries on certifying proposed surplus payments to employers.

Paying surplus to employer

• Once the actuary has given the actuarial certificate; the employer has consented to the surplus repayment; and the members have been given three months’ notice of the payment, the trustees may proceed with the payment.
• The employer must be paid within five working days of the date of the actuarial certificate, as opposed to the 15 month timescale that currently applies.
• The DWP intends the new, much shorter, timescale to ensure that any surplus release reflects the scheme’s most up to date funding position.

Authorised member surplus payments

• The consultation paper confirms that HMRC will consult separately on changes to allow direct payments of surplus to members to be treated as authorised payments for tax purposes.
• The possibility of paying a new “authorised member surplus payment” will be in addition to the existing option for trustees to use surplus to improve members’ benefits (with the employer’s agreement, if required by the scheme rules).
• An authorised member surplus payment may only be paid to members who have reached normal minimum pension age (NMPA). Authorised member surplus payments awarded to members below NMPA must be held as deferred benefits.
• The draft regulations include consequential amendments to the revaluation and transfer values regulations, to provide that:
  • Where a member is awarded an authorised member surplus payment before NMPA, the payment must be revalued up to the member’s NMPA by the lower of the consumer prices index (CPI) and 2.5%;
  • An authorised member surplus payment revalued in accordance with this new provision will not be included in any revaluation of the member’s other benefits; and
  • Actual or prospective entitlement to an authorised member surplus payment will not be treated as benefit accrual for the purposes of rights to a transfer value.
• We can expect further details to be contained in tax legislation in due course. One reading of the draft legislation is that government expects authorised member surplus payments awarded below a member’s NMPA to be paid to members on reaching NMPA. If so, this could prove onerous for scheme administrators, if they must pay out (possibly small) benefits, whenever an affected member reaches NMPA.

Notification to the Pensions Regulator (TPR)

• Trustees must continue to notify TPR within a week of making a payment of surplus to the employer.
• New requirements will require additional information to be included with the notification, including:
  • The amount by which the value of the scheme assets exceeds the value of the liabilities on the low dependency funding basis;
  • The scheme’s total assets and liabilities on the low dependency funding basis;
  • Details and values of any improvements agreed to member benefits in connection with the payment to the employer; and
  • Details and values of any authorised member surplus payments.

The Pensions Regulator (TPR) statement on surplus flexibilities

• TPR’s recent statement on surplus flexibilities sets out its early views on principles which trustees should consider when releasing surplus. TPR intends to consult on supporting guidance later this year, once the DWP has responded to the current consultation on the draft regulations.
• TPR recommends steps for trustees to take in preparation for discussions on surplus, including:
  • Adopting a surplus policy, if one is not already in place;
  • Ensuring that the scheme’s funding and investment strategy aligns with the surplus policy;
  • Initiating conversations with key advisers;
  • Considering whether the trustee board has sufficient expertise for running on a scheme;
  • Reviewing scheme data and administration, including the position on equalisation of guaranteed minimum pensions (GMPs) and remedying any issues with historic alterations; and
  • Engaging early with the employer, including consideration of sharing any surplus released between the employer and members.
• Factors TPR expects trustees to consider include:
  • The appropriate size of any financial buffer in the scheme; above the low dependency funding level;
  • The planned length of any running-on;
  • The strength of the employer covenant and its future prospects (although TPR does not expect trustees to perform a full covenant assessment for every decision to release surplus);
  • Any additional protections which may be appropriate, such as contingent asset support;
  • The extent to which members have contributed to the scheme, plus any reasonable member expectations; and
  • The impact of any surplus release on the trustees’ investment strategy.

Superfunds

• Defined benefit (DB) superfunds will initially be excluded from the release of surplus provisions.
• The DWP plans to make separate provision for releasing surplus from superfunds when the future statutory authorisation and supervisory framework for superfunds has effect.
• Releasing surplus from superfunds is expected to be subject to a stricter funding test and different regulatory conditions.

Authored by Jill Clucas.