Scheme surplus rules – the lottery and the ‘fix’

Rising funding levels and maturing schemes mean this question is coming up more and more, and people are often surprised by the complexity, and uncertainty, of the answer. It certainly isn’t, as employers usually hope, a simple “yes”.

The DWP’s consultation on Options for DB Schemes has shone a spotlight on why it’s so complicated, and explores how the position might be simplified by introducing a statutory override. The thinking being that removing barriers to surplus extraction could make running on a pension scheme (rather than targeting buyout with an insurer in the short-term) more attractive to employers and, in doing so, open up new investment strategies which could benefit the UK economy as a whole.

So why is returning surplus to employers such a lottery, and is it going to be fixed?

The lottery

Whether and when you can extract surplus from a pension scheme, and return it to the employers, depends, firstly, on what your scheme rules say.

What your rules say will, in turn, depend on who they were drafted by, when they were drafted, and how they’ve evolved over the years. This is what we mean by a ‘rules lottery.

There are a number of variables between schemes’ surplus rules, such as:

• whether they have a power to return surplus
• who holds the power – is it the trustee, the employer or both (the rules might even give a role to members)
• whether there is any discretion or requirement to use surplus to augment benefits before returning money to employers
• whether you are extracting surplus from an ongoing scheme or on wind up
• whether the powers are framed narrowly or in broad terms (they may be based on former legislative or tax requirements that no longer apply)
• whether they contain any conditions or specific procedural requirements (e.g. consultation or notice provisions)
• how the surplus rules interact with other provisions in the rules (such as expense provisions and wind-up powers).

There is also a technical question as to whether, and in what form, you entered into a section 251 statutory resolution to preserve/amend surplus powers in your rules in light of certain provisions in the Pensions Act 2004.

The fix

So, would a statutory override fix the problem?

Here comes my second favourite answer, “to some extent”.

When it comes to considering a potential course of action, trustees generally need to follow a two-stage decision making process:

1.           Do we have the power to do it (i.e. the “can” question)? and

2.           Is it an appropriate exercise of our power (i.e. the “should” question)?

A statutory override could help level the playing field in terms of the first question. In other words, it could gift all schemes with broadly the same powers to extract surplus regardless of what their rules currently say. However, how effective an override could be in addressing the rules lottery will depend on exactly how it is framed. A level playing field isn’t necessarily that easy to create because you aren’t starting from a blank sheet of paper. There will also be the question of how any rules override joins up with the existing statutory framework around returning surplus to employers.

But (and it’s a big but), the second question (i.e. should they return surplus) is almost always where things get more complicated and difficult to predict.

This is because even if trustees have a power to extract surplus, they can only exercise that power:

• in accordance with their wider trust law duties – which generally require them to act in the interests of members, and
• at the relevant time – which means they generally can’t make decide how they would exercise a power in advance.

Therefore, simplifying question one by giving all trustees the same powers, wouldn’t mean that a particular trustee board would, or could, necessarily use those powers in a particular way, at a particular point in time. A trustee board would need to go through a proper process at the relevant time, taking into account a range of factors before making a decision about whether and how to use scheme surplus.

This means that “it depends” is likely to remain a fair answer to the question of whether employers can extract surplus from their pension scheme.

But pension scheme surpluses can be big money, it’s not surprising that employers want to know that not only do they have their surplus rules lottery ticket but that their odds of winning are as good as they possibly can be.

Just don’t forget that members may be lining up for their ticket too.