The control over an estimated £160 billion in pension fund surpluses in the UK is becoming a point of contention between corporate plan sponsors and trustees, as the government moves to establish new regulations governing these excess funds.

According to the Pension Protection Fund (PPF), the UK's defined benefit (DB) corporate pension market is valued at £1.1 trillion, with its funding position having improved significantly since 2019. This shift is largely attributed to rising yields on UK government bonds, which have boosted expected investment returns.

These surpluses represent a pool of capital that could be returned to shareholders, used to enhance benefits for retirees, or controlled by insurance companies following a buy-out transaction of the pension scheme.

A consultation by the UK's Department for Work and Pensions on this issue will close on September 2nd, after which the government will finalize rules with the Pensions Regulator regarding the use of surplus funds.

In a buy-out deal, a company pays a fee to an insurer, which then assumes the assets of its DB scheme and the ultimate responsibility for paying member pensions. The insurer retains any excess investment returns after paying retirees.

In a recent report, Morten Nilsson, CEO of pension provider Brightwell, stated that for smaller pension schemes or those with weaker covenants, a buy-out with an insurer "will remain the primary goal and likely the best option."

Nilsson added that for larger schemes, "the decision is less clear-cut. Our research indicates that 70% of large schemes currently intend to continue running," rather than opting for an insurance buy-out.

While most DB occupational pension schemes were historically in deficit, the Pensions Regulator now estimates that approximately 80% are in surplus on a low-dependency basis.

This means pension trustees can reasonably expect the scheme to withstand any market shocks without requiring financial support from the corporate sponsor.

The Pensions Schemes Act, passed in April, effectively started the debate on the use of fund surpluses. This legislation provides corporate sponsors with more flexibility, provided they remain within certain safety thresholds.

Estimates of the amounts involved vary. The government's estimate is £160 billion, while data from consultancy LCP indicates that the total surplus among FTSE 100 companies alone could reach £36 billion by the end of 2025.

Rob Yuille, head of workplace pensions at the Association of British Insurers, noted, "The low-dependency funding level is very imprecise." He believes interpreting what constitutes "low-dependency" still relies on trustee judgment. Given the significant discretion left to trustees, Yuille expects most schemes will adopt a prudent approach.

The same applies to the sponsoring companies. A Chief Financial Officer's attitude towards the protection offered by a surplus is likely influenced by their past experiences dealing with pension deficits.

Claire Altman, head of pension risk transfer at Standard Life, remarked, "A lot depends on the age of the CFO at the corporate sponsor."

According to LCP data, between 2005 and 2017, FTSE 100 company pension schemes were in deficit every year except one, forcing CFOs to find extra funding annually to fill the gap. This generation of CFOs tends to prioritize removing pension risk from the corporate balance sheet, potentially favoring a buy-out transaction with an insurer.

Once pension trustees are satisfied with a scheme's solvency, the next question is whether and how to use any surplus to benefit retirees, company shareholders, or both.

Yuille pointed out, "What (corporate) schemes can do isn't necessarily an either/or. They can distribute surplus to shareholders while also increasing benefits for members."

Surplus funds can be distributed directly to members as a one-off payment or credited to their pension accounts to enhance future benefits. Surplus can also be transferred into a defined contribution (DC) plan as part of the company's overall pension arrangement, potentially offering members more choices for growth strategies.

Steve Hodder, a pensions investment consultant at LCP, anticipates some of his clients will take this path. He stated that if using the surplus helps "provide generous retirement benefits for the workforce and helps the business grow sustainably, then it's a win for everyone."