Exclusive: Certainty is asymptotic

Background - About SMF^TM

For defined benefit pension schemes in surplus, trustees and sponsors face a critical governance question: How much surplus can be safely distributed?

The Surplus Management Framework^TM(SMF) provides a rigorous, risk-based solution by distinguishing between:

Trapped Surplus: The surplus that needs to be retained for risk management purposes.

Distributable Surplus: The surplus that can potentially be released, as desired.

Sponsor covenant strength directly determines distribution capacity - weaker covenants require more surplus to be trapped as a risk buffer, leaving less surplus spare to be distributed.

Investment strategy choices can have material impacts -  increases to equity allocations, resulting in increased risk, also increase trapped surplus requirements, reducing surplus distribution opportunities in the near-term.

The SMF is designed to transform surplus distribution from a potentially contentious negotiation into a structured, risk-based decision.

DB Superfunds - significant capital requirements

A basic principle underpins this entire discussion:

To be absolutely certain that member benefits will be paid in all circumstances requires a funding level that approaches infinity.

That is clearly impossible. But it highlights a crucial point: certainty is asymptotic. Each incremental increase in confidence requires a disproportionate increase in financial resources.

In the UK DB superfunds capital regime (interim for now), buffers are large, surplus is tightly trapped, and distributions are heavily constrained -  far more so than might be expected for well-funded single-employer DB schemes.

We do not view this as conservatism for its own sake. It is the inevitable consequence of demanding very high certainty in the absence of an operating covenant.

Moving from 90% to 99% certainty is not marginal. It requires covering deep tail risks -  scenarios that are rare, but not implausible.

High confidence in the absence of covenant means large buffers are needed

Where regulation is comfortable relying on future actions - sponsor support, contingent assets, management intervention - the required confidence can be achieved with less capital in pension schemes today.  Schemes can and do often target lower than full funding on a solvency basis.

Where that reliance is removed, certainty must be bought upfront.

In the Surplus Management Framework (SMF), covenant quality is defined as the degree to which the operating sponsor can credibly cover the scheme's potential financial shortfall under adverse but plausible scenarios.  

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