Exclusive: Certainty is asymptotic

Background - About SMF™

For Defined Benefit Pension Schemes in Surplus: How Much Surplus Can Be Safely Distributed?

Trustees and sponsors of defined benefit pension schemes in surplus face a critical governance question: How much surplus can be safely distributed? The Surplus Management Framework™ (SMF) provides a rigorous, risk-based solution by distinguishing between two key categories:

Trapped Surplus

This is the surplus that needs to be retained for risk management purposes. It acts as a buffer against potential financial shortfalls.

Distributable Surplus

This is the surplus that can potentially be released, as desired by the trustees and sponsors.

The strength of the sponsor's covenant directly determines the capacity for distribution. Weaker covenants necessitate a larger portion of surplus to be trapped as a risk buffer. This, in turn, leaves less surplus available for distribution.

Investment strategy choices also have significant implications. For instance, increases in equity allocations can heighten risk, thereby increasing the requirements for trapped surplus. This reduces the opportunities for surplus distribution 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 fundamental 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.

This is clearly impossible. However, it highlights a crucial point: certainty is asymptotic. Each incremental increase in confidence necessitates a disproportionate increase in financial resources.

In the UK DB superfunds capital regime (which is interim for now), buffers are substantial, surplus is tightly trapped, and distributions are heavily constrained. This is 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—such as sponsor support, contingent assets, or 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.

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