How much surplus will be released from UK DB Schemes?
“Prediction is very difficult, especially about the future.” ― Niels Bohr
It is an often quoted statistic that UK DB pension schemes are in aggregate surplus of £160bn. However the UK Government's Department for Work and Pensions (DWP) has recently projected in its impact assessment that it centrally estimates that £11.2bn will be released from DB schemes (to sponsors, members and as tax) due to surplus reforms [1].
Is this reasonable?
Spoiler alert - £11.2bn looks a little low to us.
Crystal ball gazing is an inexact art, so what we offer is a reasoned opinion. We explain our view in the rest of this article, using our proprietary Surplus Management Framework (SMF) as a guide.
Starting Point
Firstly, we note [2] that the £160bn is specifically the low dependency surplus (at 30 Sept 24) for schemes that are already in surplus. On a buyout basis at the same date there is an aggregate deficit in the order of £140bn for schemes that are in deficit.
We look across the aggregate DB universe (ie. include all schemes) - our starting point is a low dependency surplus of £137bn. The aggregate low dependency funding level is around 112%.
Applying the SMF
Successfully managing surpluses whilst ensuring members remain protected requires strong governance and solid scaffolding - such as that provided by our proprietary Surplus Management Framework (SMF). Two metrics from our SMF are useful here, the Value of Contingent Sponsor Support (VCS) and Reliance. We discuss these metrics and their application to DB pensions further in our SMF white paper.
The PPF Purple Book suggests that the schemes have generally well (though not completely) derisked investments and high liability hedging levels in aggregate. The VCS is the economic value of downside funding support provided by sponsors over the horizon. We model the industry's VCS to be around £25bn with a 10 year horizon.
Reliance is a metric that broadly considers the extent to which schemes are expected to be reliant on external support over that time horizon. We model the industry's level of reliance in the next 10 years to be around 20% - not too high on the scale from 0% to 100%.
Starting at 20% reliance, release of surplus would lead to those schemes placing greater reliance on sponsors, the question is to what extent trustees and sponsors agree that reliance can be extended. Greater reliance is only desirable if sponsor covenants can support it.
Let's assume that the industry targets an average 25% level of reliance - higher but not too much higher than the baseline. That would be consistent with an industry aggregate release of surplus funds of £27bn. That still leaves in excess of £130bn of surplus in UK DB pension schemes (in surplus) - retaining security for members. Additionally, in run-on, schemes would be expected to continue to invest in a manner that would replenish and regenerate surpluses over time.
Crystal Ball Gazing
We estimate that the total value of supportable surplus release could be £27bn and possibly higher than that over time allowing for future asset outperformance and further iterations of surplus release as a result.
The DWP central estimate of £11.2bn of surplus release implies a much lower propensity to release surplus. Some of the difference in viewpoints (but unlikely all) could be explained by a proportion of schemes opting to insure, paying surpluses away as premiums, instead of running on and releasing surpluses in the manner discussed here.
We will keep a close eye on how this evolves but our view is currently that, with proper governance in place to manage surpluses, the scale of surplus release could be greater than recently estimated by the DWP.
Contact us if you are a DB pension trustee, sponsor or involved in in-house governance, and interested to explore these concepts further.
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