Buying out all scheme liabilities and winding up the scheme is often the hardest job a board of trustees will ever be faced with. We hear a number of myths and rumours flying around, from trustees, pension managers, companies and even consultants who specialise in other areas! In this series, we aim to bust those myths and promote a better understanding of the journey to wind up a scheme. The series continues with: 

Myth 5: “Dealing with my wind up surplus will be straightforward”

Being able to afford to fully secure scheme benefits with an insurance company is a key outcome that many trustees are working towards. Having enough money to afford this and still have surplus funds leftover may seem like a dream scenario but it can bring with it a number of difficult considerations and decisions for trustees to grapple with and piece together - think of it like a jigsaw puzzle!

What picture are you aiming for?

Do you want actually want a surplus? It might be easier for the employer to top up a small deficit than deal with the complications that surpluses bring.

The scheme’s rules will likely set out how a surplus should be treated. In the first instance, trustees should obtain legal advice to help them interpret any requirements under the rules – for example, it may be clear that surplus funds are due back to the sponsor, or that they must be distributed among the membership in the form of augmented benefits. In some cases scheme rules can be vague, and give trustees power or discretion over the surplus without giving step by step instructions. Having discretion on the distribution of surplus comes with its own headaches – how do you fairly attribute surplus funds to members? Having a small surplus is possibly the worst outcome in that the expenses associated with dealing with it will far outweigh the additional benefit to members. 

How many pieces?

While the final surplus can’t be known exactly until the scheme is fully wound up, it’s important to get an early view of the likely end position before entering into a final buy-in. Developing a detailed ‘surplus balance sheet’ will help trustees determine the scale of the puzzle. Every scheme cost, expense and advisor fee should be compiled, along with contingency allowances, to produce as accurate a view as possible of the wind up costs. It is likely that, on the route to winding up, trustees will have already transferred some risk to insurance companies via a buy-in. In such cases the liabilities may be partly or fully matched by the buy-in policies and expenses and contingencies become increasingly important in determining the likely surplus or deficit. Holding an expense reserve of a percentage of liabilities is unlikely to be appropriate and a bottom up approach to understanding expenses will give a more reliable picture of this component. Trustees and sponsors will then be able to take confidence that there’ll be sufficient funds to finalise the wind up, and start planning for any surplus.

Starting to build the picture

Where scheme rules don’t give defined instructions on how to treat a surplus, trustees must deal with challenging considerations, negotiations and decisions. Upfront and open discussions to  agree whether to return funds to the sponsoring employer, augment member benefits, or reach a compromise between the two will be like putting the key corner jigsaw pieces in place. 

If the decision is made to use some or all of the surplus to augment member benefits, there are still some key issues to consider before the puzzle can be completed. Trustees may want to augment benefits of a select group of members – perhaps those affected by scheme or benefit changes in the past, like closure to accrual for example. Care, and legal advice must be taken to avoid issues such as unfairness or bias when awarding augmentations to some and not others.

The final piece

Once a decision has finally been reached, the last stage is letting the members know. News of improved benefit security on buyout is typically warmly received by members, and even more so when it comes with a benefit augmentation. However, care is required where only certain groups of members are being augmented. When funds are being returned to the employer, this can be trickier to message positively to members. The requirement to consult with members on any refund to the employer can add complexity and extend project timescales by several months. Careful planning is key. 

Having slotted the various puzzle pieces together just so, it’s time for trustees to sit back and relax…

If you’d like to talk further about your scheme’s journey to wind up, please get in touch.