As recently as last year, scheme surpluses were not high on most trustees’ agendas – instead something to be thought about in the future, should they arise. However, recent rapid rises in gilt yields has brought surpluses firmly onto the agenda.

So, what should trustees be thinking about? How should they take potential surpluses into account in broader journey planning discussions?

As with many items that trustees need to manage, the scheme-specific “answer” needs to be approached from an integrated perspective, drawing on the scheme’s covenant, actuarial, investment and legal advisors – as well as engagement with the sponsor.

We believe there are three key steps in the process:

1. Understand your current position and access to the surplus
2. Define the end-goal for use of the surplus
3. Design and implement a strategy to realises that end-goal

Understand your current position and surplus access

There are many actuarial bases on which a scheme can be in surplus. However, the starting point for any analysis is for trustees to consider how well funded the scheme is relative to their ultimate funding goal (or if they are still forming a goal, it could be helpful to understand the funding level on a buy-out basis).

It is also important to understand how robust any surplus really is. It can evaporate quickly, not just through general funding movements but also as a scheme is prepared for an insurance transaction (e.g. identification of additional liabilities through legal due diligence, or haircuts on illiquid trades).

If the scheme is not yet in surplus, trustees will have flexibility to establish structures to prevent a surplus arising (such as escrow, reservoir trusts, co-investment vehicles etc).

It is also important to understand the extent to which trustees (and / or the sponsor) can access any surplus and under what circumstances – for example, some Trust Deed and Rules only allow access to a surplus once a scheme is wound up.

Define the end-goal for use of surplus

There are a number of options for utilising a surplus and the “right answer” will be scheme-specific. The chosen option will have implications for journey planning and will inform how the surplus is ultimately “spent”. Options include:

• Buy-out with an insurer
• Transfer to a consolidator
• Run the scheme on

The strength of the covenant will be a key consideration, as it provides an underpin to scheme risks until the endgame is reached or all benefits are paid out. It is therefore important to regularly assess and consider the strength of the covenant and whether any structural enhancements are required to underwrite any residual funding and investment risk

Other considerations in setting the end-goal will include:

• Timeframe to access surplus/reach funding goal
• How surplus can be utilised (return to sponsor/augmentation of benefits/meet scheme costs etc.)
• Benefit structure (do the trustees have the right to grant discretionary benefits)
• Accounting impact from a sponsor perspective
• Tax considerations
• Investment strategy optimisation
• Member communications/PR implications

Design and implement your end-goal strategy

Once the goal on how to use the surplus has been established, consideration should then turn to how to design and implement a strategy to reach that goal. It is usual for trustees to set this strategy in conjunction with the sponsor. Our recommendation is that trustees put a framework agreement in place with the sponsor, which documents (as relevant):

• Long-term goal and expected timeframe to reach it
• Desired use of surplus
• Investment strategy – expected corridor of funding / ensuring strategy aligns with the end-goal
• Relevant implementation steps required to reach the end-goal (e.g. data cleansing)
• Contingency plan that includes pre-agreed actions and/or covenant protections
• Any mechanisms being used to avoid trapped surplus

We have experience of arranging many surplus management options – including escrow, reservoir trusts, escrow trusts, employer to trustee company loans to fund buy-in premiums, ABC vehicles. We would be delighted to discuss the right option and supporting framework for your situation.