Will companies try to secure debt over pension surplus?
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Some companies are looking at whether and how they can secure debt over pension scheme surpluses, one covenant specialist has suggested, while acquirers are looking for targets where a DB surplus has not yet been recognised.
As new legislation is set to let employers access surplus in defined benefit schemes before wind-up, some companies may already be factoring this into their future plans.
The vast majority of schemes that do decide to run on may well only take off prudent amounts down to a certain level to give to the sponsor, said head of covenant advisory at XPS Group Arabella Slinger.
“But you are inevitably going to see some – and they will be the minority, but they will be the ones that make the headlines,” she said speaking at the XPS Conference 2025 on Wednesday.
Slinger said employers under stress with a well funded scheme that struggle to raise funding elsewhere could, in theory, look to the pension surplus to fund the business – which may still become insolvent, with scheme members potentially getting lower benefits than they were promised.
“We're also seeing – and this is something that is happening now – we're seeing people looking at trying to secure debt over surpluses, working out how they can do that. We're seeing mitigation for transactions being extracted not just down from the section 75 levels, but back down to low dependency,” she said.
The prospect of getting access to large pension surpluses is so attractive for companies, there are now some that are scouring the market looking for acquisition targets that are undervalued because a surplus in the pension scheme has not yet been recognised, she added.
The pension schemes bill does not define the level of funding that needs to be retained in the scheme after surplus is paid out. A consultation on regulations will set out the detail in the bill, but in its response to the previous government’s DB options consultation, the government said it was “minded to amend the threshold at which trustees are entitled to share surplus with the sponsoring employer from the current buyout threshold to a threshold set at full funding on the low dependency funding basis”. There is no built-in provision giving members a share of any surplus; instead, it will fall on trustees to negotiate this if appropriate.
Others believe securing debt with pensions surplus directly seems too early given the amount of time until the legislation on surplus release will be finalised. There is also an expectation that trustee consent will be required and the 25% tax charge, noted EY Parthenon partner Karina Brookes.
“Anecdotally we had heard that third parties looking at accounting surpluses may now be including them in analysis given the belief they might be accessible,” Brookes added, speculating that this could potentially be a lender looking at putting the surplus into a net debt calculation.
Schemes are taking very different approaches, she pointed out, with some moving towards risk transfer and finding attractive pricing. Others are holding off to assess other options.
A snap poll at this week's XPS event showed 38% of attendees representing DB schemes aim to move to buy-in or buyout as soon as possible, but slightly more (41%) intend to explore run-on options. A fifth were still undecided.
“While waiting for further clarity in terms of legislation and regulation, schemes are using surplus to tidy up their broader pensions position,” EY's Brookes said.
This includes funding accrual, expenses, unfunded liabilities and looking at scheme mergers.
“We would advise trustees to keep a record of how much surplus is being used in this way, as it often comes in smaller requests from the corporate which can add up quickly, and to make sure that these decisions are made looking at both covenant and investment risk,” she advised.
Surplus extraction was an idea by the previous government in light of the current large DB surpluses of a combined £240bn on a Pension Protection Fund basis. The current government rekindled the debate in January.
The vast majority of schemes that do decide to run on may well only take off prudent amounts down to a certain level to give to the sponsor, said head of covenant advisory at XPS Group Arabella Slinger.
“But you are inevitably going to see some – and they will be the minority, but they will be the ones that make the headlines,” she said speaking at the XPS Conference 2025 on Wednesday.
Slinger said employers under stress with a well funded scheme that struggle to raise funding elsewhere could, in theory, look to the pension surplus to fund the business – which may still become insolvent, with scheme members potentially getting lower benefits than they were promised.
“We're also seeing – and this is something that is happening now – we're seeing people looking at trying to secure debt over surpluses, working out how they can do that. We're seeing mitigation for transactions being extracted not just down from the section 75 levels, but back down to low dependency,” she said.
The prospect of getting access to large pension surpluses is so attractive for companies, there are now some that are scouring the market looking for acquisition targets that are undervalued because a surplus in the pension scheme has not yet been recognised, she added.
The pension schemes bill does not define the level of funding that needs to be retained in the scheme after surplus is paid out. A consultation on regulations will set out the detail in the bill, but in its response to the previous government’s DB options consultation, the government said it was “minded to amend the threshold at which trustees are entitled to share surplus with the sponsoring employer from the current buyout threshold to a threshold set at full funding on the low dependency funding basis”. There is no built-in provision giving members a share of any surplus; instead, it will fall on trustees to negotiate this if appropriate.
Others believe securing debt with pensions surplus directly seems too early given the amount of time until the legislation on surplus release will be finalised. There is also an expectation that trustee consent will be required and the 25% tax charge, noted EY Parthenon partner Karina Brookes.
“Anecdotally we had heard that third parties looking at accounting surpluses may now be including them in analysis given the belief they might be accessible,” Brookes added, speculating that this could potentially be a lender looking at putting the surplus into a net debt calculation.
Schemes are taking very different approaches, she pointed out, with some moving towards risk transfer and finding attractive pricing. Others are holding off to assess other options.
A snap poll at this week's XPS event showed 38% of attendees representing DB schemes aim to move to buy-in or buyout as soon as possible, but slightly more (41%) intend to explore run-on options. A fifth were still undecided.
“While waiting for further clarity in terms of legislation and regulation, schemes are using surplus to tidy up their broader pensions position,” EY's Brookes said.
This includes funding accrual, expenses, unfunded liabilities and looking at scheme mergers.
“We would advise trustees to keep a record of how much surplus is being used in this way, as it often comes in smaller requests from the corporate which can add up quickly, and to make sure that these decisions are made looking at both covenant and investment risk,” she advised.
Surplus extraction was an idea by the previous government in light of the current large DB surpluses of a combined £240bn on a Pension Protection Fund basis. The current government rekindled the debate in January.
