In this insight we report on a recent Pensions Ombudsman decision regarding distribution of surplus on a scheme wind up, the Pensions Regulator’s latest blog on pensions dashboards and a DWP Taskforce consultation on social factors guidance.
TPO determination on distribution of surplus
With more schemes recently being in surplus, the difficult issue of how surplus might be distributed on wind up is once again back in the headlines after several decades on the backburner. Deciding how a surplus in a pension scheme should be distributed can be contentious not least because scheme members can find it hard to understand why the sponsoring employer might be a contender for any of the surplus.
Trustees must tread carefully when deciding how to distribute surplus funds on wind up, ensuring that they act within the scope of relevant scheme provisions and follow a proper decision-making process. They also need to comply with relevant legislation including section 76 of the Pensions Act 1995 (Section 76) which, amongst other things, requires that notice is provided to scheme members about a proposal to distribute surplus to an employer and that members are invited to make written representations.
We summarise below a recent decision of the Pensions Ombudsman (TPO) in which he upheld a scheme trustee’s decision to distribute a surplus following winding-up of a section of a segregated pension scheme to the principal employer. The determination provides useful guidance for trustees when faced with a decision as to how to distribute a wind up surplus, including the factors to take into account and what it means to consult.
The scheme rules
The scheme rules on wind up in this case provided that the trustee could, in consultation with the employer, use any surplus to augment members’ benefits “if it considers it just and equitable to do so.” Any remaining assets would then be paid to the employers.
The trustee’s decision
After consulting with the employer and members, the trustee decided to return all surplus assets after tax to the employer following completion of the winding up. It made its decision after liaising with actuarial and legal advisers and after considering several factors including the following:
- The views of the employer and the members;
- The sources of surplus which included market conditions, investment performance and contributions to the section, the latter of which included material additional contributions of over £16m that the employer had made to the section between 2005 and 2016 which permitted the section to follow an investment strategy with significantly reduced risk. The trustee saw these additional contributions as the main reason why the surplus had arisen and had taken actuarial advice before arriving at this view;
- Member expectations;
- Member benefits - Members’ benefits had been secured in full with an insurance provider. Furthermore, members who had been overpaid benefits had been allowed to continue receiving these higher benefits;
- Member augmentations - those in service when the section was closed to future accrual had received an augmentation;
The member’s complaint
The member complainant did not agree with the trustee’s decision – his complaints were on grounds that might typically arise in many surplus distribution decisions. The complainant believed that “all the monies paid into the Scheme were done so to benefit its members” and that “it was ‘morally indefensible…to boost [the employer’s] profits…”. In returning surplus to the employer, the trustee had not acted in the best interests of scheme members and beneficiaries.
The member did not believe that the surplus had arisen primarily because of the employer’s contributions but that it was made up of several factors including member contributions and monies retained by the section when members passed away.
Another source of complaint concerned the consultation process; the complainant believed that the employer consultation process was flawed being ‘heavily biased’ and not a ‘two-way’ process, and that the member process was insufficient and a ‘tick box exercise’.
TPO decision
The remit of TPO
TPO did not make any decision on whether the trustee had complied with Section 76 because he is prevented from doing so by legislation. Compliance on Section 76 is instead governed by the Pensions Regulator.
This meant that TPO was confined to considering whether the trustee had complied with the scheme rules and interpreted them correctly, had taken into account appropriate factors when reaching its decision (relevant and not irrelevant ones) and that the trustee’s decision was not perverse (i.e., not so unreasonable that no reasonable person acting reasonably could not have made it).
The Scheme rules
TPO considered the relevant Scheme rules – TPO confirmed that the scheme surplus provision allowed the trustee to decide not to augment member benefits on a section wind up.
The requirement to consult
He also considered member and employer consultation.
TPO found that the requirement to consult with the employer under the scheme rules required the trustee to inform the employer about the surplus proposal, and after doing so, consider the employer’s views with ‘an open mind’. The employer could not insist on any particular course of action. TPO found that the trustee had complied with the relevant scheme provisions on employer consultation and had interpreted them properly.
The member consultation requirements derived from statute and, although TPO was not permitted to consider statutory compliance, he was able to look at the process generally and whether it met the requirements of good scheme administration. He found that the trustee had communicated effectively with members and had considered their views.
TPO’s views on consultation provide useful pointers for any consultation process not just that relating to surplus.
Beneficiaries’ best interests
When making decisions, trustees must act in the best interests of beneficiaries. TPO confirmed that, when considering this duty, scheme employers can be included as potential beneficiaries. This also accords with the Regulator’s view that beneficiaries can include the employer when considering a return of surplus.
Part of considering best interests includes looking at the purpose of the trust and the benefits that it was intended beneficiaries should receive. TPO found that a trustee paying surplus assets to an employer after securing members’ benefits in full would be acting in accordance with proper purposes (provided of course that other requirements as regards decision making are met).
Furthermore, a trustee is allowed to prefer the interests of some beneficiaries over others – this includes not just preferring the employer over members but preferring certain categories of member over other ones (for example, members with different benefits or rates of revaluation).
Appropriate factors
TPO found that all of the considerations taken into account by the trustee were potentially relevant when making a decision on surplus. It had considered all relevant factors and not taken into account irrelevant ones.
Was the trustee’s decision unreasonable?
In essence, no. The trustee was able to demonstrate that it had considered the members’ position and had considered relevant factors. The decision to return all of the available surplus to the employer was not unreasonable. This did not mean that a different decision could not have been made which was also not perverse. If trustees act within their powers and make a proper decision neither TPO nor the courts can step in just because they might have made a different decision.
Concluding comments
Reaching a decision on surplus is challenging not least because there are competing interests that trustees must consider. This determination provides useful guidance on both distribution of surplus and decision making in general. Although not all factors will be relevant in all cases, factors which are likely to be relevant include:
- The purpose of the trust;
- How the surplus might have arisen including consideration of both member and employer contributions and funding history;
- Consideration of which parties have borne the risk of providing benefits under the scheme;
- The views and interests of the employer(s) as a potential beneficiary of the scheme;
- Members’ views, interests, and reasonable expectations; and
- Member benefits including how and to what extent they are being secured.
TPR blog on pensions dashboards checklist
The Pensions Regulator’s latest blog is all about the dangers of trustees ‘procrastinating’ and not starting the necessary preparatory work to ready their scheme for connecting to pensions dashboards in sufficient time to meet the relevant deadlines (31 October 2026 is the backstop connection date with staged dates along the way for schemes dependent on type and size which will be set out in guidance but which have not yet been published).
The blog provides a link to the Regulator’s dashboards preparation checklist which sits within its initial dashboards guidance as a useful aid for preparation.
Action: Trustees of schemes in scope (occupational schemes with 100 or more non-pensioner members and personal and stakeholder pension schemes) should press on with their preparations for dashboards (or start the work if they have not done so already).
DWP Taskforce consultation on social factors
On 19 October 2023, the DWP’s Taskforce on Social Factors (see our Insight) launched a consultation on its guide on social factors which provides trustees with guidance on how social risks and opportunities can be identified and monitored as part of the investment decision making process and stewardship of investments. It is split into three sections: (1) why social factors are important and how they fit in with trustees’ fiduciary duties; (2) what data trustees can utilise to manage social investment factors; and (3) a framework for addressing social factors in pension portfolios.
The consultation includes over 30 recommendations for the UK pensions industry on how it can improve incorporation of social factors into investment decisions. They include:
- trustees ensuring asset managers consider social factors and have strong engagement on this area and trustees having sufficient knowledge and understanding of this area;
- the DWP providing its formal expectations on social factors with these being overseen by the Pensions Regulator;
- the Regulator increasing awareness of social matters;
- the government addressing social factor data availability issues and gaps;
- investment consultants providing investment advice on social factors as standard and making sure they have the capabilities to provide such advice;
- legal advisers supporting trustees on their ESG and stewardship legal duties which means advisers must have sufficient understanding of this area of law; and
- businesses and employers having relevant policies, due diligence and processes on human rights issues and adequate disclosures on social factors.
The consultation closes on 1 December 2023.
Action: Trustees have a duty to consider financially material factors when making investment decisions and this includes ESG considerations. There is increasing scrutiny on trustees as regards ESG matters from all fronts - the government, regulators, members and climate activists. We have seen legal challenge in this area recently (see our Insight) and there are likely to be more challenges going forwards. Trustees should make sure that they are meeting relevant requirements on ESG matters, liaising with their advisers if they require confirmation of this.