Steve Webb: 100% PPF cover would help support surplus extraction

Sir Steve Webb, Partner at LCP and former Pensions Minister and MP very kindly had a chat with me about surplus extraction. I set out a summary of this fascinating interview below. 😊

PG: What are the government’s stated and unstated aims in allowing surplus extraction?

Steve: The process started under the last government, and while there are slight differences between the two administrations, their agendas are quite similar. Looking at the July 2023 consultation alongside the Mansion House statement, the initial idea was that DB schemes should re‐risk—that is, invest in productive finance (whatever that means)—to generate surpluses. They believed that one reason schemes might not re‐risk is that sponsors wouldn’t see the upside if increased risk meant a greater chance of incurring a deficit. In other words, the original goal was to get about £1.2 trillion of DB scheme assets more productively invested by allowing sponsors to capture some of the surplus.

Allowing sponsors to access some of the upside was central to that thinking. Since then, there has been a shift: even if schemes don’t re‐risk much, putting surplus money into the hands of corporate Britain (used loosely since many sponsors aren’t strictly British) is seen as beneficial for the economy. It’s less about re‐risking DB schemes and more about unlocking money that isn’t being used effectively—money that companies can use to invest in their businesses, pay DC contributions, and dividends. Plus, the government stands to gain tax revenue. Even at 25%, if billions are extracted, that still amounts to billions.

PG: So, it was originally part of a “let’s get everyone investing more in the UK” policy strand and when that didn’t fully work out, the Government still thought it was good for the economy and business?

Steve: Yes, and it’s interesting how the term “UK” is used here. The previous government wasn’t as explicit about focusing solely on the UK—while they cared about growth, the Mansion House compact on DC didn’t specifically mention the UK. In contrast, the Labour Manifesto emphasizes the UK, so for this government it really is about national growth.

PG: Do you think the aims will be achieved through surplus extraction?

Steve: That depends on whether they take a maximalist or incremental approach. Every scheme is unique. Without a comprehensive and bold strategy, the rules or any override might not work effectively, and trustees or corporates may be too nervous to act. To have a significant impact, surplus might need to be defined as anything above low dependency funding—not just funds above the buyout level, which would exclude many schemes.

Additionally, trustees need assurance that if money leaves the scheme, members’ benefits remain secure. Schemes can use contingent assets or insurance on a case-by-case basis, but we believe that expanding the PPF to 100% cover is the boldest, most comprehensive solution. With full cover, trustees can be confident that if the sponsor continues, the scheme remains sound—and if the sponsor fails, the PPF protects members’ benefits. However, if trustees remain nervous despite these measures, nothing may happen at all.

PG: I suppose if you make the PPF seem more than just a last-resort safety net, it might encourage schemes to take on excessive risk, so there is a balancing act there.

Steve: Exactly. Any form of 100% insurance creates a risk of moral hazard—like having full car insurance might lead someone to drive recklessly, but we still have speed limits. Still, there will be a pensions regulator, a funding code, and ongoing evaluations. The government wants schemes to take on more risk, but not recklessly, so maintaining the funding code remains essential.

PG: Surplus extraction has been allowed before. What’s different this time compared to previous attempts, which left us with poorly funded schemes?

Steve: There are two points here. First, surplus extraction can now generally occur above buyout levels in most cases. Previously, schemes approaching buyout would simply buy out, leaving little surplus to extract and negligible tax revenue. More recently, some companies have “mopped up” surplus by reducing the funding of running costs or diverting surplus to DC components within a DB trust.

Second, if you look back to the 1990s during contribution holidays, HMRC banned schemes from being more than 105% funded because of extra tax relief. Then came various headwinds—97 legislation requiring indexation, longevity improvements, accounting changes, tax issues, and falls in interest rates and returns—that pressured funding. Today, however, the overall funding position is much more robust. More schemes are well-funded, and measures can be taken to lock in gains, for example by moving to low dependency funding. While hedging risks like longevity reduces surplus, it also locks in some of the gains.

PG: What are your concerns about this policy?

Steve: It works if it gives trustees sufficient comfort. My concern is not that trustees will simply allow surplus extraction—since the statutory override does not give corporates an automatic right to demand funds. The government has talked about an agreement between trustees and sponsors, meaning trustees retain a clear veto. I don’t expect trustees to casually hand over the keys to the safeguard.

The worry is that nothing happens at all. The risk is that caution sets in – after all, regulators rarely get fired for over-regulating, they get fired for letting bad things happen. The changes may not apply broadly, and in the cases where they do, the money could end up leaving the UK. A comprehensive approach is essential.

PG: Do you think any adjustments to the policy would help ensure better outcomes, or is the current approach the best possible?

Steve:  Well, we don’t know what the final policy will be yet. The consultation they are responding to is the February 2024 DB consultation by DWP, and we haven’t seen their full response. All we’ve seen is the Rachel Reeves/Keir Starmer press release and speech, in which they said they would act in this space and override scheme rules. However, the override mentioned is very specific—it applies only to the technical issue of requiring a resolution passed before 2016 to allow surplus extraction under certain circumstances. Without such a resolution, you can’t extract surplus. In simple terms, they plan to override that provision, but on its own, it doesn’t go far. If the scheme rules still state that any surplus belongs to the members, additional measures are necessary. They seem to have assumed that was the only substantive barrier, but we believe trustees need a more comprehensive, general override of scheme rules.

PG: So, those are the additions you think are necessary when the policy is introduced?

Steve: Yes, probably. Also, trustees need to be convinced that the changes are clearly in the members’ interest—not merely acceptable because they benefit the sponsor, current employees, or the broader economy. While one might argue that what’s good for the economy is good for members, that is too indirect for an individual scheme.

PG: Do you have any concerns about the optics of this for scheme members?

Steve: Yes, communication is critical. There’s a risk that a process—even one with many safeguards—could be portrayed in the media with headlines about companies stealing workers’ pensions, reminiscent of the Robert Maxwell era. Proper framing is vital. For the past four years, DB schemes have been funded on a prudent basis, which usually results in a surplus. These schemes are mature, many having been closed for years, and their members are aging. Prudence has led to surpluses, and since sponsors have contributed most of this money, one might argue that they should recover some or that members should receive a share through discretionary benefits or uplift. There’s also a timing issue: some members are very old, and because DB schemes include a range of ages with regular attrition, those with no indexation on pre-97 service may need prompt action. I’m not suggesting we focus solely on older members legally, but any benefit for members could be significant.

PG:  Are there better ways to support DB scheme investment and value for money?

Steve: There’s a supply-side question—this was noted in the DC arena, and to some extent in DB as well. There might be more willingness to invest in illiquid assets if a longer, say 10-year, time horizon is in place. Approaching a buyout also complicates matters. Insurers can manage illiquid investments, but it does make the process messier. Regarding value for money, it’s interesting because members mainly care that their pension promises are met while the sponsor remains solvent, so value for money is less of a concern for them. It matters more to the corporate sponsor, who is ultimately liable. However, this hasn’t been a top priority for corporates—they did welcome the change in the PPF levy, where its allowed to reduce the levy if necessary rather than overcharging, which is a positive development.

PG: Is there anything else I should ask or that you think is worth mentioning?

Steve: The language in the Prime Minister’s and Chancellor’s speeches was quite strong. After 18 months of consultation, one hopes that the response will include definite measures to be enacted in an Act of Parliament—specifically, this year’s pension scheme bill—with progress made in parallel as the bill moves through Parliament. Additionally, TPR is expected to move forward with either a surplus code or an appendix to the funding code addressing services, and this should happen quickly. My concern is that if the regulator waits until after primary legislation and subsequent regulations to consult on a code, the window for action may close. Urgency is key.