Corporate pension funds are once again in the enviable position of having to decide what to do with these surpluses. Historically, there have been three ways of reducing surpluses: a ‘contribution holiday’ under which contributions by employers or employees are suspended; improvement of pensions or a refund to the employer.

Yet the ownership of the surplus has been a sensitive issue in some European countries.

In the Netherlands during the late 1990s, labour unions strongly contested the right of some of the country’s leading employers to reclaim the surpluses of their company pension schemes.

In Switzerland, the law governing occupational pensions explicitly forbids a corporate pension plan paying back a surplus to its parent company.

In the UK, employers who have closed their DB schemes now face the problem of so-called ‘trapped’ surpluses - surpluses that, for tax reasons, are expensive to extract. Some are arguing that the government should make it easier for employers to get their hands on money which they believe they are entitled to.

So what should be done with surpluses? We wanted your views. As ever, there are problems of definition. In the UK, the issue of surpluses has been confined to defined benefits (DB) schemes, until recently the dominant occupation pension plan design.

Yet some of the managers of continental European pension funds who responded to our questionnaire make the point that the disposal options for pension fund surpluses will differ according to whether the plan is DB or DC.

One manager at a Belgian pension fund says: “Given the fact that the fund sponsor remains liable for the pension rights of members in a DB plan, it seems logical that a sponsor should also reap the benefits if there are surpluses.

“In a DC plan however much, if not all of the risk is carried by the fund’s members, so they should be rewarded for taking the risk and the surpluses should stay with the fund.” The growing importance of collective DC schemes in the Netherlands and elsewhere in continental Europe clearly coloured the views of some respondents.

Two in three (65%) of the pension fund managers, administrators and trustees who responded to our survey say that corporate sponsors are not entitled to the surpluses of their corporate pension schemes, or to a share of these surpluses.

A Dutch pension fund manager, noting the relaxation of the requirement for UK companies to index pensions, says that surpluses should be reserved for the indexing of pensions. Another suggests that employers are entitled to the surplus only “provided they can solidly guarantee future funding”.

The activities of private equity firms and hedge funds also come in for criticism, with pension fund managers pointing out any pension fund surplus will add to the attractions of a company for takeover purposes. “It’s the labour force’s money, ” one manager says.

Only a minority (33%) would support the view that a pension fund surplus is an integral part of the value of the sponsoring company and its shareholders should therefore also be entitled to at least a proportion of the surplus. Again there is evidence that recent activities of private equity firms in this area have hardened opinions.

Rather more than half of pension fund managers (57%) think that the surpluses of corporate pension schemes should be used only to improve member benefits. Some point out that, even without an obligation to use surpluses in this way, improving benefits will effectively remove up any surplus

 

Taking a holiday

Another option is a contributions holiday, either for the employer, the employee or both. The subject of employers’ contributions holidays is a sensitive one, particularly in the UK where pension holidaying employers have been blamed for allowing their schemes to slide into deficit after the tumble in equity market prices.

Yet most of our respondents (58%) think that the sponsors of corporate pension schemes should be allowed to take contribution holidays if their pension fund has a surplus. One UK pension fund manager points out that in the UK there is nothing to stop them: “There is no law now that mandates regular contributions, only funding levels.”

Taking a different view, the manager of a Dutch scheme suggests that employers should be obliged to make a minimum contribution payment, however healthy the fund.

The manager of a Swiss pension fund points out that a contribution holiday is one of only two options available to an employer if there is a pension fund surplus of the options available, and only if it is shared between employers and employees. “If surpluses are available we have by law only two possibilities - a contribution holiday on a paritarian basis, or an improvement of members benefits. My preference is for the second possibility.”

The question of whether employers should be allowed to use the surpluses of their pension schemes to finance redundancy payments is more controversial, since this is seen not only as robbing Peter to pay Paul but ‘ultra vires’ - beyond the powers of the employer.

This is supported by the results of our survey. Three in four respondents (75%) think that they should not be used for this purpose.

The manager of a UK pension scheme suggests that such use of the surplus is allowable “only if they are used to meet the costs of early retirement but not if they are used to fund redundancy payments outside the terms of the pension scheme”. In some countries, notably the Netherlands, corporate sponsors have switched from final salary to career average plan designs in an effort to retain a DB scheme.

Pensions lawyers have argued that although the intention behind such a move is laudable, the principle is wrong. Yet most of our respondents (80%) disagree with this. Similarly most respondents (63%) say that, when a pension scheme is liquidated, any surplus should be distributed to the active members and the beneficiaries of the scheme. Among the minority who disagree, there is the view that this option “should be considered but not be obligatory”.

A minority think that the sponsor is entitled to some of the surplus in such situations. “The sponsor is also a stakeholder,” one Dutch manager points out. Another argues that “liquidation is different. First the liabilities must be financed with a no risk guarantee and the money that is left can go back to the sponsor.”

Unfair shares

Sponsors of corporate pension funds have argued that the sharing of risk between employer and employee is asymmetrical, since any surplus within the pension fund belongs to the beneficiaries, while they are required to cover any deficit. There is little sympathy for this view, however, with only a minority (38%) in agreement. Many feel that employers have options other than increasing coverage when faced with a deficit; for example, cutting benefits.

A majority (60%) agrees that preventing sponsors of corporate pension schemes from extracting surpluses from their pension funds will discourage them from making extra contributions to these funds.

So should it be easier for sponsors to extract surpluses? In the UK, tax authorities have made it difficult and costly for companies which have closed their DB pension schemes to gain access to any subsequent surpluses. Bodies representing corporate treasurers and financial officers have lobbied the government to relax these constraints.

Such lobbying gets little support from our respondents. Most(70%) say that governments should not make it easier for employers to extract surpluses from corporate pension schemes.

However, the manager of a UK pension fund thinks that the possible predations of ‘corporate raiders’ on company pension scheme surpluses should not determine policy: “There is a challenging balance to be found that enables responsible employers to benefit from prudent funding while protecting against corporate raiders.”

Most (76%) agree that corporates have been too quick to close their DB schemes because of the impact of deficits on their balance sheets, although there is some defence of the DC option. Yet few pension fund managers (33%) expect to see a return to the ‘golden’ period of pension surpluses and contribution holidays. So maybe the problem of what to do with surpluses will not prove to be a problem at all.