Defined benefit (DB) pension scheme sponsors should be wary about the potential for surplus money to end up trapped or unproductive, LCP has said, urging scheme sponsors to work closely with trustees to agree a mutually acceptable endgame objective.

The firm’s latest corporate report explained that improved funding levels and subsequent surpluses mean new considerations for scheme sponsors about their ultimate strategy, including how accessible the surplus is and deciding if contributions are still needed.

In light of this, LCP encouraged sponsors to take advice on how and when their scheme rules permit refunds of surplus and ensure that they have up to date estimates of their funding position, explaining that this will help to “maximise opportunities”.

In addition to this, the report suggested that there has “never been a more important time” for sponsors to be investing in line with their long-term strategy, explaining that higher gilt yields, capped inflation and Covid-19 impacts have reduced liability targets.

However, it acknowledged that some schemes will need to make "difficult decisions" around liability driven investment (LDI), explaining that trustees may need to consider whether to accept lower LDI hedging or fewer growth assets following the gilts crisis.

Inflationary increases are also a consideration, as LCP noted that while using index-linked gilts is the most common approach that schemes use to hedge inflation, investments reflecting inflationary changes such as ground rents and long lease property could mean better protection at better value for schemes with long time horizons.

It also suggested that there may be strong public and member pressure to grant higher pension increases in some cases due to high inflation and against the backdrop of the cost-of-living crisis.

LCP partner, Phil Cuddeford, stated: “Scheme surpluses are a nice problem to have but sponsors need to work out the direction of travel for their scheme with their trustees in order to negate any risks.

“There are so many issues for sponsors to keep on top of, whether it’s responding to the new world of less efficient LDI, higher for longer inflation and interest rates, the prospect of tougher new rules on pension scheme funding or exploring new options for endgame.

"For the sponsor who is on the ball with oversight of their pension scheme, this is also a time of great opportunity.”

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