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Pension surpluses need to be given greater consideration in corporate transactions as ‘mood music’ changes – LCP

Pensions & benefits DB corporate consulting Corporate strategy Economy

Changes in government regulation and continued high levels of pension scheme funding are leading to a shift in the ‘mood music’, and now schemes could increasingly be seen as an asset rather than a liability when it comes to corporate transactions.

LCP is highlighting that a new mindset is needed around how pension schemes are assessed and valued.

The July 2023 Mansion House announcements around reforms encompassing the use of surplus, the cut on the tax rate that applies on a refund of surplus (from 35% to 25%), and the industry debate around ideas such as LCP’s Powering Possibility in pensions, all point to a potential softening in attitudes to employers accessing surplus.

However, there is uncertainty around how the value of the surplus can be realised, and careful judgment needs to be applied to the specific circumstances before coming to that conclusion.

There are three things that should be a key part of due diligence:

  • Understanding how robust the surplus is involves looking beyond just the accounting surplus and, for instance, measuring the scheme’s funding position on a self-sufficiency measure, i.e. at what point the scheme can operate without further funding from the sponsor with investments in low-risk assets.
  • Taking a close look at the scheme’s governance and how much intervention the trustees can have. This includes understanding whether the surplus may be needed to pay benefit improvements or if a payment to a sponsoring company can be made.
  • Understanding the decisions on future plans for the pension scheme and business. For instance, plans for the business may mean it makes sense to remove all pension risk in the period of ownership. A key consideration is understanding if an insured buy-out can be achieved with investment returns over time or whether a sponsor contribution is likely to be required to get there. Detailed analysis, including a review of the buy-out position informed by current insurer pricing and modelling that allows for the impact of members retiring, can often be a pleasant surprise for a potential purchaser.

Helen Draper, Partner at LCP, commented: “The mood music is changing when it comes to pension schemes in transactions. Historically, they have been viewed as a liability, but as funding levels have increased, there has been more focus on how scheme surpluses can be unlocked. This means more scrutiny and understanding of schemes is needed to assess the value of any potential benefit from a surplus.”

Helen has written a blog on the topic that can be read here.

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