Unlocking DB pension scheme surplus: a new consideration for employers and potential acquirers

For many years, the dominant question for employers sponsoring defined benefit (DB) pension schemes, and for the prospective acquirers assessing them in the context of an acquisition or other corporate activity, was how to manage a deficit. That position has changed materially.

The Pensions Regulator’s (TPR) latest analysis indicates that around 80% of DB schemes are now in surplus on a low-dependency basis (broadly, the funding level needed to pay benefits as they fall due without reliance on future employer contributions), with around 60% in surplus on a full buyout basis (the cost of securing all benefits with an insurer). Whether those numbers hold for any individual scheme depends on its asset allocation, liability profile and demographic experience – but the direction of travel is clear.

That therefore creates a different question: “What could the surplus mean for the business?”

For many schemes, surplus simply provides additional security for scheme members and a buffer against adverse experience. For others, however, it may represent value capable of being returned to the sponsoring employer.

That possibility has become significantly more relevant following the Pension Schemes Act 2026 (the PSA 2026). The PSA 2026 introduces a new statutory framework intended to make surplus release available to a wider range of DB schemes, including schemes whose rules do not currently contain an effective power to return surplus to the employer. The new regime is expected to come into force in April 2027, subject to the making of final regulations.

The significance of the changes extends beyond pension scheme governance. Employers, shareholders and prospective acquirers should start to consider whether DB surplus is capable of becoming an economic asset and, importantly, whether that potential value should form part of their thinking when assessing a business.

From pension risk to potential value

Historically, surplus has been viewed as something of a stranded asset. Even where a scheme was well funded, the ability to return surplus to the employer was constrained by a scheme’s rules and legislation.

The PSA 2026 changes this. It introduces a statutory modification power enabling trustees, subject to prescribed conditions, to amend scheme rules to permit surplus payments where an effective power does not already exist. The Government’s draft regulations propose replacing the existing requirement to be funded above full buyout before surplus can be returned with a low-dependency funding test. In broad terms, the proposed test would require an actuary to certify both that the scheme is in surplus on the low-dependency basis at the relevant time and that, at any given time in the following three years, it is at least as likely as not that the scheme’s assets will remain greater than its liabilities on that basis.

It is also important to note that any surplus payment made to an employer will continue to be subject to an authorised surplus payments charge, currently 25% of the amount of the surplus payment.

The draft regulations are positive from an employer’s perspective but do contain a number of key checks and balances, so it is important not to overstate what they permit. A surplus is not automatically an employer asset and the draft regulations do not give employers an unconditional right to take surplus assets out of a pension scheme.

Crucially, trustees remain the key decision-makers. Any surplus release will remain subject to trustee decision-making and the trustees’ fiduciary duties. The PSA 2026 does, however, change the statutory framework within which that decision is made, including removing the existing requirement for trustees to be satisfied that a surplus payment is in the interests of members. Trustees will nevertheless need to balance the relevant considerations in accordance with their fiduciary duties. TPR has emphasised that the new regime does not prescribe either a particular level of surplus release or how the economic benefit should be shared between members and the employer. 

The proposed regulations also contemplate employer consent to the payment, together with notification to members and actuarial certification. The precise requirements also remain subject to the final regulations. 

Surplus extraction will not necessarily be the right strategy for every scheme. Depending on the scheme’s funding position, maturity, investment strategy and endgame, surplus may instead provide additional security for members, facilitate benefit enhancement or be retained as a funding buffer. For acquirers/investors, the important point is therefore not simply whether a scheme has a funding surplus, but what strategic options that surplus creates and which of those options could ultimately generate value for the corporate group.

The reforms do not, therefore, create an entitlement to surplus, but they do create a credible route by which a pension funding surplus may potentially become realisable value.

Why this matters to private capital

Traditionally, acquirers and investors have assessed a target’s DB scheme primarily through the lens of risk: funding volatility, ongoing contribution requirements, and the potential risk of regulatory action by TPR.

Where a scheme is well funded, that analysis should start to be run in both directions.

A prospective acquirer/investor may encounter a target company with a mature DB scheme that is funded at or above its low-dependency liabilities and which therefore has a realistic prospect of ultimately releasing some of its surplus. The scheme is still a liability-management issue, but it may also credibly be viewed as a potential source of capital value.

That does not mean a surplus amount should simply be added to enterprise value. The amount ultimately available may be materially below any headline funding surplus – the scheme needs to retain sufficient resilience, the trustees must agree to any surplus return (and will likely be prudent in terms of the amount they are prepared to agree is returned), investment performance going forward remains uncertain, and the 25% authorised surplus payments charge and implementation costs represent significant leakage.

The opposite assumption, though – that a surplus has no value because it sits inside the pension scheme – is also likely to now be too conservative in the post-PSA 2026 world.

A more useful question may therefore be: “What is the probability-adjusted, net value of the surplus that could realistically be released and when is it likely that such value could be realised?”

Should surplus be used in deal price?

This is likely to start to become more of a focus for deal teams. There is no single correct answer as to whether potential DB surplus should affect enterprise value. Much will depend on the circumstances of the particular scheme and transaction. A buyer assessing a target with substantial surplus in its DB scheme should, though, distinguish between three concepts:

• Headline surplus, being the actuarial excess of assets over liabilities on a particular funding basis (likely to be on a low-dependency or solvency basis).
   
• Potentially distributable surplus, being the proportion which could realistically be released having regard to: (i) the applicable statutory tests; (ii) trustee decision making (including whether part of the surplus may be used to increase members’ benefits); and (iii) the need for the scheme to maintain an appropriate funding buffer.
   
• Net value of distributable surplus, being the amount which could ultimately reach the corporate group after tax and other transaction costs.

The figures at each of these levels could be very different.

The new regime makes the second and third concepts materially more relevant because the legal route to extraction is becoming more accessible. 

Surplus therefore has the potential to introduce a new dimension to deal pricing, centred on which party should capture the benefit of a pension funding surplus and how the inherent uncertainty (both as to the value and timing of realisation of any surplus) should be reflected in the allocation of risk.

A buyer may take the position that, given the funding, trustee discretion, tax and execution risks associated with any current surplus, no credit should be given for it in determining deal price. At most, the buyer may be prepared to give credit on a heavily discounted basis, reflecting the uncertainty as to whether, and when, the surplus can ultimately be realised. The seller, conversely, may argue that the surplus is an asset generated during its period of ownership, including through prudent funding and sizeable employer contributions over time, and should therefore be reflected in the deal price.

In practice, the parties may seek to bridge the gap through a range of mechanisms. A contingent value right or deferred consideration structure could allow surplus-related value to be shared if a payment is actually made post-completion. The choice of mechanism will depend not only on scheme-specific factors (e.g. the maturity of the surplus, the trustee relationship and the regulatory landscape at the time), but also on the wider deal dynamics (e.g. the relative negotiating leverage of the parties and the competitiveness of the process). 

Exit planning

For a sponsor approaching an exit in the future, a DB scheme in substantial surplus could become a genuinely differentiating feature of the equity story. A buyer evaluating the business may ask exactly the same questions as the original investor – how much surplus exists, how robust is it, what is the scheme’s endgame and how realistic is a return of surplus to the employer?

If those questions have already been addressed during a holding period, the sponsor may be in a much stronger position to demonstrate the economic significance of the scheme.

It is for this reason that a potential exit is arguably too late a point at which to discover that the pension scheme may contain value.

Instead, the funding position and endgame strategy – whether that is run-on, buyout or a combination or staged approach – should be considered alongside the company’s wider capital strategy. The objective should be to understand how any funding surplus might best be deployed to assist in the preferred strategy for the scheme. 

As with most DB pension related matters, there is almost certainly value in engaging with the trustees early and proactively. Whether to make a surplus return payment remains a trustee decision and TPR has emphasised the importance of constructive engagement between trustees and employers when considering surplus release. Sponsors who have built a track record of transparent engagement with their trustees may therefore be better positioned when surplus release becomes a realistic prospect.

For an owner approaching an exit, that history of constructive engagement is likely to prove valuable in and of itself.

What should acquirers, investors and employers do now?

The first step is not to aggressively pursue a surplus return payment. Instead, it is to establish whether there is realistically something to pursue. That means understanding the scheme’s current funding position, its investment strategy and whether there is an endgame strategy in place already for the DB scheme and, if not, what the options are for one. 

For an acquirer or investor conducting due diligence, it means moving beyond the traditional question of “is there a deficit?” and asking instead:

• Is the scheme in surplus, and on what basis?
• How much of that surplus could realistically become distributable to the company?
• What would need to happen for that value to be realised?
• How much would be left after tax and an appropriate prudential buffer?
• What is the likely timeline, and how are the trustees expected to approach a request for surplus release?

The emerging value of DB surplus

The UK DB market has spent much of the last two decades focused on eliminating deficits and managing risk. That focus is not going away entirely, but the funding strength of many schemes means that a different issue is now emerging.

For employers, surplus may become a source of capital value rather than a stranded reserve. For private equity investors, it may form part of the value-creation and exit story. And for M&A teams, the central question is becoming: who captures the benefit of value that has historically been treated as locked inside the pension scheme?

The new legislation does not turn every DB surplus into cash. Nor does it eliminate the complexities of trustee discretion, tax leakage and long-term funding risk. But it does change the conversation, and the acquirers, investors and employers who engage with it earliest are likely to be better placed to understand and capture any value that can ultimately be realised.