Turning pension surplus into a long-term asset | Insight Investment

Defined benefit plans have entered a new era of surplus, but what happens next is where the real opportunity begins. Surplus doesn't have to be a one-time windfall. With the right strategy, it can be a long-term asset.

After years of low interest rates and funding pressures, many plans now find themselves in surplus, driven by rising discount rates and strong equity performance. But before plans spend their surplus assets away, we believe they should think about managing them strategically on balance sheet to generate potential lasting economic value for both sponsors and participants.

That value can take many forms. Three examples are enhancing retirement benefits for future or past service, strengthening solvency, such as in the context of retiree medical or M&A, generating GAAP pension income while avoiding costly settlement charges. Innovative DB strategies are evolving to share risks and rewards more equitably, helping to ensure benefit security while still offering upside for plan sponsors and retirees.

We think managing surplus effectively starts with first principles. It's important to focus on ensuring benefit security and independence from future plan sponsor contributions, and then capturing affordable upside without overreaching. From there, it comes down to disciplined execution.

In our view, the essential elements include clarifying surplus objectives and implementing strong governance upfront, then monitoring risk to ensure progress towards those objectives. Second, defeasing benefits by investing a portion of assets directly against liabilities. This means hedging economic sensitivities to lock down the outcome, generating liquidity to pay benefits, and seeking to grow the assets by targeting a yield in line with the liability discount rate.

These three steps put your plan on track to secure the benefits it owes to retirees. Finally, you can comfortably focus on growing your plan's excess assets. Investing surplus requires balance.

Fixed income assets provide clarity, can deliver a degree of certainty, and can offer appealing yields. Return-seeking assets offer growth potential, but with more volatility. There's no one size fits all solution, so getting the balance right is key. That's where the right partner makes all the difference.

At Insight, our heritage and liability-driven investing, surplus management, and solution design means we are highly experienced in playing that role. Managing surplus isn't just about funding level, it's about unlocking value for your organization and the people who depend on it. With the right strategy, your planned surplus can be a long-term asset. If you're interested in discussing this topic further, please contact us.