The covenant of defined benefit (DB) pension schemes is the ‘underpin’ to any surplus release strategy under the changes proposed in the Pension Schemes Bill, according to PwC partner, Atul del Tasso-Dhupelia.

Speaking during a Society of Pension Professionals (SPP) webinar on the use of DB surplus in run-on, del Tasso-Dhupelia described the covenant as “the ultimate backstop” if things go wrong or not as expected during surplus release.

He stressed that for trustees to agree to a run-on surplus strategy, they will need a sufficient level of covenant strength, visibility and downside protections.

He warned, however, that the type of covenant required is very different from the arrangements that have supported deficits over recent decades.

Therefore, del Tasso-Dhupelia urged trustees to see the covenant not as a blocker but as an enabler, highlighting that many current frameworks, designed for deficit recovery, may need to be reshaped under the new regime.

“The majority of covenants are in-scope and have the potential to support a surplus release strategy,” he said.

“We’ve done some research looking into the population of schemes and, if you assume schemes are well funded, the level of covenant required to support run-on for surplus could be provided by existing sponsors," he explained.

"However, the majority of these will need a degree of optimisation, refinement and reorganisation.”

He added that, in some cases, the current group structure might not be able to support surplus run-on, while the funding threshold set out in the new regime would have a direct impact on the level of covenant protections required.

For example, he said that the introduction of a low-dependency threshold could increase the number of schemes with insufficient covenants.

Against this backdrop, del Tasso-Dhupelia underlined the importance of ongoing integrated monitoring frameworks, describing them as a “key protection” to allow surplus release in the future.

He concluded that not tweaking the covenant correctly at the outset could have “large consequences" later down the line.

The comments follow the government’s proposals within the Pension Schemes Bill to broaden the rules on surplus extraction, enabling DB schemes to release funds to sponsors and members under certain conditions.

The reforms have been welcomed as “bolder than expected” by parts of the industry, with many stressing the potential to make better use of the significant surpluses now reported across the sector.

Indeed, recent analysis has shown that DB schemes are reporting record levels of surplus, with around two-thirds of schemes in surplus and an increasing number fully funded on a buy-out basis.

However, industry bodies have also urged caution, emphasising the need for safeguards to ensure member security is not compromised.

The Association of Professional Pension Trustees (APPT), for instance, has argued that surplus release should only be permitted in schemes that are demonstrably well funded, with trustee consent, independent actuarial certification and strong oversight from The Pensions Regulator (TPR).

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