Choose your own adventure: How to make the most of pension surplus

With many corporate defined benefit (DB) plans seeing their funded ratios improve, questions about how to invest surplus assets are on the rise. Furthering the dialogue, several companies have used surplus in creative ways, including reopening plans with a cash-balance-type benefit, and others are tracking pending legislation in the US and UK that could provide greater flexibility in the use of pension surplus.

In this shifting landscape, we think plans have an opportunity to align their investment strategy with the objective they set for their surplus assets. To help, we’ve designed a framework with three possible paths (and a nod to the long-running “Choose Your Own Adventure” book series some readers may recall from their school days):

• Path 1: Hibernate the plan with the goal of maintaining the plan’s surplus
• Path 2: Maximize surplus for a specific use case(s) allowable under pension law while mitigating the risk of future deficits
• Path 3: Fund future benefit accruals by seeking a target surplus return to cover service costs and plan expenses

In this paper, we walk through each of these options, offering thoughts on what might make them a good fit for a plan and insights on best investment practices and potential outcomes based on illustrative case studies. In preparation for this research, we conducted an informal survey of plan sponsors about their current surplus objectives. While 22% selected the more traditional hibernation as their “top priority,” we thought that in this era of exit strategies and frozen or terminated plans, it was notable that the most common choice was to fund future benefit accruals (37%).

That said, plans choosing their path will need to consider...