Escrow: An ideal solution for small schemes

Schemes that never expected to be fully funded suddenly find that they are, with many hundreds more very close. However, as with many things in the world of pensions, small schemes can still find themselves disadvantaged when it comes to the solutions available to them. To date, escrow has been no exception, largely due to the lack of affordable options at that end of the market. Happily this is now shifting and escrow is becoming an appropriate choice for small schemes and here’s why they should consider it.

An escrow is an arrangement whereby an employer places cash to a third party provider to hold, for any number of reasons. They are highly flexible arrangements and can encompass wide ranging trigger events that suit both the trustee and the employer. They can be used rather than paying contributions directly into the pension scheme keeping the assets potentially on the employer balance sheet and can be returned at the end of the arrangement if no trigger event has occurred. They also provide a simple and efficient solution where shortfalls may exist in a scheme, as well as preventing a trapped surplus.

In a journey to buyout, they can really come into their own.

Using escrow can materially improve the chances of a successful insurance transaction for a small scheme by demonstrating a clear funding strategy to finance a deal. For the sponsor, as well as mitigating the risk of trapped surplus, it also significantly reduces the likelihood of a future failed transaction.

Here’s how:

Mitigating the risk of trapped surplus

One of the significant benefits of using an escrow is the mitigation of the risk associated with a sponsor trapping surplus through over-payments into the pension scheme. In traditional setups, if a sponsor overpays, the excess funds can become trapped within the scheme, leading to inefficiencies and potential financial loss. Individual scheme rules would need to be assessed to understand who owns such a surplus. And any returns to the sponsor, assuming they are viable, would be taxed at a punitive 25%.

By utilising an escrow, sponsors can allocate funds with greater flexibility. If the actual funding requirements turn out to be lower than anticipated, the surplus funds can remain in the escrow, generating a return, rather than being locked into the pension scheme. Access to escrow funding will continue to provide financial security to the scheme in the meantime.

Attracting insurers in a competitive market

Feedback from insurers indicates that they view pension schemes with additional contingent funds held in escrow more favourably than those without. This is particularly important for smaller schemes trying to enter a congested insurance market. By having an escrow, these schemes demonstrate a higher level of financial security and preparation. In short, it is further conviction supporting a successful deal. Consequently, schemes with an escrow may find it easier to secure favourable agreements with insurers.

Generating returns

Funds held in an escrow are held in a designated client account, with the option to access a Money Market fund, if appropriate for the pension scheme. This feature might be beneficial for smaller pension schemes, who can retain their liquidity and access a better rate of return on the funds, allowing them to make the most out of their available resources.

The benefits are clear and there are scalable solutions available now streamlining the approach – using standardised terms to significantly lowers costs, the process can become more efficient and affordable for schemes of all sizes. Once again levelling the playing field for the smaller scheme and, crucially, providing best solutions and outcomes to all members, regardless of what size scheme they’re in.

How ZEDRA can help 

ZEDRA brings together its expertise in Pensions and the provision of escrow services to provide an escrow solution available to pension schemes of all sizes. Our streamlined service has taken out the complexities and cost traditionally associated with escrow.

The service is streamlined, cost effective and efficient to set up. It is accessible to schemes of all sizes and we can work with all of your existing advisers.

To find out more, contact Sue Wakefield or Alan Greenlees to discover how we’re already helping clients tackle this challenge.

ZEDRA escrow services are provided via Zedra Trust Company (UK) Limited.

Zedra Trust Company (UK) Limited is authorised and regulated by the Financial Conduct Authority, register reference 119184, including for the provision of payment services.