Whatever you call it, a large number of DB schemes are working hard towards this target. There are, of course, alternative and credible options to buy-out for stakeholders to consider. But that is a conversation for another time. For most decision makers, a transaction with an insurer to secure members’ benefits remains a rock solid solution.

The challenge many schemes are now faced with is trying to make yourself stand out from the crowd. It is very much a buyers market, given the high demand. The size of that challenge is directly correlated with the size of your scheme. Smaller schemes – and by smaller, think less than £100m – are finding it increasingly difficult to secure deals versus 12 or 18 months ago. There are still opportunities out there and there are a handful of insurers very active in this market. However, you could likely be one of hundreds of schemes in this arena trying to catch the insurers’ eye during their triage process.

The demand crunch means that schemes may need to re-think their timescale for executing a deal, and ‘tread water’ holding their position until space becomes available. There are obvious options to do this, like de-risking your investment strategy and monitoring market pricing to maintain your healthy funding position. However, that may be easier said than done. And if you still have some preparation work to do in the meantime, you are exposed to risk that the market moves against you (no matter how well hedged you think you are).

The most critical element is that these schemes, who have worked so hard to get close to being 100% funded and afford such a transaction, remain in a robust position to act quickly when the opportunity presents. The temptation may be there to put more money to the scheme to support that market readiness mentality.

Many sponsors of DB schemes are loathe to over finance, especially in a market where money is tight and doubly so when it may not even be necessary. As we all know, extracting surplus from schemes is currently difficult and tax inefficient from the company’s point of view. This is even despite the tax rate for surplus extraction reducing from 35% to 25% with effect from 6 April 2024. In a market where cash remains king, holding sufficient capital to fund a premium may be necessary in this competitive environment.

So, how can sponsors avoid overfunding? And at the same time, provide trustees with the financial security that money is guaranteed to be available for a successful transaction?

Unfortunately, I am giving no prizes away if you correctly guessed the answer as ‘escrow’. The title of this article was a relatively obvious giveaway.

I experienced the same sentiment when working with sponsors and trustees who were faced with the scenario described above; escrow was the obvious solution.

The sponsor would agree to allocate funds to an escrow with the explicit trigger being a release of funds to the scheme as and when needed to fund a shortfall for an insurance transaction. Any funds unused in the escrow after the successful transaction, would be returned back to the sponsor. As they are not being extracted from the scheme, they would not be taxed at the penalising rates as per earlier.

From the Trustee perspective the availability of funds in escrow provided tangible security that a transaction would happen. It can be used to strengthen your business case with the insurer when they are triaging your case. It provides greater security than a call over a bank account, or a corporate loan, which would need to be secured in the future. It directly increases the security of members benefits, both for now and for the future.

The legacy challenge with escrow has been their complexity and the costs associated in setting them up, meaning it was typically only a viable option for the larger schemes. However, this doesn’t need to be the case if the escrow is being used for a very specific circumstance and all parties are pragmatic in their approach.

With all current parties being very clear at the outset of how the escrow would be used – and importantly, what it would not be for – it allows for standardised legal terms to be prepared. A streamlined approach seems to be synonymous with smaller schemes in the insurance market; and escrow is no different.

This streamlined approach escrow means that it is far more accessible and affordable for schemes of all sizes. It can represent that ‘win-win’ solution for sponsors and trustees/members in these circumstances, and it may also help you gain traction with the insurers.

Alan Greenlees – Client Director, ZEDRA Governance

This article was featured first by ZEDRA here