Rethinking escrow accounts: More than just cash?

Many DB pension schemes use escrow accounts as a way of bolstering security without immediately locking assets into the scheme. They're a useful tool, offering a balance between flexibility for the sponsor and comfort for trustees. Whether set up to support funding plans, provide contingent support in adverse scenarios, or help avoid the “trapped surplus” conundrum before an endgame, escrow arrangements are firmly part of the DB funding landscape.

You can read more about the role of escrows within DB funding here: LCP Contingent Funding Handbook.

Traditionally, the default approach has been to hold cash in escrow accounts. This makes sense: it's liquid, low-risk, and easy to administer. But with a more dynamic pensions backdrop, it’s time to revisit that default.

Cash is (finally) paying something again

For many years, ultra-low interest rates made holding cash a somewhat dull proposition: safe, yes, but yielding next to nothing. Now, with higher interest rates, even simple deposit accounts can deliver a return that’s not negligible. That alone has made cash feel more attractive again.

But should cash really be the end of the conversation?

Cash+ and beyond? Getting more from your escrow

In today’s market, there are options that can provide better returns without straying too far up the risk curve.

For some time, money market / liquidity funds have offered incrementally higher returns than pure cash whilst retaining a very low-risk approach – arguably even less risk than the single counterparty exposure of cash at bank. Going further, you can now consider other "cash+" strategies, such as the likes of short-duration credit, which might offer greater expected returns for a modest increase in risk and complexity. For schemes where the escrow account is expected to be in place for a few years, this could make a meaningful difference.

The key is that the escrow doesn’t necessarily have to just sit there, passively awaiting a trigger event. As the pensions industry grapples with topics such as use of DB surpluses, it’s worth trustees and companies reviewing the likely timeframe of any escrow holdings – it may be that other options better align with the scheme’s broader objectives.

Strategic use of gilts and other assets

Another approach is to think about how the escrow could hold assets that are useful to the scheme even before they’re formally released. For instance, gilts held in escrow could potentially align with the scheme’s long-term de-risking journey. If the escrow ends up transferring to the scheme, those gilts might slot straight into the liability-hedging portfolio. If not, they remain high-quality, potentially inflation-linked assets in the meantime.

For sponsors, this could be a way to manage strategic alignment between corporate capital and pension needs – using escrow as a kind of flexible bridge, rather than just a lockbox of cash.

Tailoring escrow to purpose

The most important thing is that the asset strategy within an escrow account should reflect its role. If it’s purely contingent support for downside protection, then security and liquidity might trump all. If it’s more about smoothing funding over a few years, there may be room for a bit more return. And if there’s a good chance it ultimately ends up in the scheme, it may make sense to hold assets that will be useful there.

Escrow accounts are a powerful tool, and with a bit of creative thinking, they can do more than just sit on the sidelines.