BT will pay £600m in annual contributions either directly to the BT Pension Scheme or into a new co-investment vehicle from July 2023, in another sign that more sponsors are setting up special purpose vehicles and escrow accounts to ensure they have access to potential surplus funds.

 

Brightwell developed the solution together with BT Group as part of the 2020 valuation “to reduce the risk that funds which are not needed by the BTPS become trapped in the scheme”, a spokesperson told mallowstreet. 

 

From 1 July 2023 to 30 June 2030, BT will pay £600m a year either directly to the scheme or to a new co-investment vehicle, the scheme’s annual report shows. Funds invested in the new vehicle will be used to help build the scheme’s cashflow aware portfolio . 

 

If there is a funding deficit as at 30 June 2034, the co-investment vehicle will pay funds to the scheme, while any remaining funds in the vehicle would be returned to BT if they are not needed by the scheme when assessed by the trustee over the period 2034 to 2036.  

 

The £47bn fund was 91% funded in June 2022, with a deficit of about £4.4bn. The funding level reduced compared with 2021, when it was at 93%, which the scheme attributed to higher inflation expectations and lower than assumed investment returns. 

 

BTPS is not alone – NatWest will pay £471m of pension contributions into a new trust structure this year instead of the pension fund directly, changing a 2018 memorandum of understanding with the trustees, and Taylor Wimpey set up an escrow account in 2021 after the scheme reached full funding  on a technical provisions basis. 

 

 

Setting up special purpose vehicles or escrow accounts is a hot topic among defined benefit schemes, as employers are keen to avoid a trapped surplus, since repaying money directly from a pension scheme to an employer is taxed at a punitive rate and sometimes forbidden by the scheme rules. 

 

The aggregate surplus of the schemes in the Pension Protection Fund 7800 Index is estimated to have increased to £378.6bn at the end of April 2023, and the PPF funding ratio stood at 136.1%. High funding levels, perhaps coupled with an additional injection for a buyout, mean sponsors want to make sure any leftover money comes back to them.  

 

“One of my clients is in the middle of a buyout. They’ve done a second buy-in, and rather than have a potential trapped surplus under the schedule of contributions, we have an escrow account,” says Michael Clark, a professional trustee at Independent Governance Group. 

 

Although escrow accounts and SPVs are nothing new – Clark says he has been using escrows since the 1990s – they are being set up more given the current high funding environment. Some firms, like Zedra and Law Debenture, even offer escrow agent services, while Barclays is also active in the escrow market. 

 

The creation of a separate fund for avoiding surplus is normally driven by the sponsor, says Clark: “It's not usually trustees that come up with it. Any trustee, given the choice, would rather have the money." 

 

Accounts for avoiding a surplus are used for example where a derisking transaction is being targeted but the data has not be cleansed, he notes, as without knowing the exact liabilities and to what level to fund them, employers prefer keeping contributions outside the pension scheme itself. 

 

There are costs involved in setting up such vehicles, which Clark says should be taken on by the scheme sponsor. 

 

The investments in such accounts tend to be “fairly conservative”, he adds – for escrows they are mainly cash and gilts – to preserve the value of the contributions. Clark admits there is an opportunity cost but notes this is borne by the sponsor, who might need to make up any funding shortfall from low investment returns. 

 

 

Though a nice problem to have, for a scheme to be in surplus opens up countless questions, from who can decide how to use it, to how it can be divided fairly among different member groups if trustees do want to increase benefits beyond the required level. Sponsors are now also exploring other ways to use surpluses – checking for example if assets can be transferred to another pension scheme in the group, or if individual members can be moved to an overfunded scheme.  

 

Emma King, a partner at law firm Eversheds Sutherland, says there has been a definite increase in pension funds setting up escrows. Her firm has also been contacting employers to remind them to check their pension scheme’s funding level, as some might not be aware by how much defined benefit funding levels have risen. 

 

Others are only too aware of the risk that money could be left in the scheme. “I've seen a sponsor thinking about it when the scheme was not even at technical provisions,” King says. 

 

She notes that trustees, on the other hand, tend to want to wait with diverting contributions into an escrow until the scheme has at least reached full funding under technical provisions. 

 

The decision partly depends on how prudent the technical provisions are, she notes – if they are very prudent, it might only be a small step from there to full buyout funding. 

 

 

A key risk for trustees to bear in mind when funds are put into a separate account is company insolvency. King says trustees can get legal charge over the escrow, to make sure the  money does not fall into any insolvency estate.  

 

A charge “would usually give them protection of the funds in the account up to the amount of the section 75 debt”, says King. 

 

Trustees also have to be happy with the triggers. “Making sure that when they need the money... in whatever circumstance, whether it's insolvency or whether they want to move to buyout, that they are going to get access to it” is crucial, she says. 

 

There are different types of structures available to those who have agreed for contributions to be paid into a separate account, but which one is better? 

 

Whether schemes use escrows or special purpose vehicles largely depends on what the trustees and sponsors want the money to do, believes King: “Do you want it just sitting in an account with interest, or do you want something more sophisticated in terms of the investments and a custody agreement?” 

 

Tax considerations also come into play, which is why some sponsors created their SPVs as Scottish limited partnerships in the past, which are a separate legal entity. They are also taxed differently.  

 

However, SLPs have come under fire over money laundering and asset concealment in recent years. The government has introduced a bill to tighten rules around limited partnerships to tackle these issues, demanding among others that limited partnerships have a registered office in the jurisdiction of registration, and that its managers have a UK-registered office. The economic crime and corporate transparency bill was debated in the House of Lords last Thursday.