Jonathan Bull looks at the protection provided by trustee and sponsoring employer insurance
Reasons to consider purchasing insurance
Liability for breach of trust is a personal liability and a trustee is liable to both the scheme beneficiaries and to scheme creditors. The risk is potentially greater after a winding up where there may be missing beneficiaries or other contingent liabilities and no assets. A trustee or trustee director is also potentially at risk of having to pay a civil fine for breach of pensions’ legislation. Fines for individuals range up to £5,000 and for corporate trustees £50,000.
As well as giving protection to individual trustees, insurance can provide cost-effective protection for the assets of the scheme and the company, thus ultimately benefiting scheme members.
Trustees and sponsoring employers of occupational pension schemes are also continuing to face challenging issues such as: RPI v CPI, auto-enrolment and scheme compliance, GMP equalisation, The Pensions Regulator’s focus on improving defined contribution schemes, data protection, pension liberation and a variety of pension de-risking exercises.
Through the management of claims and the receipt of notifications, insurers are well positioned to assess the issues that are proving particularly problematical as well as those that have resulted in claims with payments made.
It is important to try and avoid claims arising in the first instance and a risk management review is an important tool in helping to minimise the potential exposure to claims. It should identify, evaluate and manage the significant risks to the pension scheme as well as assessing the effectiveness of internal controls to determine whether they are suitable and adequate. Members can then be advised of this procedure on an annual basis, which should help to increase confidence in their pension arrangements.
Claims experience demonstrates that errors can occur even in the best managed schemes, particularly in the increasingly dominant environment of defined contribution schemes. The risks are also potentially greater after a winding up where there may be missing beneficiaries or other contingent liabilities and no assets. Accordingly, insurance is playing an increasingly important role in protecting trustees and pension scheme assets as it provides an external resource of protection.
OPDU is continuing to see an increase in the notification of claims as well an increase in potential litigation. Our own claims experience has seen issues that have involved individual claims sums of up to £20 million to date. One common feature is, as one would anticipate, the importance of the accuracy of data and we encourage trustees therefore to ensure that regular data health checks are carried out. The Pensions Regulator has also adopted a tougher approach on poor record-keeping.
The following issues have recently given rise to problems:
• Incorrect formulas used for calculating benefits
• Interpretation of Trust Deeds
• Overpayment of benefits
• Misapplication of scheme rules
• Seeking Court Directions
• Early retirement and ill-health disputes
• Rectification proceedings
• Accounting irregularities
• DC choices of investment funds
• Data protection issues
• Improper scheme amendments
• Pension Sharing Orders
• General administration errors
• TUPE issues
• Misrepresentations by trustees
• Transfer values
• Incorrect quotations
• Discrepancies between scheme documentation and administration practice
• Delays in transfer and payments of benefit assets
• PPF levy issues
• Equalisation issues
Amendments to scheme documentation
In particular, we have seen a notable rise recently in the number of issues relating to defective scheme amendments, with claims involving sums of up to £5 million to date from relatively small schemes with assets of less than £60 million. When making changes to scheme benefits, the effect of a failure to correctly amend documentation can therefore have serious consequences.
By way of example, in a case where the contractual documentation between the member and the scheme was amended, but the Trust Deed was not, the intended equalisation of benefits to age 65 was entirely ineffective. This meant that the scheme was obliged to pay benefits to members from age 60. The error did not come to light for several years with the effect that the scheme unexpectedly found itself facing an additional liability to its members in excess of £1 million.
In another notification involving the implementation of equalised benefits, the drafting of trust documentation was unclear and gave rise to two conflicting interpretations. On one interpretation, the scheme would have faced an additional liability of approximately £15 million to its members. Although there was no question in this instance of any wrongdoing by the trustee, the scheme had to incur significant legal costs negotiating with its members and entering into a court approved agreement. This case clearly illustrates the significant cost liabilities that a trustee is exposed to, even in circumstances where no actual claim has been intimated. (OPDU Elite provides an extension to reimburse such costs – it is important to note that this type of legal expense would not usually fall within the scope of ‘defence costs’ as defined in many insurance policies).
A continuing theme, both in past and current years, has been calculation errors. In terms of over-payments or over-quotations of benefits, a member is only entitled to compensation if he/she can demonstrate that there has been reliance on the error. Claims by members that they have relied on incorrect quotations to their detriment are common.
The member will often seek to argue that he/she would not, for example, have taken early retirement were it not for the over-quotation and that he/she should be paid the benefits as quoted on the incorrect statement. There is often a small additional claim for distress and inconvenience.
In the case of over-payments, it may not be practical or possible for the trustee to recoup the over-paid benefits from the member. This can result in the scheme suffering a loss.
In terms of under-payments, the trustee is under an obligation to correct the error both retrospectively and going forward. Whilst this might not necessarily give rise to a claim against the trustees, the errors themselves can still be extremely time-consuming to correct. This is particularly the case where the errors go back many years (15 years is not unusual in our experience). Where the errors originate from the administrator, there may be a meritorious claim against the administrator for losses suffered. The employer and/or the trustees should consider whether or not they wish to include Third Party Service Provider Pursuit Costs Cover within their policy of insurance to provide protection against such an eventuality.
Early retirement requests
Early retirement requests have frequently given rise to complaints by members that the trustees have exercised their discretion improperly. However, recent claims experience suggests that, where the trustees consistently approve such requests, members are more likely to believe that the ‘request’ is in fact a mere formality. This problem has reared its head more frequently recently as harsh economic conditions (and large-scale redundancies) have meant that trustees have been more likely to refuse early retirement requests.
Although the Trust Deed may make it absolutely clear that such requests are within the trustee’s discretion, that does not prevent a member from complaining to the trustee using the Internal Dispute Resolution Procedure (IDRP) and, if that is unsuccessful, to the Pensions Ombudsman. Whatever the merits, the members’ complaints can be time-consuming and expensive to defend.
Whilst it is never possible to eliminate the possibility of a claim entirely, the examples above may assist by illustrating some typical areas that are currently giving rise to problems for trustees. Also with the continued growth in defined contribution (DC) schemes, it is important to recognise that the trustees of such schemes face different legal risks and exposures from those of defined benefit schemes. DC trustees have ultimate responsibility for the accuracy of statements, market valuations and increasingly important, the selection and monitoring of investment vehicles offered. These factors increase the risk for claims occurring which has been borne out by claims experience.
Accordingly, insurance is playing an increasingly important role in protecting trustees and pension scheme assets as it provides an external resource of protection. By taking out insurance, trustees can be confident that they have protection against the liabilities that might arise in performing their duties while also giving members comfort that their interests are being looked after properly in preserving the fund assets which is particularly important today when deficits are common. If the decision is taken to adopt insurance, however, it is important to have a policy specifically designed to respond to the needs of trustees and other individuals involved in the management of pensions. This is highlighted by the potential conflicts of interest which commonly exist when a trustee is also a director of the sponsoring employer company with duties to the company and its shareholders. Accordingly, it is not recommended that reliance be placed upon a Directors & Officers (D&O) policy of insurance as the cover will not be tailored to meet the specialised circumstances relating to pensions and potentially there will be competing calls on the policy. Similarly, it is also very unlikely that a global policy of insurance will provide detailed cover sufficient to meet the potential liabilities under UK legislation and regulation.
Exoneration and indemnity clauses
Many trustees will have the benefit of clauses within the trust deed and rules exonerating them from liability and in many instances, an indemnity may be given by the scheme or the sponsoring employer company. However, it is not always appreciated that such clauses are subject to statutory limits. For example, an exoneration or indemnity from the fund cannot operate for any breach of trust relating to investments and it is also prohibited for the scheme to indemnify trustees for civil fines and penalties. A trustee or trustee director is potentially at risk of having to pay a civil fine for breach of pensions’ legislation. Fines for individuals range up to £5,000 and for corporate trustees £50,000.
It should also be appreciated that an indemnity from the employer would be of no value upon an insolvency when the trustees are still having to manage the scheme. Insurance, however, should stand in front of such indemnity and exoneration clauses and can cover civil fines and penalties provided that element of cover is not paid for from the scheme’s assets.
Exoneration clauses are also subject to several other limitations including not affording protection from claims involving third parties and they will always be construed restrictively by the courts. In addition, the problem with relying purely on exoneration and indemnity provisions is that they merely transfer any liability between the trustees, the beneficiaries and the employer. Moreover in today’s environment, trustees do not usually wish to rely on such legal technicalities when facing legitimate claims from members.
A trustee’s personal exposure does not cease when they retire and their post retirement situation may make them particularly vulnerable. Problems in pensions often take a considerable time after the event to materialise. Retired trustees should ensure that they have the guarantee of cover in the event that the scheme ceases to be insured. They can then rest assured that they have cover personal to them, irrespective of what the employer or trustees have done, or not done, about insurance since they retired (OPDU Elite provides lifetime cover for retired trustees from the date of expiry of the main policy of insurance thus giving valuable peace of mind).
Cover for claims
A frequently asked question is “Are we covered for past actions that were taken before the date that we take out insurance”? The answer is that trustee liability insurance operates on a ‘claims made’ basis, which means that there is potentially cover for claims made against the insured during the policy period irrespective of when the event giving rise to the claim occurred. Therefore, this is another reason to consider taking out insurance sooner rather than later to give protection for mistakes that might have already occurred in the past. However, this will be usually subject to not previously having had insurance and being unaware of the circumstance likely to give rise to the claim when purchasing insurance.
Separate discontinuance and ‘run off’ policies of insurance can be purchased to protect trustees once a scheme has wound up. Cover can be provided to protect trustees against loss for liability or defence costs arising from breaches of trust whilst the scheme was ongoing. Another relevant consideration is that there may be missing or overlooked beneficiaries who surface when all the assets of the scheme have been distributed.
As would be expected, the cost of trustee liability insurance varies according to the size of the scheme and is also dependent on several other factors including the limit of insurance and excess adopted. However, the cost starts at a few thousand pounds for a small scheme and an approximate indication of cost should be able to be obtained easily for any size of scheme without having to complete a full application.
Understandably, many trustees and sponsoring employers are now seeking the financial comfort that an appropriately structured insurance policy can provide to the assets of the scheme and company as well as to individual trustees. In addition, effective risk management procedures can play a significant role in minimising liabilities and should also be favourably taken into consideration by insurers.
Written by Jonathan Bull, executive director, OPDU