Pension Funds Online

Trustee Protection and Liability Insurance

The Pensions Act 2004 is intended to simplify the operation of occupational pension schemes while at the same time increasing the protection for members. However, the Act significantly increased the responsibilities of pension trustees and company directors and officers. Trustees must review their existing practices and consider implementing new procedures to ensure compliance. Wide-ranging proactive powers have also been given to the new Pensions Regulator.

Protection

In the past, most trustees relied upon exoneration and indemnity clauses to shield them from personal liability and some viewed insurance with a degree of scepticism. However, this position has dramatically reversed and many trustees and sponsoring employers now appreciate the financial comfort that an appropriately structured insurance policy can provide. Indeed judicial opinion has been expressed that trustees should seek such protection prior to undertaking their duties. Moreover, the Ombudsman and some commentators have expressed the view that consideration should be given to making insurance compulsory. In any event, insurance should be considered by all schemes and will play an increasingly important role in protecting pension funds as evidenced by the recent experience of claims.

Historically, there was a tendency for extensions to existing D&O policies to be given to cover trustee liabilities but this practice is not recommended. It is preferable 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 that commonly exist when a trustee is also a director of the sponsoring employer company with duties to the company and its shareholders. As a trustee, however, there is an overriding duty owed to the scheme beneficiaries which is paramount.

A statutory indemnity might be applicable but only if the trustee has acted honestly and reasonably and, in the opinion of the Court, ought to be excused for any breach of trust. This will be decided, however, after the event. In addition, 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 acknowledged that it is difficult to draft or amend such clauses in a way that ensures that they are 100% watertight. In the event of a claim, substantial legal costs may be incurred in establishing the position and a loss to the fund or employer may arise; or worse, the trustees may find themselves personally liable without any recourse. Furthermore, exoneration clauses operate to exclude the trustee from the relevant liability and as such they will only apply to claims made by a member and not claims made by a third party. There is also some doubt as to whether liability for breach of a duty in the Pensions Act can be excluded. Additionally, liability in relation to investment management cannot be excluded under Section 33 of the Pension Act 1995. This is likely to be considered to extend to any indemnities given from the fund assets.

Also 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. Furthermore, why should a pension member, who has a valid claim, be defeated by a legal technicality i.e. an exoneration clause. Insurance, however, is available as an external resource of protection and should stand in front of such indemnity and exoneration clauses. There have also been recent changes to the Companies Act 1985 which potentially have a bearing upon the indemnification of company directors. Although the intention of the legislation was to relax the previous restrictions on such indemnities being given, some commentators have suggested that, in relation to pension schemes, the new provisions might affect the validity of such indemnities in the form that they are currently granted. It is recommended that trustees consult with their advisers and insurers on these issues.

Insurance

A combination of various forms of protection can be utilised but comprehensive insurance can be regarded as the ultimate safety net. To be of value, however, it is important to ensure that any insurance policy provides effective insurance protection with cover at corporate and personal level for all the parties involved in the management of pension schemes.

In considering such insurance, the fundamental concern is as to the nature of the insurance cover being offered. Insurance cover can either be based on:

• loss or,
• legal liability

Historically, pension trustee policies tended to be based on legal liability being the trigger for claims. However, modern policies can be based on loss. The two cover quite different areas, with loss cover extending far wider than legal liability. The difference between the two types of insurance is that loss insurance would cover the fund for the loss that resulted from the trustees’ negligence even though the trustees had no strict legal liability to the members. Conversely, liability insurance would not meet any claim.

The distinction between loss and liability insurance is of paramount importance when considering whether or not to take out insurance, trustees will commonly be advised that insurance merely covering their legal liability does not in practice give them any additional protection. This is because they would in effect only be insuring against the risk of failure for some reason of the exoneration and indemnity clauses.

Conversely, loss insurance can be more valuable for the trustees, employer and members jointly. Although the trustees might not be personally liable they would know that the insurance policy would meet any claims that arose from negligence. Thus the trustees can give a higher level of comfort to members that their interests are being looked after properly in preserving the fund assets which is particularly important today when deficits are common. The members would have recourse (effectively against the insurer) if a loss resulted from negligence.

Who should be protected?

All those individuals involved in the administration of an occupational pension scheme should be covered by the insurance policy. Although there may be technical difficulties over the legal persona of the pension fund, it is sensible to verify that costs or liabilities, which fall to be paid out of the scheme’s assets, can form claims on the insurance policy.

The insurance policy should include protection for:

• Trustees
• The Pension Fund
• Corporate Trustees
• Internal Administrators
• Directors of Corporate Trustees
• Internal Advisers
• Sponsoring Employers
• Internal Dispute Managers

Therefore all parties should be entitled equally to the protection of the insurance so that it is not in the interest of any party to create a liability on the trustees purely to get the benefit of the insurance. This makes the cover much more valuable than pure legal liability insurance for the trustees only.

It is particularly important to ensure that the insurance policy provides for severability of cover for the individual interests so that even fraud by one of the insureds does not invalidate the cover for the other innocent insureds. In the event of a problem arising, individual trustees should be satisfied that the insurance policy will pay for their interests to be separately represented if appropriate and that they will not be overridden by the interests of the other parties covered by the policy.

What should be covered?

• Errors and omissions
• Employer indemnities
• TPR civil fines and penalties
• Exonerated losses
• Ombudsman complaints
• Litigation costs
• Defence costs
• Retirement cover
• Fidelity/pension crimes

Cover for Retired Trustees

In addition, a trustee’s exposure does not cease when they retire and their post retirement situation may make them particularly vulnerable. Accordingly, it is important to check that the position of retired trustees is properly protected. The solution is for retired trustees to have independent 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. The period of cover for retired trustees should be checked (opdu provides 12 year cover at no additional cost).

Trustees and pension schemes can also incur significant legal expense in going to court to seek directions or if they are joined by another party who is seeking the court’s directions. Reported examples include the High Court decision in the National Bus privatisation case with costs exceeding £1 million; the South West Trains case in which the pension fund paid £1.4 million in legal costs and the National Grid litigation in which the legal costs were thought likely to be in excess of £3 million. The introduction of pre-emptive costs orders for beneficiaries to challenge trustees has fuelled the position. Even the preliminary stage of deciding whether costs should be borne by the pension fund can be expensive. In order for insurance cover to be as valuable as possible, opdu provides optional cover for legal expenses incurred in these situations, which do not necessarily involve a legal liability upon the trustees.

Insurance Rates & Limits

Until recently, market rates for all classes of insurance were rising dramatically and the Professional and other Errors & Omissions liability sector particularly suffered. Various factors contributed to this situation including: significant claims payments; poor investment returns preventing insurers from subsiding underwriting losses from investment income; and a reduction in the number of insurance companies. In addition, some insurers reduced the limits of liability that they were prepared to underwrite while at the same time increasing the deductible (excess) to be borne by the insured. Underwriters have also become increasingly concerned about scheme deficits and some insurers have excluded cover for sponsoring employers as a result.

Consideration should also be given to the most suitable structure for insurance arrangements in instances where there are both Defined Benefits and Defined Contribution schemes with the same sponsoring employer. The differing nature of the risks could produce unintended complications if DB and DC schemes are insured under the same policy with a single limit of cover.

Claims

Defined contribution schemes have grown in number over recent years and 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. Claims experience has also demonstrated that mistakes in record keeping and data can be very expensive to correct. Other issues which may give rise to problems and potential liabilities include: the number and suitability of investment options offered – particularly any default option as the circumstances of member beneficiaries will vary considerably (the vast majority of members elect the default fund); inaccurate collection of contributions; communications with members; ownership of company shares and contributions not being paid into the correct fund. These factors and others should be regularly reviewed by trustees to ensure their continued accuracy and appropriateness. The trustees have an overriding duty of care to the members and must oversee the operation of the scheme.

Some typical recent examples of the subject matter of claims in which opdu has been involved are as follows:

• Incorrect formulas used for calculating benefits
• Interpretation of Trust Deeds
• Overpayment of Benefits
• Misapplication of Scheme Rules
• Seeking Court Directions
• Early retirement & ill-health disputes
• Rectification proceedings
• Accounting irregularities
• DC choices of investment funds
• 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

The issues have involved individual claim sums ranging up to £20m to date. Experience demonstrates the importance of the accuracy of data and it is recommended trustees ensure that regular data health checks are undertaken.

Conclusion

The purchase of properly drafted and comprehensive insurance policies can be a cost-effective means of protecting members benefits, the sponsoring employer, individual trustees and internal administrators from losses resulting from claims, be they well-founded or not. In addition, effective risk management procedures can play a significant role in minimising liabilities that should be favourably taken into consideration by their insurers. Also potential candidates for trusteeship should not be deterred from playing such a vital function if the above measures are adopted.