The opdu Report - Issue 12, May 2002

Insurance: Protecting Pension Funds
Jonathan Bull

In recent years the potential liabilities of trustees and their advisers have come into sharper focus. In this article, we examine measures which trustees can take to manage their exposure. These measures include liability insurance, practical and cost effective risk management reviews and legal expenses insurance.

Liability Insurance

Duties and Liabilities of Trustees
The post-Maxwell environment has brought a public focus on the management of occupational pensions with a proliferation of regulation in an increasingly litigious climate. Accordingly, the complexities of regulation have considerably increased the potential for non-compliance with costly consequences.

Trustees are legally responsible for managing the assets of the pension scheme which concept was firmly endorsed with the implementation of the Pensions Act 1995 imposing an array of offences punishable by fines and penalties. In addition to the Pensions Act, there is a whole new raft of legislation imposing fundamental changes to the way in which pension schemes are administered i.e. the Data Protection Act 1998 and the adoption of EMU.

The ease of access for complainants to the regulatory authority Opra and to the Pensions Ombudsman has also seen an increase in the number of claims the defence of which, regardless of their merits, involve time and expense. In addition, the rules on the allocation of legal costs often result in pension schemes having to subsidise these disputes making scheme assets vulnerable.

The above risks are even greater when complications arise such as company mergers or winding-up. Furthermore, the trustee’s exposure does not cease when he retires which may make him particularly vulnerable if there are missing beneficiaries or other contingent liabilities and the scheme has no assets and the company no longer exists.

How then can those involved in the management of pensions protect themselves, when their responsibilities include liability for the actions of others as well as their own?

Protection
A combination of various forms of protection can be utilised but comprehensive insurance can be regarded as the ultimate safety net. The Trustee Act 1925 provides a statutory indemnity 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.

Indemnity & Exoneration Clauses
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 which 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 trustee may find himself personally liable without any recourse. In any event, such clauses contained in the trust deed will only be effective as between the members and the trustees, they cannot provide protection against claims from third parties or regulatory action.

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. Insurance, however, is available as an external resource of protection.

Insurance
A solution can be found in providing trustees with their own independent insurance. Indeed, the last Ombudsman was reported as saying that consideration should be given to making insurance compulsory in order to protect the assets of the pension fund. Opra also requires members of its trustee panel to have appropriate indemnity cover in place at all times.

Today’s trustees need protection against the risks and costs associated with regulation and reputation as well as the risks of legal liability and trustees’ exposure does not cease when they retire - their post-retirement situation may make them particularly vulnerable.

In some instances, extensions to existing D&O policies have been 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 which 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.

To be of value, it is important to ensure that any insurance policy provides comprehensive insurance protection with cover at corporate and personal level for all the parties involved in the management of pension schemes.

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

Putting all the interests involved together as insureds should mean that conflicts can be avoided, for example, between the trustees and the pensions manager or administrator which could arise if only the trustees’ liability is insured and the pensions manager is not insured. The common interest should be to put up the best defence to any claim that is made and not to argue amongst the parties involved.

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
• Opra civil fines and penalties
• Exonerated losses
• Ombudsman complaints
• Litigation costs
• Defence costs
• Retirement cover – 12 years
• Fidelity/pension crimes

Cover for fines and penalties must not be paid for by the pension fund as this would be in breach of Section 31 of the Pensions Act 1995.

It is important also to verify whether the insurance will still respond where there is an indemnity, either from the scheme assets or from the employer.

It is very unlikely that any insurance policy would cover investment losses. However, it is possible for insurance to cover the net loss to the pension scheme arising out of a wrongful act, even where the trustees are exonerated.

Cover for Retired Trustees
As previously stated, trustees’ exposure does not cease when they retire. 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) as well as whether a separate premium is payable and, if so, by whom.

New Developments
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. Recent reported examples of substantial legal costs being incurred 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 £1.3 million in legal costs and the current National Grid litigation in which the legal costs are likely to be in excess of £3 million by the time it reaches the House of Lords.

In order for insurance cover to be as valuable as possible, opdu has developed optional cover for legal expenses incurred in those situations described above, which do not necessarily involve a legal liability upon the trustees. Otherwise there is potential for the pension scheme to suffer a “double whammy” i.e. not only is there an increasing chance of the scheme ending up in court but also of having to pay for the privilege by subsidising everyone else.

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. Moreover, there are an increasing number of instances in which trustees find themselves going to court to ask for directions or being joined by another who is seeking the court’s directions. In these circumstances, it is usual for the scheme to be ordered to meet the costs.

This is an extract of an article that was written for Professional Pensions

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Telephone: 020 7204 2400
Email: enquiries@opdu.com