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The opdu Report - Issue 21, November 2006 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, which substantively came into force in April 2005, has significantly increased the potential liabilities of pension trustees and company directors and officers. It will necessitate trustees reviewing their existing practices and implementing new procedures to ensure compliance. Wide-ranging proactive powers have also been given to the new Pensions Regulator. Risk Management Trustees have a duty to monitor the management and administration of their scheme to make sure those providing services to them carry out their responsibilities properly. Trustees should therefore ensure that objectives and procedures that are appropriate to their scheme are identified and implemented. Managing risk also gives trustees the opportunity to embrace best practice and review external standards. There are many issues that can pose a potential threat to the security of scheme assets or members’ benefits and these risks may vary depending on the nature and circumstances of the scheme. However, it is evident that in applying a more risk focused approach to the external supervision of pension schemes, the Pensions Regulator will take into account the skills and knowledge of the trustees, as demonstrated by their stewardship of the scheme, including the effectiveness and appropriateness of the scheme’s internal controls and risk management systems. Members must be able to rely on their trustees to protect their interests and to strike a fair balance between the different groups of beneficiaries. Trustees must ensure proper governance and risk management. However, if trustees do not understand their scheme’s overall strategy and the attendant risks, they are less likely to ask the right questions to ensure that the appropriate strategy is accomplished. The significance of a pension scheme, in terms of assets under management, contributions and impact on the sponsoring employer and members, makes it essential for the trustees to review the overall risks involved particularly where the scheme’s funding may be coming under strain. The basic internal control objectives, however, do not differ as between different types of pension scheme. Successful risk management for pension schemes involves the trustees taking a positive role in the identification of scheme risks and the development of relevant risk management objectives. Once the trustees have identified the risks that are most relevant to them, careful management is required and trustees must determine and record their control strategy for each of the risks they have identified. Trustees knowledge and understanding The new legislation imposes a duty upon trustees and directors of trustee companies to be conversant with their own scheme documents and to have “knowledge and understanding” of funding and investment principles. In addition, trustees and trustee directors must also have knowledge and understanding of the law relating to pensions and trusts. The Regulator has issued various Codes of Practice. The Codes do not have the force of law but will be admissible as evidence and taken into account by any court, tribunal, the Pensions Ombudsman or the Regulator when deciding whether trustees have acted properly. It is likely, therefore, that trustees will have to successfully demonstrate their reasoning for failure to adhere to a specific code. The Codes of Practice give practical guidance on the levels of knowledge, training, experience and qualifications that trustees will be required to attain. Trustees will have to determine a level of knowledge and understanding that is appropriate for their own scheme and this will vary according to the individual nature of each scheme. Trustees serving on investment sub-committees are also likely to be expected to have greater knowledge of those issues needed to perform their role properly. However, it is not intended that trustees should be experts but they must have a sound understanding of the key issues involved in carrying out their duties as trustees. Nevertheless, it would appear that a professional trustee will still owe a higher standard of care than lay trustees. Investments The European Pensions Directive has also had a bearing upon the investment of assets within the Pensions Act 2004 and requires an investment function to be performed in relation to the “prudent person rule”. This will apply to both trustees and fund managers. The Pensions Act builds upon the framework set out in the Directive and replaces the existing prescriptive MFR with a scheme-specific approach. The above new provisions are intended to ensure that trustees acquire sufficient knowledge to make informed decisions and to be able to critically evaluate professional advice received. Nevertheless, it is of concern that good candidates for trusteeship will be deterred from standing which is contrary to the Government’s stated aims. However, this may not happen if sponsoring employers provide trustees with adequate time and training to perform their role effectively. In addition, many trustees and sponsoring employers now appreciate the financial comfort that an appropriately structured insurance policy can provide. Accordingly, insurance should be considered by all schemes and will play an increasingly important role in protecting pension funds as evidenced by recent claims experience. Insurance and Aspects of DC Trusteeship 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 has significantly increased the potential liabilities of pension trustees and company directors and officers. It necessitates trustees reviewing their existing practices and implementing new procedures to ensure compliance. Wide-ranging proactive powers have also been given to the new Pensions Regulator. The Act imposes a duty upon trustees and directors of trustee companies to be conversant with their own scheme documents and to have “knowledge and understanding” of funding and investment principles. In addition, trustees and trustee directors must also have knowledge and understanding of the law relating to pensions and trusts. The Regulator is issuing various Codes of Practice which will not have the force of law but will be admissible as evidence and taken into account by any court, tribunal, the Pensions Ombudsman or the Regulator when deciding whether trustees have acted properly. It is likely, therefore, that trustees will have to successfully demonstrate their reasoning for failure to adhere to a specific code. 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. 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. 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. In some instances, extensions to existing Directors & Officers 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. A combination of various forms of protection can be utilised but comprehensive insurance can be regarded as the ultimate safety net. 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 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 trustees may find themselves personally liable without any recourse. 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. Insurance, however, is available as an external resource of protection. 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 advisors and insurers on these issues. Cover for Retired Trustees Trustees’ 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). 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 are excluding 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. 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 which 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.
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