OPDU Report 26 October 2009

Advisory Service Forum
The Role of Insurance in Protecting Pension Trustees, Pension Schemes and Sponsoring Employers
Jonathan Bull

Managing Risk

It is important that pension schemes are effectively governed which also will assist in reducing the potential exposure to claims. A risk management review can assist in this respect as it should identify, evaluate and manage the significant risks to the pension scheme and assess 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 also demonstrates the importance of the accuracy of data and it is recommended trustees ensure that regular data health checks are undertaken. These procedures will help reduce exposure to risk and limit the potential liabilities of trustees.

Potential Exposure

Trustees and schemes face a multitude of risks and the responsibilities of a trustee are onerous. Insurers are seeing a general increase in the notification of claims as well as an increase in litigation. These increases stem from the greater potential for mistakes to occur which amount to a breach of trust, statute or maladministration. This is due to the proliferation of legislation and regulation as well as the inevitable uncertainties as to how the Pensions Ombudsman and the courts will decide matters. Liability for breach of trust is a personal liability and a trustee is liable to both the scheme beneficiaries and to scheme creditors. Professional advice should be sought when appropriate and failure to do so may in itself be held to be a breach of trust. If trustees are uncertain as to how to exercise their powers, they can also apply to the court for directions (see under: Court Applications).

The risk is potentially greater after a winding up when 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 the Pensions Act 1995. Fines for individuals range up to £5,000 and for corporate trustees £50,000. 

Protection: Exoneration & 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.  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.  Also such clauses cannot include liabilities for investment issues and civil fines and penalties. More importantly, 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 thus protecting the assets of the scheme and company as well as affording personal protection to individuals while at the same time covering claims that arise from negligence.

Insurance Protection

Insurance is therefore playing an increasingly important role in protecting pension funds which is also evidenced by the recent experience of claims. The purchase of a properly drafted and comprehensive insurance policy can be a cost-effective means of protecting members benefits, individual trustees, the sponsoring employer, pension managers and internal administrators from losses resulting from claims, be they well-founded or not. The view has also been expressed that any scheme in deficit may be under an obligation to consider insurance.

If the decision is taken to adopt insurance, 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. As a trustee, however, there is an overriding duty owed to the scheme beneficiaries which is paramount. Accordingly, it is not recommended that reliance be placed upon a Directors & Officers policy of insurance as the cover will not be tailored to meet the specialised requirements when dealing with pensions and potentially there will be competing calls on the policy.

To be of value, 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 the pension scheme. Accordingly, the sponsoring company should also have the benefit of cover which should include cover for any indemnities that might have been given thus helping to protect the company’s balance sheet.

Loss Policy

In considering such insurance, the fundamental concern is as to the nature of the insurance cover being offered.  Insurance can either be based on legal liability or loss. 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. However, 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 scheme 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 internal management 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 scheme, it is sensible to verify also that costs or liabilities, which fall to be paid out of the scheme's assets, can form claims on the insurance policy. The following should be included:

• Trustees 
• Sponsoring Employers
• Corporate Trustees 
• Internal Advisers
• Directors of Corporate Trustees
• nternal Administrators
• The Pension Scheme
• 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. Some policies do not afford cover for separate representation although there may be clauses providing for severability of facts and knowledge.

What should be covered:

• Errors and omissions
• Full severability of cover
• Maladministration  
• Individual representation
• Employer indemnities
• Retirement cover – 12 years
• Exonerated losses
• Public relation expenses
• Regulatory civil fines and penalties
• Costs re investigations by regulatory
• Ombudsman awards authorities
• Mediation & Arbitration
• Fidelity/pension crimes
• Defence costs
• Extradition proceedings
• Litigation costs 
• Court Application Costsn
• Prosecution costs
• Third party pursuit costs

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.  Accord-ingly, it is important to check thatthe position of retired trustees and pension managers is properly protected.  The solution is for retired trustees to 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. Cover is available for 12 years in this respect from the date of expiry of the main policy of insurance.

Court Applications

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. Insurance can be obtained to cover these expenses which do not necessarily involve a legal liability upon the trustees but the scheme will usually be responsible for the legal costs of all the parties involved. There have been several high profile cases involving costs in excess of £1m which have had to be met from pension scheme funds. (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).

Limits of Insurance – DB and DC

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 unless the limit is increased sufficiently.

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. Regrettably, errors can still occur even in the best managed schemes and  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 in this context 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; 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. In any event, the trustees have an overriding duty of care to the members and must oversee the operation of the scheme.

Conclusion

Most trustees will wish to take advantage of all the protections available to them and therefore to have the benefit of exoneration clauses, indemnity provisions and insurance. In addition, effective risk management procedures can play a significant role in minimising liabilities and also should be favourably taken into consideration by insurers when assessing premiums. Many trustees and sponsoring employers now do appreciate the financial comfort that an appropriately structured insurance policy can provide to the assets of the scheme and company as well as giving protection to individual trustees. Existing trustees and potential candidates for trusteeship should not be deterred from playing such a vital function if the above measures are adopted.

Jonathan Bull
Executive Director
OPDU Limited
020 7204 2432
jonathan.bull@opdu.com
www.opdu.com