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OPDU Report 27 June 2010 - Annual Risk Conference Special Edition Insurance: How to protect yourself, the
Scheme & the Sponsoring Employer
The issue of protecting trustees from liabilities has become particularly topical following the various headlines reporting the liability of trustees including the cases involving the incorrect authorisation of unsecured loans to sponsoring employers. Also last year, in the ES Group Pension Scheme determination, the Pensions Ombudsman found several breaches and the trustees were personally liable to pay in excess of £500,000. While such cases will be assessed on their individual facts, insurance is nevertheless playing an increasingly important role in protecting pension funds as evidenced by recent claims. The responsibilities of a trustee are onerous and claims experience demonstrates that errors can occur even in the best managed schemes particularly in the increasingly dominant environment of defined contribution schemes. 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 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. Limited 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. 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. Exoneration clauses are also subject to several other limitations 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. More importantly why should a pension member, who has a valid claim, be defeated by a legal technicality i.e. an exoneration clause. Wider Protection: Insurance Insurance, however, is available as an external resource of protection and should stand in front of such indemnity and exoneration clauses. 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. 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 (D&O) 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. Furthermore, D&O policies will often contain an exclusion for any acts or omissions while acting as a trustee or administrator of the pension scheme. 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 scheme, 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 following should be included:
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. 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. How the Policy is triggered?
What should be covered
Some elements of cover will be termed “Extensions” but in practice they may form part of the main policy without an additional premium. Alternatively, they may only be effective if specified in the Schedule and an additional premium has been paid. Accordingly, it is important to check the position. Trustees should also check that they have cover in relation to the new data protection powers that were introduced in April which enable fines of up to £500,000 to be imposed for serious breaches of the Data Protection Act. The policy of insurance can be paid for by the company or from scheme assets but if the latter, there must be an express power within the deed and rules to do so. As previously mentioned, it should also be noted that if trustees do purchase insurance utilising scheme assets, then the insurance cannot cover civil fines or penalties. In these circumstances, it is usual for the sponsoring employer to pay for this element of cover. It is also perhaps worth noting that the OPDU Elite policy is a “claims made” policy which means that there is potentially cover for claims made against the OPDU 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 joining OPDU membership. In addition, a trustee’s exposure does not cease when they retire and their post retirement situation may make them particularly vulnerable. It is important, therefore, to check that the 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. (OPDU Elite provides 12 years cover from the date of expiry of the main policy of insurance thus giving valuable peace of mind). 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 expenses 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 Experience The value of insurance cover is, however, probably best demonstrated when it comes to claims which can affect even the best managed schemes. No trustee wants to be in the position of facing a claim by a scheme member, the employer or even the scheme itself. Having an awareness of the common pitfalls is one of the most effective ways of avoiding just such an eventuality. Insurers are seeing a general increase in the notification of claims as well an increase in litigation. OPDU’s own claims experience has seen issues which have involved individual claim sums of up to £20m 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 healthchecks are carried out. This issue has also been brought to the fore recently with The Pension Regulator’s tougher approach on poor record-keeping and its Consultation Document issued on 2 February. The following areas, for example, are currently giving rise to problems: Calculation Errors 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 which they may look to the Trustee or Administrator to pay. 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 Cover within their policy of insurance to protect themselves against such an eventuality. Another notification related to the equalisation of benefits which is likely to be resolved shortly by way of court determination. A number of members had complained that the sponsoring employer had not implemented this decision correctly and were seeking to recover about £15 million in benefits from the scheme. The investigation costs that have been incurred by the Trustee’s lawyers in negotiating with the employer and the members have been considerable. Investment Losses Perhaps unsurprisingly in the current economic climate, there have been a number of notifications involving an allegation of “investment loss” against Trustees. Whereas in previous years, a delay of a couple of weeks by the Trustees and/or Administrator in transferring funds out of a scheme may not have given a Member any particular cause for concern, those same delays against a backdrop of dramatic falls in share prices can have far more serious consequences. Similarly, potential claims have arisen out of an allegation that the Trustees failed to “de-risk” the Scheme quickly enough (by reducing exposure to equity and property investments) following the onset of the financial downturn in 2007, and claims by members that they were not made aware of the risks attaching to some of the Scheme’s investments which were, in effect, “mis-sold”. Amendments to Scheme Documentation When making changes to scheme benefits, the effect of a failure to correctly amend documentation can 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). 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 of course 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 which are currently giving rise to problems for Trustees. Also with the continued growth in defined contribution 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. Conclusion Many trustees and sponsoring employers do appreciate the financial comfort that an appropriately structured insurance policy can provide to the assets of the scheme and the company. In addition, it provides protection to individual trustees while being of ultimate benefit to members. Importantly, effective risk management procedures can also play a significant role in minimising liabilities and such procedures should be favourably taken into consideration by insurers.
Jonathan Bull
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