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OPDU Report 24
- May 2008
Insurance is playing an increasingly important role in protecting pension funds which is evidenced by the recent experience of claims. However, before the Pensions Act 1995 most trustees relied upon exoneration and indemnity clauses to shield them from personal liability; but many trustees and sponsoring employers now 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. The view has also been expressed that any scheme in deficit should consider insurance. 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. Another consideration to be taken into account is the potential for the policy’s financial limit to be eroded by circumstances unrelated to the pension scheme. 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. 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. 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 indem-nities given from the fund assets. 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 tech-nicality 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. Insurance 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. 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:
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. 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?
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 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. 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. There have been several high profile cases involving costs in excess of £1m which have had to be met from pension scheme funds (OPDU 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 most 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. 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; 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. 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, pension
managers 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
insurers. 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 |
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