Comment:
Trustees - Keeping Risks within Bounds

by Robert Thomas

But boundless risk must pay for boundless gain - William Morris

There is no wisdom in waiting when danger outweighs hope and it is the part of wise men to preserve themselves today for tomorrow and not risk all in one day - Cervantes

Most people become trustees in the belief that they will be guardians of a good cause. It may not be apparent at the outset that trusteeship is an inherently risky role. If that were not so, OPDU would not be needed.

Of course, much can be done to reduce risk and to manage it. But risk will not go away entirely. The first thing for trustees therefore is to recognise the risks where they exist.

There is no doubt that the risks to trustees have increased in the last decade. This is partly due to the increasing burden of regulation and compliance, so that there is a greater than ever chance of mistakes or omissions being made. What is more, they may be noticed and brought to the attention of the authorities. The modern culture of complaint is also to blame, because consumers are publicly encouraged and have a free ride to lodge either genuine or vexatious complaints.

One of the realities for trustees is that they have to make decisions in the knowledge that they may be challenged in the future. Hindsight is wonderful. Trustees cannot be certain that their decisions are bomb proof although they can do much to ensure that their decisions will withstand a challenge.

I look at some of the risk areas for trustees.

Investment

The financial aspects lie at the heart of a pension trust, which exists solely to deliver the benefits. In defined benefit schemes trustees are often in a dilemma between the long term funding objectives and the imposed short-termism of the Minimum Funding Requirement.

All the regulatory trends - especially the MFR in its present form and in whatever form it is replaced, and the new company accounting standard FRED 20 - are tending to force trustees and employers to be more risk averse in the short term, which implies a reduced tolerance of volatility. The long term implications for defined benefit schemes - if they are not closed by employers - are higher costs and an increased likelihood of ongoing funding objectives not being achieved.

Given these conflicting constraints, the trustees' decision about the scheme's strategic investment benchmark outweighs all others in importance. The choice of investment management arrangements and the managers themselves requires care and advice but is of second order.

Defined contribution schemes and AVCs carry a different set of risks for trustees, because they and they alone must choose and monitor the investment providers and the range of investment options offered to members. The scope for future disappointment about investment performance and complaint by members is incalculable, leaving trustees open to dire charges of mis-selling and scandal.

The Myners review has thrown into public debate the issue of how trustees handle decisions about investment by casting doubt about the knowledge and capability of trustees.

Administration

This is the second area of trustees' delegation and is just as important as investment. Trustees have in the past underestimated the risks to them from maladministration or from the simple mistakes of administration which will inevitably happen. These include regulatory lapses, misallocation of contributions and miscalculation of benefits. Putting matters right after the event, especially in defined contribution schemes, can be a nightmare.

Discretions

Decisions by trustees are increasingly challenged, partly because the amounts distributable on the death of a member have increased but also because the domestic circumstances of a deceased member are sometimes complicated. Another fraught area for trustees are ill-health pensions in schemes where trustees have the power to grant them under the rules and ill-health is not clearly defined. There is no substitute for extreme care in the exercise of discretions. If trustees ignore relevant facts or seriously misconstrue rules or simply come to a perverse conclusion, then they will deservedly be in the firing line.

European Law

The judgements handed down in Strasbourg have given trustees many headaches and left a trail of unresolved problems. The issues are primarily the equalisation of benefits for men and women and the related question of the rights of part-timers. Some of the problems in the UK arise from the complications of our bizarre system of contracting out, which the European Court does not see as its affair. But the UK authorities have made no attempt to assist trustees over these issues.

The problem affects ongoing schemes but is felt most acutely when trustees are winding up schemes. Trustees are often advised to delay the winding up until legal uncertainties are removed. At the same time they are under pressure from scheme members and at the receiving end of ignorant political criticism for not having completed the winding up.

Trustees have to consider the best interests of the generality of members in a priority class, which are usually to proceed as quickly as practicable with the winding up. This may mean trustees having to take a practical view of a problem, but it then exposes trustees to the risk of challenge by members in the event of a retro-spective ruling on a principle or clarification of a technical point. The difficulties of schemes in winding up is a subject in itself.

Divorce

I mention this because it is topical. Trustees have to accept pension sharing orders from 1 December 2000. At the time of writing trustees of many schemes are battling with the complexity of this overriding legislation. Trustees have options, but not the option to do nothing.

The issues are the fiduciary duties of trustees, if any, to ex-spouses and the administrative complications to the scheme. Do the trustees wish to accept internal transfers and to establish a new class of member? Without labouring this question on which there are different views, one can only stress the importance to trustees of taking legal and investment advice. The mis-selling risk is material.

The new Human Rights Act is sure to generate new challenges to occupational pension schemes, either to the rules or the structure of schemes, or to the decisions and actions of trustees. More issues raising similar risks to trustees as there are with pension sharing on divorce are on the way.

No new lessons...

What then are the lessons for trustees?
In a real sense the old guidelines still apply, but are even more imperative today. Trustees must demonstrate process, exercise due care, allow sufficient time for consideration and discussion, take all necessary advice and properly record their decisions. Mechanisms must be in place and monitored for trustees to be confident that what has to be done by way of compliance is done and on time. Where members' queries arise, trustees need to be sure that they are dealt with as fully as possible before they become complaints.

When complaints are made and the formal internal disputes procedure is used, it is vital that the initial response is the right one and the complaint is fully examined. In large schemes where the trustees are not able to handle every complaint at the start or every discretionary decision, exceptional care must be made in articulating the delegation. One has no wish to make work for the Ombudsman or Opra or the Courts.

Crossing the road

Trustees who are thorough and disciplined should not be too pessimistic about the downside risks, but should be conscious of them, like the prudent man crossing the road. Some people prefer the analogy of walking through a mine-field but that is an overstatement. However, unlike in William Morris's The Earthly Paradise trustees' risks must be bounded. Trustees do need a sense of self-preservation and danger should not outweigh hope or reason.

Robert Thomas is a director of Law Debenture, and is a full time professional trustee of pension schemes. Robert trained as an actuary, and then pursued a career in investment management.

Since joining Law Debenture six years ago, Robert has gained his fellowship of the PMI. Robert represents Law Debenture on the pensions committee of the Association of Corporate Trustees, and is a regular writer on pension scheme trusteeship.