Advisers will often act as adviser or trustee to occupational pension schemes. However, there are risks that they should be aware of says Jamie Ricketts
Traditionally IFAs have been involved in pensions from both the personal and corporate angle. For many IFAs, advising companies on their scheme, either as a trustee or solely as an adviser, has been a means of adding value to a client and a relatively safe and stable source of earnings.
However, over the last few years the pensions landscape in the UK has changed significantly and these changes affect IFAs in a number of ways.
Many of these changes have been regulatory and have, in some instances, increased the risks faced by IFAs, either in their role as advisers or trustees. The pensions arena is evolving fast; pensions shortfalls, scheme specific funding, introduction of the Pensions Regulator and Pensions Act 2004 have not only contributed towards an ever more challenging environment, but have also placed a range of new burdens and responsibilities upon trustees and advisers.
This is coupled with changes in the socio economic environment. The demise of final salary schemes and scheme underfunding has been coupled with reduced state pensions, lower annuity rates and increased longevity. Many consequently face lower incomes and standards of living in retirement than they anticipated. Also, as a society we are becoming increasingly litigious, people are not afraid to take legal action if things go wrong; the responsibilities of trustees and advisers have therefore never been greater.
Most recently we have seen a real growth in pension scheme related fraud. Indeed, in the last ten years, some £75 million of fraud, of different types, has been detected. Concealment fraud involves an individual receiving the pension of a deceased person. Trustees must protect the assets of the scheme - if the fraud occurs through failures in the administration process, they are liable.
As in other areas, identity theft is growing fast. Over the past ten years, 36% of people paying into a private sector pension have moved house and failed to inform the provider of the new details. This puts the member at risk of their pension details falling into the wrong hands. If administrators fail to adhere to the stringent identity check procedures, this again can put trustees at risk, as it is a failure to protect the scheme's assets.
Despite the existence of the Fraud Compensation Fund, if fraudulent behaviour is directly attributable to the trustee or administrator, or if it is a result of maladministration or failing to adhere to the scheme rules or requirements of the law, the trustees will be joint and severally liable.
Nonetheless, many advisers fail to appreciate the extent of the risks faced. Only 15% of pension schemes currently purchase professional trustee liability insurance - insurance that covers both trustees and the sponsoring employer from claims arising from the scheme members.
So what are the risks?
Trustees are at risk if they are deemed to have committed a 'wrongful act'. This encompasses an extensive range of actions, such as: a breach of duty; neglect; error; maladministration and misstatement.
Claims are made if:
- The trustee has failed to pressurise the sponsoring employer enough to rectify any scheme deficit through increased contributions
- Not selecting the most prudent companies to work on behalf of the scheme, such as investment managers or auditors - with even the biggest brands in fund management suffering from bouts of poor performance there is little room for error.
- Trustees amending the rules of the scheme, but not informing members of the change, leaving them with lower benefits than they were expecting - communication is key, and yet it is often unintentionally neglected, leaving trustees exposed.
Many trustees make the error of believing that the closing of a scheme means a reduction of their liabilities, in fact, the opposite is true. There are a number of reasons for this:
- When a member is notified of the intention to close a scheme, they will closely scrutinise their benefit statements which increases the likelihood of them noticing an error and making a claim against the trustees and pension scheme.
- The Trustee Act 1925 rules that trustees must advertise when a scheme is to be wound up, which increases the chance of claims from missing members.
- New trustees may also be appointed at wind up, which means that past errors often come to light.
So how can trustees and advisers protect themselves against such claims and also against the legal cost of fighting these claims? The type of protection required will vary depending on both the nature of the scheme and the trustee's situation, and trustees should ensure that the cover purchased offers them adequate protection, as well as the sponsoring employer.
Trustee liability cover - provides indemnity cover for trustees of ongoing pensions schemes (also providing cover for the scheme itself and the sponsoring employer). With this, trustees are protected from the aforementioned 'wrongful acts' and may cover direct financial loss as a result of a dishonest act by a fellow trustee.
Run-off cover - this provides an indemnity to trustees of wound up pension schemes and can run for up to 12 years in the future and be backdated to the time when the scheme was established in order to provide complete peace of mind. With it, trustees are protected from acts of negligence committed in good faith.
Overlooked beneficiary cover - provides indemnity to trustees of wound up schemes for having unintentionally overlooked a scheme member or a period of their pension entitlement The cover runs for a period of 15 years and limits the range from £100,000 to £10,000,000, though higher levels of cover are available.
The cost of the insurance is dependent on many factors. For trustee liability insurance annual premiums start around £1,000 for £1 million cover for a small scheme of £2 million fund size. Cover for a larger fund of >£250 million costs around £11,000 for the same level of indemnity, though if required, cover of up to £10 million is also available.
The cost of run-off and overlooked beneficiary insurance ranges from around £10,000 for a smaller scheme with a £1 million limit and six years duration, to £75,000 for a larger scheme.
In short, trustees and advisers should always carefully consider the risks that they face in their role. These should be discussed with the sponsoring employer and the trustee has a right to ask for a reasonable amount of protection in return for the service they are providing.
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