Pension buy-outs: trustee liability post winding up

Winding up a pension scheme means bringing the scheme to an end and closing the trust. During the process, the pension scheme’s assets, and liabilities, are either moved to another pension scheme or, more likely, are used to buy insurance products to provide benefits to members, and thus are bought-out. 

Many trustees see a buy-out and wind-up as the end of their responsibility, meaning they assume they are “off the hook” once members’ benefits have been bought-out and the scheme has been wound up. However, the reality is that there are always risks for trustees and the question is how best to mitigate those risks. 

Former trustees and past decisions of the trustees remain in scope for future challenge, subject to any limitation period protections in operation.

What risks remain for pension trustees once a scheme has been wound up?

In the context of winding-up, there are several risk areas for trustees which could potentially give rise to claims from former members of the pension scheme, even when members’ benefits have been insured and policies issued to members.

For instance, trustees will potentially remain liable for any errors in the benefits insured. Failure to insure the correct benefits, typically agreed upon within the benefit specification at the time of buy-out, will result in trustees remaining liable. In addition, liability in respect of missing beneficiaries, where benefits have not been secured at all, will also be retained by the trustees. 

Although there is statutory protection in respect of unidentified beneficiaries of the trust, this does not protect trustees against liabilities to identifiable but untraced beneficiaries of the pension scheme who later make a claim. The protection is therefore only in relation to truly “unknown” beneficiaries, not those who are untraceable or who have been overlooked through poor record-keeping. 

There is also risk related to the trustees’ decision to buy-out members’ benefits. This decision is of monumental importance and could be challenged if considered not to have been in the best interests of members or if the trustees have been shown to have acted improperly in any way. Other decisions around buy-out, such as the use of surplus, could also be open to challenge.

These risks of liability mean it is important for trustees to think ahead, identify where any issues could be raised and take action to protect themselves against these risks. 

What protections do pension trustees have against liability?

There will usually be existing protections for trustees under their scheme rules.

Scheme rules usually contain an exoneration clause which removes trustee liability for certain actions. If a trustee’s actions fall within the terms of the provision, they cannot be held liable. However, there are limits on what can be covered by an exoneration clause. For example, it cannot protect trustees in relation to fines from the Pensions Regulator and will not apply in cases of dishonesty. It is important to note that exoneration clauses apply to both current and former trustees and continue to apply once the scheme has been wound-up.

Most pension schemes also contain an indemnity clause which offers protection for trustees. Under an indemnity, a trustee remains liable for their actions, but the employer or the scheme will pay any losses or damages imposed on the trustee following a claim. Regulator fines and civil penalties, however, cannot be paid for out of scheme assets. 

Any indemnity from the scheme will cease to have any value once it has wound up given that there will no longer be any scheme assets. Trustees should therefore consider seeking a standalone indemnity from the employer to explicitly protect them post-winding-up.
This is because there is a lack of legal clarity as to when the clause may expire once the scheme is wound up. An indemnity clause from the employer in the scheme documentation may survive the winding-up process, but this is dependent on the wording of the specific clause.

As a general rule, directors of a corporate trustee are not liable for breaches of trust committed by the trustee company itself, even when they are directly involved in the breach. This is due to the “corporate veil” protection, which generally treats a company as a separate legal personality distinct from any individuals involved. 

Limitation periods may also provide some protection for trustees as they set a time limit within which legal proceedings must be brought. Different limitation periods apply depending on the type of claim being brought. 

Trustees are also protected by statutory discharges in circumstances where the insurer becomes insolvent. This means that the trustees would not be liable to pay the benefits, but only covers the benefits which are actually bought-out, and not benefits which trustees have in error failed to insure.

Gap analysis – trustee risk compared to liability protection 

Trustees should analyse where a particular scheme has gaps in protection, which gaps are higher risk for the scheme in question, and what additional protections can be obtained to cover these risks. 

Areas of liability that are not covered and therefore may create potential gaps include trustee defence and investigation costs, overlooked beneficiaries, poor record keeping and administration, fines and penalties faced by trustees, and the risk of indemnities not surviving wind-up. 

The two main ways of filling these gaps are via a standalone indemnity to ensure protection for trustees post-wind-up, and insurance that provides protection where a beneficiary has been missed or overlooked. 

Standalone sponsor indemnities are usually granted as a supplementary element to insurance and would only be expected to apply where the insurance does not meet the claim. The trustees will need to negotiate the terms of the indemnity with the company. 

The question of how favourable to providing a standalone indemnity a company turns out to be will largely depend on the bargaining position of the trustees. Negotiation points may include any limits of the amount of cover and period over which the indemnity will remain in force

Residual risks cover usually provides the most comprehensive level of protection for members. It would not cover trustee defence costs, but it is likely to reduce the risk of members bringing a claim against the trustees. However, residual risks cover involves a time consuming and expensive due diligence process by the insurer, which poses risk of any “skeletons” being dug up. Any material issues identified are likely to be excluded. As a result, residual cover will not always provide sufficient benefits to warrant the cost. 

Alternatively, run-off cover would also provide a strong level of protection for trustees, usually at a lower cost and without the same level of due diligence as residual risks cover. It could also protect trustees against defence costs. However, there would be more limits on the cover, including an aggregate liability cap, which could mean that trustees are forced to cover their own defence costs where claims exceed the cap or are otherwise excluded by the policy.