Exoneration, indemnities, insurance and the art of sleeping at night: trustee and member protection on DB wind-up

Once a DB pension scheme is wound-up and the trustees have stepped down, it is meant to be the end of the road for them. The benefits are secured, and the trustees can finally switch off their pensions brain and get a good night’s sleep. Or can they?

Even after the buy-out has been completed, the “what ifs” can keep a retired trustee up at night. What if a member’s pension has been misunderstood or miscalculated? What if someone turns up with a long-lost piece of paper evidencing their entitlement to a pension or the law has been clarified entitling them to a different benefit than the one that has been bought out? What if the individual annuity policy doesn’t cover everything it was meant to?

If you’re a trustee or indeed sponsor, the goal is simple: make sure that when the scheme winds up, everyone involved can sleep soundly. And that means thinking carefully about indemnities, insurance, and how member benefits are protected, long after the scheme itself has disappeared.

Statutory protections for trustees

Legislation helps a bit. 

Trustees can benefit from a statutory discharge where the liabilities in respect of a member have been secured with an insurance policy. This is definitely reassuring, but does not get you all the way to a sound night’s sleep. If the trustees didn’t know about a particular benefit and so didn’t secure it, liability won’t be discharged. 

There is also protection against unknown beneficiaries crawling out of the woodwork at a later date if trustees place adverts to alert potential beneficiaries of their intention to wind-up the scheme. Again though, there are limits on the protection that this provides – it won’t get trustees off the hook in relation to beneficiaries that they should have known about but have overlooked because of, for example, poor record keeping. 

Finally, as a last resort, trustees can ask the court to relieve them from personal liability if they have acted honestly and reasonably, and ought to be let-off. However, there is an obvious drawback with this – it is at the discretion of the court so there are never any guarantees. 

Exoneration and indemnity provisions in the trust deed: a complete safety net?

Scheme rules will invariably have a form of indemnity and an exoneration clause, a comforting legal hug that says, “Don’t worry, you’re covered (unless you’ve been fraudulent or wilfully naughty)”. 

An exoneration clause generally says that no liability attaches a trustee if they have done something wrong but didn’t mean to. An indemnity provides the trustees with financial protection from either the scheme or the sponsors if it turns out there is something they are liable for but they were trying to do the right thing. 

The first chink in the  armour which both forms of protection provide is that they may not cover all potential liability. The second is that there is a legal question over whether or not they survive the trust being wound-up.

In addition, an indemnity from the scheme is worthless after a wind-up as there won’t be a scheme with assets anymore. 

That is why trustees will invariably ask for an indemnity from the employer before wind-up. From a sponsor point of view such an indemnity will need to considered very carefully – looking at things like notification and conduct of any claims and how it interacts with any run-off insurance. No employer wants to find that the run-off insurance does not respond when it should and the buck stops at the employer’s door. 

Trustee run-off insurance: extra peace of mind?

Run-off insurance is the “sleep at night” cover that trustees conventionally put in place to protect themselves against claims after the scheme has been wound up. All trustees want it. It is trustee liability insurance with a long tail: ten, even fifteen years. It covers the usual suspects: breach of trust, negligence, misrepresentation, maladministration, and, if you’re lucky, missing beneficiaries. It can give trustees a helpful layer of protection which isn’t dependent on the employer. 

A practical point: check the small print. Have you had advice on quantum? How are costs defined? What are the exclusions? How does claims handling work? 

Trustees should also be aware that the sponsor will have an interest in the provider, level of coverage and cost (even if scheme assets are meeting it) and how it will interact with any indemnity they have given. 

What about claims from members after wind-up 

We haven’t seen this yet in practice – but just imagine what this might involve: multi-million-pound claims and years in court. As a retired trustee in your deck chair on a beach, you really don’t want to be facing the worry of court hearings, the glare of the press and angry letters from members. Not to mention fears about who will be funding any solution and whether it will be your house. 

While trustees are understandably focused on their own protection, they also need to think about how any claims for benefits from beneficiaries would be satisfied. 

There is no substitute for doing a thorough job at the time of buy-in to make sure the insured benefits match scheme benefits. A full buy-out means each member gets an individual annuity policy. It’s the pensions equivalent of a weighted blanket: regulated, capital-backed, and (usually) very reassuring.

However, the insurer is only taking on the benefits set out in the policy. There are always risks that sit outside the policy: benefit errors, missing beneficiaries, legal quirks that no one spotted at the time. And once the scheme is wound up, there’s no trust fund left to deal with them.

So what happens if something goes wrong? Beneficiaries may be able to sue for the entitlement to higher benefits. There will be time limits. But no trustee wants to face the threat of this let alone actual claims. 

Residual risk insurance - the panacea?

One way of managing this risk is through residual risk insurance - an insurance policy that steps in when something slips through the cracks, to cover “unknown unknowns”. Employers and trustees are usually concerned to ensure they understand the value of residual risk insurance. 

The hope is that once the premium is paid, the trustees and employer walk away, and everyone sleeps more soundly in the knowledge that the insurer will step in if the buy-out policy doesn’t fully cover the entitlements of members. The member experience is also attractive, as they would only have to deal with one counterparty. 

However, in practice, the picture is a more nuanced. 

Residual risk policies may not cover all unknown risks. Before agreeing to provide cover, insurers will carry out their own due diligence (which may slow down your buy-in or buy-out). Anything they spot as a potential issue will likely be excluded from the policy unless the trustees can resolve the issue to the insurer’s satisfaction. Insurers also have their own standard exclusions which will cover some of the key legal risks, such as deed invalidity – although those issues should already have been checked as part of the trustees’ own pre-buy-in due diligence. 

Insurers aren’t always open to offering residual risks to smaller schemes. Even when available, cover can be a significant cost. Clearly, this is not a ‘one size fits all’ solution.

The employer indemnity? 

An employer indemnity could be drafted to give members direct contractual recourse against the sponsor, rather than having to go through the process of claiming against retired trustees of a wound up scheme.

The terms of any such contractual promise will be bespoke and carefully negotiated. The parties need to think about how long it will last and most importantly, what exactly it will cover. 

The layered approach for peace of mind

In reality, dealing with residual liabilities on wind-up is rarely about a single solution. It’s about layers. 

Each component of the different layers has its strengths and weaknesses and covers different scenarios. The key is to understand how they interact and plan ahead, to avoid having to deal with these issues at a late point in the process.

If the trustees can decide what strategy makes sense for their scheme and ensure the relevant elements are lined up in advance, then, when the scheme is finally wound up, everyone can sleep soundly, without worrying about what might be lurking under the bed.