- 1 -
PENSIONS PROFESSIONALS – SOME EMERGING RISKS
CRAIG MONTY, LOVELLS
29 MARCH 2001
PROFESSIONAL INDEMNITY FORUM CONFERENCE
QUEENS’ COLLEGE, CAMBRIDGE
1.Scope of this paper
1.1The aim of this paper is to consider, in broad terms, the roles which various professionals play in the running of occupational pension schemes and the types of risks to which they are exposed in carrying out those roles. The paper will seek to demonstrate that professionals have an increasingly important part to play as pension schemes become ever more complex and subject to more and more regulation, and that claims against pensions professionals are likely to be a growth area in the coming years.
1.2The scheme of the paper is as follows:
(a)The paper begins with an explanation of what occupational pension schemes are, a little bit about their history, and an indication of their importance in modern society.
(b)There is then consideration of the increasing role of professionals in the running of pension schemes and the increasing likelihood of claims against them.
(c)To aid understanding of what follows, the paper next explains, in simple terms, how occupational pension schemes work.
(d)There is then consideration of the position of a number of specific professions: solicitors, actuaries, pension scheme administrators, and investment advisers/fund managers.
(e)There is also consideration of the role of the Pensions Ombudsman and the part he has played in the growth of pension scheme disputes.
2.What are occupational pension schemes?
2.1Everyone understands, in broad terms, what is meant by an occupational pension scheme. It is an arrangement whereby an employee, as part of his remuneration package, is provided with an income in his retirement out of a fund maintained by his former employer.
2.2The statutory definition is as follows:
“any scheme or arrangement which is comprised in one or more instruments or agreements and which has, or is capable of having, effect in relation to one or more descriptions or categories of employments so as to provide benefits, in the form of pensions of otherwise, payable on termination of service, or on death or retirement, to or in respect of earners with qualifying service in an employment of any such description or category” - Section1, Pension Schemes Act 1993.
2.3The first arrangement which might be called a pension scheme was established in 1671 by HM Customs and Excise. Initially, this required a retiring employee to be paid a pension by his successor, but by 1686 employees were required to fund their own retirement provision by making contributions towards a retirement fund.
2.4Pension provision was gradually extended to a wider range of civil servants and in the nineteenth century pension schemes became more widely available to employees in both the public and private sectors. The railway companies were early pioneers, starting with the Great Western Railway’s Provident Society in 1838. Later other industry sectors followed and, interestingly, insurance companies were prominent with schemes being set up by the Prudential and the Royal Exchange. It is estimated that by 1900, about one million people were members of pension schemes.
2.5Of course, at this stage there was no Welfare State, which is so much taken for granted today, and nothing akin to a state old age pension. In his lecture to the Association of Pension Lawyers in October 1998, Edward Nugee QC, the senior barrister at the pensions bar, explained that in the first half of the nineteenth century, reliance was often placed on the expectation that one’s children would help support one’s old age. This explains why a high proportion of brides were pregnant at marriage; in days when divorce was rare, it was important to ensure that your wife could have children who might help to provide such support. Mr Nugee stopped short of suggesting that the fall in the number of pregnant brides up to the middle of the twentieth century could be wholly explained by the growth in pension schemes!
2.6There was never any requirement on employers to provide a pension scheme and it might wondered why they bothered to do so. Surprising though it may seem, there seems to have been a belief that pension provision for former employees was the responsibility of the good employer. But underlying this was sound business sense as expressed by the General Manager of the North Eastern Railway in 1910:
“My view of the pension is that it is an act of business common sense … not … philanthropy … Unless you have something like an efficient pension fund, the directors would be under a constant compulsion to keep on the men. It is a choice between keeping them on and sending them to the workhouse, and they could not resist keeping them on.”
The Goode Committee, about which more later, summed it up as follows:
“By the turn of the century employers had come to see occupational pensions not simply as a means of looking after their employees when they became too old to continue work but in terms of enlightened self-interest”.
2.7It is that same enlightened self-interest which continues to provide the rationale for pension schemes today. Employers recognise that a generous pension scheme is a powerful weapon in attracting and keeping quality staff.
2.8Figures taken from the recent Myners Report demonstrate the strength and prevalence of occupational pension schemes in the UK economy. For example:
(a)Pension funds held 19.6% of the UK equity market in 1999.
(b)The market value of total pension fund assets in that year was £800bn.
(c)There are twelve UK pension funds with assets of £10bn or more, the largest (British Telecom’s) having assets of £29.7bn.
2.9The other important point to make here is that occupational pension schemes are quite different to personal pension policies. The latter are policies which individuals can take out with insurance companies to provide an income in retirement. They were, of course, the subject matter of the so-called pensions mis-selling scandal when financial advisers encouraged members of generous occupational pension schemes to abandon those schemes in favour of personal pension policies when to do so was clearly not in the member’s interests. That scandal and the legal issues to which it gave rise have been fully ventilated previously and this paper looks only at occupational schemes.
3.The increasing importance of professionals in the running of pension schemes and the increasing likelihood of claims against them
3.1Pension schemes came under the spotlight in the early 1990s when the Maxwell scandal exploded. As is well known, it emerged that Robert Maxwell had propped up his ailing business empire by using pension scheme assets with no regard for how this would affect the pensions payable to the workforce. The result was financial carnage with members of the schemes left with wholly inadequate provision for their retirement.
3.2The Government’s response was to set up the Pension Law Review Committee chaired by the very eminent lawyer, Professor Roy Goode. Its task was to conduct a comprehensive review of pension provision in the UK and to make recommendations as to how the legislative framework for such provision could be amended to provide greater protection for employees. The Committee reported in September 1993 and many of its recommendations were adopted in the Pensions Act 1995 which came into force in April 1997.
3.3The emphasis in the Pensions Act 1995 was on increased regulation, transparency of dealings and accountability. It is beyond the scope of this paper to describe the provisions of the Act in any detail but the following can be mentioned:
(a)There was created a regulatory body (the Occupational Pensions Regulatory Authority) to which all schemes are accountable. OPRA has extensive powers to investigate possible non-compliance with the provisions of the Act and to prosecute, fine, prohibit people from acting as trustees, wind-up schemes etc.
(b)There is requirement under the Act for the body of trustees to include member-nominated trustees. This is so that the running of the affairs of the pension scheme is not left exclusively in the hands of people whose primary interest may be thought to be to do the best possible for the sponsoring company.
(c)There was introduced a Minimum Funding Requirement (MFR) for all schemes to ensure minimum levels of solvency. In practice, there have been many problems with the MFR and in his recent budget, the Chancellor of the Exchequer announced proposals to replace it with a long term scheme specific approach based on transparency with additional measures such as a statutory duty of care for the scheme actuary, stricter rules on voluntary winding-up and an extension of the fraud compensation scheme.
(d)There were restrictions placed on the ability of the employer to amend the scheme. In particular, it is no longer possible for an employer to amend a scheme in a way which affects any entitlement of a member save in very limited circumstances.
3.4Of particular interest in the current context are the provisions of the Pensions Act 1995 relating to “professional advisers”.
(a)The trustees of most occupational pension schemes are required to appoint an actuary. This must be a named individual rather than a firm and it is this individual who must perform certain functions required to be performed by the Act. In particular, it is the scheme actuary who is responsible for the production of valuations of the scheme (see below).
Functions which do not have to be performed by the scheme actuary can be performed by any actuary. But if the trustees rely on someone other than an actuary appointed by them they run the risk of OPRA imposing civil penalties or removing them from office.
(b)Similar provisions apply in relation to the appointment of an auditor to the scheme
(c)The Act also requires the trustees to appoint a fund manager if their scheme has “investments” as defined in the Financial Services Act 1986. This will catch most schemes other than those invested solely in property or cash. If the trustees rely on a fund manager other than one appointed by them, they run the risk of penalties.
(d)There is no requirement for a scheme solicitor or lawyer but if the trustees rely on a legal adviser other than one they have themselves appointed they again run the risk of penalties.
3.5In one sense then, the Maxwell scandal and its aftermath presented a great opportunity for pensions professionals since the new regime relies heavily on them to see that pension schemes are run properly. Professionals have thus become a key feature of occupational pension schemes and their role gets ever more important as the amount of regulation continues to increase.
(a)There is relevant primary legislation after the Pensions Act 1995. There is the Welfare Reform and Pensions Act 1999 and the Child Support Pensions and Social Security Act 2000, as well as the Financial Services and Markets Act 2000 on the investment side.
(b)The volume of secondary legislation and non-statutory guidance is prolific. As at August 2000 there were in force 14 sets of regulations on contracting-out, 30 sets on other social security matters, 13 sets of secondary Inland Revenue legislation, 11 guidance notes from OPRA, over 70 Pension Schemes Office Updates since 1995, 8 guidance booklets from the National Insurance Contributions Office and 11 actuarial guidance notes.
(c)This complexity is reflected in the number of lawyers now advising specifically on pensions. The Association of Pension Lawyers, founded in 1985, now has over 700 members. There are over 80 textbooks on pensions matters to refer to and at least 11 specialist pensions journals.
3.6Against that background it is hardly surprising that claims against pensions professionals are on the increase.
(a)Put shortly, more regulation has meant more involvement for professionals with increased scope for things to go wrong.
(b)The increasing complexity of pensions law and regulation is both the reason for increased professional involvement and the reason why mistakes are bound to occur.
(c)There is today a greatly increased awareness of the importance of pensions, the things that can go wrong with them and the rights which workers have for the protection of their benefits. The Maxwell and pensions misselling scandals in particular, and the Government’s responses to them, have brought pensions an unprecedented amount of press coverage and public prominence.
(d)Add to these factors the growth of the “claims culture” which is being experienced and an increase in claims against pensions professionals is inevitable.
(e)There is also the Pensions Ombudsman factor. As described below, the Ombudsman provides a cheap and informal forum for the resolution of pension disputes, including those against professionals.
4.Brief tutorial on how pension schemes work in practice
4.1Before turning to consider the roles of particular professionals and the risks to which they are exposed it may be helpful to say something about how pension schemes work, focusing on those areas where there is particular scope for professional risk.
4.2So long as a pension scheme is approved by the Inland Revenue, contributions into it will attract tax relief and investment returns achieved by the fund will similarly be free of tax[1]. In order to obtain Inland Revenue approval, the scheme must be established under irrevocable trust and as mentioned above there is a Pensions Act 1995 requirement for the trustee body to include member-nominated trustees. There will usually be a detailed trust deed setting out the duties and powers of the trustees, amongst other things, and then a set of rules setting out the contributions and benefits payable under the scheme.
4.3There will be a “Principal Employer” under the scheme and in larger schemes there will be “Participating Employers”, ie companies associated with the Principal Employer whose employees are entitled to be members of the scheme.
4.4The third category of players are of course the employees and ex-employees themselves (often referred to as the members of the scheme). They are usually sub-categorised as actives (ie people still employed by the Principal Employer or one of the Participating Employers), deferreds (ie people who have left employment, probably to work elsewhere, and who will have an entitlement to receive benefits from the scheme when they reach retirement age), and pensioners (ie people in receipt of a pension).
4.5There are two types of occupational pension scheme: defined benefit schemes (otherwise known as final salary schemes) and defined contribution schemes (otherwise known as money purchase schemes). There are important differences between how these two types of scheme are funded and the benefits they provide.
4.6In a defined benefit/final salary scheme, a member’s pension at retirement is calculated by reference to his length of service and his salary at or near retirement (referred to as pensionable salary). Typically the member will be entitled to a pension of n/60ths or n/80ths of pensionable salary where n is the number of years of service. In a “60ths” scheme, therefore, someone with 30 years service will be entitled to an annual pension of 30/60 (ie one half) of their final salary.
4.7A member of a defined benefit scheme will usually be required to contribute a fixed proportion of his salary to help fund his pension entitlement. It is not unknown however for schemes to be non-contributory, by which is meant that the members do not have to make any contributions. The balance of the cost required to fund the benefits is paid by the employer, hence the expression “balance of cost scheme”. The employer will have the scheme valued on a regular basis to assess its funding position and to make sure that, in the actuary’s view, the contributions which are being made will be sufficient to cover the cost of the benefits payable. This form of arrangement can be very expensive for employers and locks him into an open-ended commitment. If there is a stock market crash, for example, the employer may find himself having to dig deep to make good a deficit in the scheme.
4.8By contrast, defined contribution/money purchase schemes are rather more straightforward. The employer and the members will contribute a fixed amount to the scheme and the pension ultimately payable will depend on the size of those contributions and the investment returns achieved on them. Each member’s pot will be used at retirement to purchase an annuity, and that of course adds an extra dimension of uncertainty for the member since the size of his pension will be very dependant on annuity rates at the time of his retirement. The advantage from the employer’s point of view is that he knows in advance what his pension cost will be and there will be no hidden surprises.
4.9Another area of importance is that of transfers from one scheme to another. Two types of transfer need to be distinguished. First, suppose the Principal Employer (which will typically be the holding company of the group concerned) sells one of the Participating Employers. The scheme will provide that the Participating Employer shall cease to be such and it will usually be agreed between the Principal Employer and the purchaser that the members employed by the Participating Employer shall become members of the purchaser’s scheme. This will require the making of what is termed a “bulk transfer” of assets and liabilities and the actuary will have a key role in determining just how much needs to be transferred.
4.10The other type of transfer is where a single member leaves the employment of the Principal or a Participating Employer. One option open to him is to leave his pension arrangements as they are in which case he will become a deferred member of the scheme. Another option is to ask for a transfer of his entitlements to the scheme of his new employer or to a personal pension policy. Once again, if this is the chosen option the actuary will have a key role to play in assessing the actuarial value of the benefits earned and the amount needed to cover them.