[Skip to content]

Sign up for our daily newsletter
The Actuary The magazine of the Institute & Faculty of Actuaries

2007 a year of challenge for trustees

There are aspects of the Pensions Act
2004 (the Act) that only came into
force on 6 April 2006 but that
introduce significant changes to the
efficient functioning of trustee boards. In particular,
the revisions to the existing membernominated
trustee (MNT) requirements (or
member-nominated directors (MND), where
the trustee is a corporate entity) represent the
start of a period of change and challenge for
employers, administrators, and trustees of trustbased
pension plans.
Member-nominated trustees and
trustee training
The Act requires that at least one-third of
trustees be nominated by members (by active
members and pensioners by means of an election
process, for example), and removes the
option for an employer to develop approved
opt-out arrangements. Existing opt-out arrangements
that have permitted employers to put
forward their own proposals to provide members
with input into the trustee function and
the operation of the pension plan must be discontinued
by no later than 31 October 2007.
Furthermore, it is envisaged that the mandated
MNT proportion will rise to one-half by 2009.
This is a minimum requirement; for example,
if there are five trustees in total then two must
be MNT, and from 2009 this will rise to a minimum
of three. The non-member-nominated
trustees, that is those nominated by the
employer, will then represent only a minority
of the trustees.
It follows that an employer who by 2009 will
only be able to influence the appointment of
up to one-half of the trustees must be confident
that those appointment decisions under his
control are made wisely and effectively.
The Act also gave wide-ranging powers to the
Pensions Regulator, who has proceeded to
develop a code of practice that includes training
materials for trustees (in particular a toolbox
for interactive use over the internet). The
Pensions Regulator requires that all trustees
must have an adequate knowledge and understanding
to properly fulfil their role, and they
must be prepared to give their time to acquire
this knowledge through employer-sponsored
training or in other ways (by using the Pensions
Regulator’s toolbox, for example). This initial
training would normally take place over a prolonged
period of time, typically between six
months and one year. Regular refresher training
will also be required.
Determining the level of
contribution to the pension plan
In trust-based defined-benefit pension plans the
trustees now have considerable power over
determining the rate of contribution to the pension
plan, and will need to bring or develop
extensive negotiation skills or experience to the
trustee deliberations. A thorough understanding
of the value of the employer’s covenant and the
required pace of contribution to meet the emerging
liabilities of the pension plan is required.
Reduced to its simplest terms, the ultimate
cost of providing a given level of pension (and
related) benefits over time can be reduced only
through enhanced total investment performance
of the invested assets, or a reduction in the
overall costs of administering the pension plan,
or a combination of both of these actions. The
trustee has overall responsibility to optimise the
efficiency of the operation of the pension plan
(for the benefit of all potential beneficiaries),
and this will require his or her diligent application
to the appointment and monitoring of the
investment managers and administrator.
Trustees must be confident enough to be willing
to discuss with their advisers the funding
implications for the pension plan of a range of
financial and demographic (including mortality)
assumptions, and understand the consequences
of varying these assumptions. This
understanding gives trustees the grounding
required to pursue what may become robust discussions
(now, more likely, negotiations) with
the employer on the appropriate level and pace
of contribution to the pension plan. An actuary
cannot predict with any degree of certainty the
specific financial and demographic assumptions
that will be borne out in reality. Rather there is
a range of assumptions with varying degrees of
likelihood to prove correct. The trustee must be
able to understand the financial implications of
choosing the assumptions and the probability
that future actual experience will reflect them,
and the financial outcome if they do not.
The trustee must also be alert to the special
role they will have in any business acquisition,
merger, reconstruction or events leading up to
insolvency. Working with the Pensions Regulator
and possibly the Pensions Protection Fund
in these circumstances may become a crucial
aspect of the trustee’s duties. An understanding
of the value of the employer’s covenant in these
circumstances and the financial implications of
possibly having to secure accrued benefits in the
insurance market (including section 75 debt on
the employer issues) is essential. Investing the pension plan assets
While the trustee can delegate his responsibility
in relation to any matter, he cannot abrogate
this responsibility. Accordingly, when appointing
an investment manager the trustee retains
all responsibility for the subsequent investment
performance of that manager. It follows that all
trustees must possess a minimum level of knowledge
in relation to investment matters. At least
one, if not more, of the trustees should have indepth
knowledge and experience. Often this
will be the chair of the investment committee
of the trustees. The world of financial derivatives,
commodities, hedge funds and the like
should be as comfortable an environment to
this trustee as that of bonds and equities.
The trustees are required to develop a ‘statement
of investment principles’. This statement
should record the types of investment that can
be made, the level of investment return expected,
and the risk the trustees are prepared to accept.
The spread of investments between classes of
investment is also noted. This statement should
be prepared with professional advice and shared
with the employer sponsoring the pension plan.
Exercising trustee discretion and
conflict of interest
The increasing responsibility and complexity of
the role of the present-day trustee is no better
demonstrated than with the exercise of trustee
discretion; for example, in the awarding of
benefits in the event of retirement due to ill
health. Rigorous processes must be developed
to ensure the provisions of the pension plan are
closely followed, and an appropriate understanding
of the financial consequences of granting
such enhanced early retirement benefits
must be maintained.
Most pension plans will offer pension benefits
following early retirement before normal pension
age. Such benefits would not normally be
available before age 50 (age 55 from 2010), and
often only with the agreement of the employer.
The pension following early retirement will normally
be calculated as the actuarial equivalent
(in value) of the pension accrued to the date of
retirement, so that no financial strain is placed
on the pension plan. When a member retires
early on account of ill health, the immediate
pension awarded will normally represent the
full pension accrued to the date of retirement
(without any actuarial reduction following early
payment) and, in many cases, may also include
credit for years of pensionable service to normal
pension age that have not yet been completed.
Part of this pension would, of course, usually be
available as a tax-free lump sum. The financial
consequence of awarding such enhanced pension
benefits where there is no impairment to
expected longevity should be obvious.
A thorough understanding of the consequences
of exercising the trustee’s discretionary
powers is needed when dealing with the distribution
of benefits available from the pension
plan following a member’s death while in
employment. Most trustees (or administrators
on their behalf) will seek written expressions of
wish from members as to how they would wish
these benefits to be awarded should they die
before normal pension age. These expressions
are, however, in no way binding upon the
trustees, who should act in their sole discretion
in accordance with the trust deed and rules of
the pension plan. There could be substantial
inheritance tax implications if the trustees are
not seen to distribute lump sum benefits, following
death in service of the employer, in
other than a wholly discretionary manner.
Furthermore, the trustee must be free of any
real or perceived conflicts of interest and must
act in accordance with the trust deed and in the
best interests of the beneficiaries. MNTs should
never consider themselves as representing a sectional
interest (for example, current employed
members only or pensioners only), nor should
they feel under pressure for their employment
prospects or security in exercising their trustee
responsibilities. Similarly, trustees appointed
from senior management must put to one side
their management or shareholder interests.
Good governance and internal
The EU Pensions Directive requires each pension
plan to establish internal controls to comply
with local laws and the rules of the plan
itself. These requirements were embodied in the
Pensions Act 2004 and, taken with much earlier
recommendations of the 2001 Myners
report on institutional investment, now represent
good governance of pension plans and
have been incorporated into the code of practice
published by the Pensions Regulator. The
trustees must establish sound internal risk controls
to ensure that they meet all of the financial,
operational and regulatory compliance
requirements to which the plan is subject. Good
governance requires that these controls are
regularly reviewed. Reference to the completion
of a risk review and the regular monitoring of
the controls should be documented in the
trustees’ annual report to plan members.
Appointing an independent trustee
It now becomes clear why, in exercising its
influence over the selection of the non-MNT
part of the board of trustees, the employer must
choose carefully and wisely. It is here that an
independent, professional trustee can offer a
wealth of knowledge, skills, and experience to
the trustee board. In many ways the independent
trustee can be compared with the role of the
non-executive director to a company. The independent
trustee will usually be the most experienced
member of the trustee board, and as such
have appropriate influence in decisions taken
with fellow trustees. The process for selecting
the independent trustee must therefore be rigorous,
and be undertaken with all due professionalism
and diligence.
A selection process that relies on personal
friends, colleagues or contacts is unlikely to produce
the desired result for this most important
role. Rather, a clear definition of the employer
requirements developed through detailed discussions,
followed by a thorough search of the
market, knowing the skills and strengths of who
is available, will produce a list of potential independent
trustees that the employer may consider.
Once appointed, the employer may also
wish to introduce appropriate monitoring of
trustee performance, and a range of relevant
measurement tools should be developed with
regard to the specific objectives of the particular
pension plan.
The appointment of a trustee is a responsibility
of profound proportions and not to be
entered lightly. But with appropriate care and
forward planning, preferably with professional
assistance, such an appointment will amply
repay the investment made.