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The Actuary The magazine of the Institute & Faculty of Actuaries

Controlling legal risks for pension actuaries

In last month’s issue, we considered the personal legal exposure of actuaries who are partners, limited liability partnership (LLP) members, and employees. Even employees and LLP members are exposed to the risk of claims in relation to their own negligent acts or omissions. In this article we consider the steps an actuarial firm might take to reduce the risk of claims.

Duty of care
Actuarial firms can face a variety of types of legal claims from a variety of people. They owe a duty of reasonable care in the performance of their contractual duties to the trustees and also to the employer for advice on corporate transactions, FRS17/SSAP24, and on benefit design and senior director remuneration. Actuarial firms may also owe a duty of care in negligence to third parties such as the employer or the members in relation to funding advice given to the trustees. Actuaries can also owe a duty of care to third-party purchasers in certain circumstances. Any risk management strategy therefore needs to control the risk of claims being brought both by the parties the actuarial firm is contracting with, and also by third parties.
All actuarial firms should have well-drafted terms and conditions of engagement. Typically, in addition to the statutory individual scheme actuary appointment under section 47(1)(b) of the Pensions Act 1995, there will be an appointment of the actuarial firm as adviser to the trustees for the purposes of section 47(3) of the Act. There will also be a separate company adviser appointment. There may also be separate engagement letters relating to the provision of investment and scheme administration services.

Liability caps
Until recently, only one major actuarial firm attempted to limit its liability by imposing liability caps. As a result of recent claims experience and the contraction in the amount of professional indemnity cover in the market, liability caps are becoming increasingly common. The actuarial firm asks the client to accept that its maximum liability under the terms of engagement in relation to any claim is limited to £X million. Other than in relation to certain types of financial services liability, there is no statutory provision that prevents actuaries imposing such caps, although they will be resisted by clients. Any liability cap will be subject to a requirement of reasonableness under the provisions of the Unfair Contract Terms Act 1977 (UCTA) as the actuarial firm will be dealing on its standard terms and conditions and arguably trustees will also be dealing as consumer. It is for the party seeking to rely on the exclusion clause to show it is reasonable.
Under UCTA, in determining whether a clause purporting to exclude liability is reasonable, the court is required to have regard to:
– the resources which the actuarial firm could expect to be available to it for the purposes of meeting the liability; and
– how far it would be open to the actuarial firm to cover itself by insurance.
In practice, liability caps are more likely to be enforceable if they are drawn clearly to the attention of the client and also if there is reasonable equality of bargaining power between the parties. If there is a genuine commercial negotiation about the allocation of risk, a court is more likely to uphold the clause. If the clause is linked to the level of professional indemnity cover available in the market and/or the size of the client and level of fees (what is appropriate for a small pension scheme may not be appropriate for a large pension scheme), there will be a greater chance of the clause surviving the reasonableness test. Also, larger firms may find it harder to enforce exclusion clauses than smaller firms without the same resources.
Liability caps only control liability in relation to the clients with whom the actuarial firm is in a direct contractual relationship. Third parties, to whom the actuarial firm owes a duty of care in negligence, are not party to the contract and are not subject to a cap. Professional firms, including actuaries, therefore attempt to control third-party liability in various other ways. One approach is to place restrictions in the terms and conditions preventing actuarial or other advice being communicated to third parties. If a report is to be disclosed, the third party has to enter into a contract setting out the uses to which the report can be put, and dealing with the issue of whether the actuarial firm assumes any liability for the advice. Sometimes professional firms go further and ask clients to indemnify them for any liability in excess of the liability cap. This is likely to be resisted by these clients’ legal advisers.
Actuarial firms should generally not be liable in corporate acquisitions if potential buyers place reliance on a valuation prepared for the trustees. This is because the valuation will not have been prepared for this purpose. However, if the actuarial firm can objectively be said to have assumed responsibility for that advice (eg it agreed the advice could be communicated to the potential purchaser in the knowledge that it might be relied upon) it can be liable. It is important, therefore, that any valuation report contains an appropriate disclaimer setting out the purposes for which it was prepared and stating clearly that no responsibility will be accepted if reliance is placed on it for other purposes. In a recent Scottish case, the absence of such a clause was held to be evidence that went to the issue of whether there had been an assumption of responsibility.

Actuaries also need to think carefully about how advice is communicated. For example, should a range of results be given? How are any caveats to be communicated? This is particularly relevant in corporate transactions where actuaries may be asked to carry out a back of the envelope calculation at 2.00am in the morning.
Failure to recognise conflicts can also expose actuarial firms to legal risk. Actuaries need to be aware when it is inappropriate for them to continue to act for all parties (generally when the actuary moves from expert valuation role to negotiating situation). There are many situations where it was common in the past for actuaries to act for all parties but where it may no longer be appropriate to do so. Often it will be possible to deal with a conflict situation by constructing a ‘Chinese wall’.
Firms also need to ensure that they have effective peer review and internal checking systems. Compared with other professions, the author’s anecdotal impression is that actuaries have very good peer review systems in place even principals’ work is checked. Unlike other professions, actuarial peer review systems do not seem to be breaking down in the world of e-mail communication. E-mail is, however, very dangerous from a risk-management perspective, and proper guidelines for e-mail use should be in place within each firm.
Risk management guidelines should put in place systems to minimise risk in each of the areas of work performed by actuarial firms. For example, scheme administration work will not expose actuarial firms to the same magnitude of claims as valuation work, but it is a classic negligence area because of the number of deadlines that can be missed. Critical date systems should be in place to ensure that these deadlines are met. Also, any benefit quotations should always be double-checked and confirmed in writing to minimise risks of claims for negligent misrepresentation.
Consideration should be given to the extent to which documentation work will be carried out. This is a high-risk area and there is a markedly different approach taken by different actuarial firms. Some firms will not as a matter of principle prepare any trust documentation others employ documentation specialists. Explanatory literature and announcements relating to changes to benefits are also very high risk.
There are differing approaches between firms in the extent to which the client’s external lawyers are involved. If the lawyers are not involved, an opportunity for risk-sharing/shifting is lost. To state the obvious, if you do everything you are liable for everything.
Once claims are made there should be proper systems for ensuring the principal risk management contact in the firm is notified so that the information can be passed to the actuarial firm’s professional indemnity insurers. Care should be taken to ensure that no admissions of liability are made and that any new documents created attract legal privilege.
Risk management guidelines need to be communicated within the firm. Risk management is not something that the principals alone should do, but is something that everyone in the actuarial firm needs to be aware of at all times.