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The Actuary The magazine of the Institute & Faculty of Actuaries

Pensions: Duty of care

In financially uncertain times, it is perhaps not surprising that historic decisions as to how pension scheme funds should be invested are coming under ever closer scrutiny. If those investments have not performed as hoped, attempts might be made to make good any perceived shortfall by means of litigation. Claims might be made against former trustees, alleging that the investment policies they adopted were imprudent. In addition, or alternatively, litigation might be brought against the scheme’s professional advisers for their role in the formulation and adoption of investment policies. This article considers some of the possible professional targets.

At the outset, however, it is worth noting that proving negligence will not be easy for any claimant. It would have to be shown that the investment policy or advice was such that no reasonably competent trustee or adviser could have adopted or given it, judged by what was known at the time, for instance, without the benefit of hindsight. Many claims will fail at this first hurdle.

It would also have to be shown that the adviser assumed, or should be taken to have assumed, a legal responsibility to protect the scheme against the loss which has arisen. In the context of investment advice, the respective responsibilities of the professionals involved may not be clear-cut.

The professional advisers
Trustees are primarily responsible for a scheme’s investment policy. However, they will probably receive investment advice and/or guidance from a number of sources, including the scheme actuary, the advising actuary, an investment adviser and a fund manager. The trustees’ reliance on such advice may well provide, whether wholly or partially, a defence to any claim against them. It may also enable them to sue the advisers themselves.

Theoretically, the role of each adviser will be different. However, all could conceivably be responsible in different ways and to different extents if investments do not perform as hoped. Further, their roles and duties may overlap, with the result that it is not uncommon for more than one professional adviser to be involved in any investment decision.

The scheme actuary
Ordinarily, making good a claim against the scheme actuary regarding the scheme’s investment policy will be difficult. Although he will usually be more involved than other advisers in the day-to-day affairs of the scheme, the link between what he does and the scheme’s investment strategy may be the most tenuous.

The position of the scheme actuary is a creature of statute and the primary source of his duties will, therefore, be statutory. His main duties include advising trustees on funding, calculating transfer values, reporting breaches of law to the regulator and advising on the financial impact of proposed changes to scheme rules. The statutory duties do not include giving investment advice.

However, this may not be the end of the story. The scheme actuary may assume, or be taken to have assumed, wider responsibilities. For example, he will often advise on the formulation of the Statements of Investment Principles. He may also have taken on a “trusted adviser” role, for example, by advising on the appointment of investment advisers or fund managers. His presence at trustee meetings and his willingness to give views on matters going beyond his statutory responsibilities may later be relied on in alleging that he assumed a wider legal duty than imposed by statute. Depending on the circumstances, it might be said that the scheme actuary took it upon himself to advise on investment strategy.

All of this means that the scheme actuary has to be clear as to what responsibilities he is prepared to assume. If he is happy to provide a service going beyond his statutory responsibilities, the letter of engagement needs to state clearly what he has agreed to do and, as important, what he has not agreed to do. Once this has been agreed, he should also see that he does nothing from which it might later be inferred that he was prepared to accept a wider responsibility than set out in the letter of engagement.

In addition, claims have been made which allege that Practice Standard GN29 imposed on the scheme actuary have a legal, as opposed to professional conduct, duty to issue a warning relating to the scheme’s investments. Under paragraph 2.5 of GN29, the scheme actuary must obtain the trustees’ agreement in advance to advise him of specified events materially significant to the scheme’s finances. Appendix B says that such events might include a change in the way assets are allocated between types of investment or any significant increase in investment concentration. Other events might include significant adverse investment performance or any other substantial depreciation.

Paragraph 4.1 of GN29 requires the scheme actuary to advise the trustees if a proposed action (or inaction) or any of the events agreed with the trustees in advance might materially affect the scheme’s financing or solvency. It is not difficult to imagine a situation where a scheme actuary might later be criticised for not having advised the trustees that a worse than expected performance of various investments, or a change in the concentration of those investments, might affect funding.

It is important to note, however, that paragraph 4.1 of GN29 probably goes beyond the obligations which the law would ordinarily impose, and that a failure to warn would not be conclusive of negligence for the purposes of a damages claim, even if it might amount to professional misconduct

Advising actuary
The advising actuary may work in the same firm as the scheme actuary. However, unlike the scheme actuary, he will ordinarily be giving investment advice. The advice will not usually be, “Invest in this or that particular asset”, but it will involve giving actuarial advice on investment strategy the kind of investments, for example, equities or gilts, which trustees should make.

If a claim is made against an advising actuary, the Court will need to consider whether the investment advice given was competent given the particular features of the scheme. Relevant considerations are likely to include the scheme’s profile. For example, a more mature scheme may need fewer non-income assets, as opposed to a younger scheme where investments with potential for long-term growth may be desirable. Funding might also be relevant, for example, a strong employer covenant or guarantee might enable more risks to be taken and a greater focus on the potential for growth. General features of the market might also be relevant, and there are claims being pursued in which advising actuaries have been criticised for not advocating a switch from equities to gilts to ensure a better match between the assets and liabilities of the scheme.

Investment advisers
The duties of investment advisers often overlap with those of the advising actuary. Indeed, claims are often made against both at the same time.

However, a crucial difference may be that an investment adviser is not ordinarily expected to give advice which requires an actuarial assessment of the particular scheme’s liabilities; although many actuarial firms do provide generic investment advice as well.

If a claim is brought against an investment adviser, the Court will ask whether the type of investment, its rate of return and the asset allocation were reasonable in the light of market conditions known at the time. As the investment adviser may have overlapping duties with the actuarial adviser, it is important that the terms of appointment make it clear what the investment adviser has agreed to do. If an investment policy is later criticised, there may be a debate as to who should be responsible, the advising actuary, the investment adviser or both.

The respective legal responsibilities of both may be difficult to establish precisely. The view of the author is that, if a particular investment policy was imprudent because of particular features of the scheme’s profile (for instance, because of actuarial factors, rather than those linked to more general market conditions), this is something for which the advising actuary is more likely to be found responsible. The investment adviser will be vulnerable if the particular investment choices were imprudent or failed to reflect the agreed investment strategy.

Fund manager
Claims could be made against fund managers if investments have not performed as hoped. The first question to consider would be whether the relevant investment management agreement actually permitted the particular investments which were made. That may not be as clear cut as it sounds. If such investments could have been made, the Court might then consider whether they should have been made, the issue being addressed by reference to what a reasonable fund manager would have done given what was known at the time.

There might be cases (rare, admittedly) when it can be established that the fund manager warranted, or should be taken as having warranted, a particular return on the investments. If that return is not achieved, there will be a claim, regardless of why the investment did not perform as promised. If, on the other hand, no warranty can be established, the outcome will then depend on whether the fund was managed with reasonable care and skill. Again, this will be assessed with reference to market practice, and not using the benefit of hindsight.

If the assets in which pension scheme funds are invested do not perform as expected, claims may follow, both against the trustees at the time and their professional advisers. How sustainable such claims will be will depend upon the facts, what could reasonably have been foreseen at the time, and the precise role each professional agreed to perform. The “no reasonable adviser could have failed to adopt a particular investment policy” test may be a difficult one to satisfy.

All of this points to the need for care and caution, and the need for clear terms of engagement setting out the respective responsibilities of each professional adviser.

Ian Gordon is a solicitor at Reynolds Porter Chamberlain specialising in professional negligence and risk management