New pension legislation could result in million pound D&O and trustee claims for insurers, say Julian Aylmer and Simon Goldring

' On 6 April, new legislation comes into force that will enable the pensions regulator to force directors and other individuals deemed to have deliberately deprived a company's pension scheme of necessary funding to compensate the scheme at a later date.

While there has been much debate about the dangers this new legislation poses for those individuals, little attention has been paid to the fact that it has also significantly increased the potential liabilities for directors' and officers' insurers.

This danger derives from the powers bestowed on the new Pensions Regulator under the "moral hazard" provisions of the Pensions Act [2004]. These provisions are intended to address the risk of unscrupulous employers dumping their defined benefit pension scheme on the new Pensions Protection Fund (PPF).

The PPF has been created to protect members of private sector defined benefit schemes whose employers become insolvent and have insufficient funds in their pension fund to meet their obligations.

At present, only current or former principals or associated employers of a pension scheme can be liable for its under-funding. However, the

Act gives power to the regulator to enforce the "moral hazard" liabilities by issuing contribution notices requiring the recipient to pay a specified sum to a scheme's trustees or managers.

Personal liability
A notice may be served on a sponsoring employer, or a person "connected with, or an associate of, the employer". This could include group companies, controlling shareholders, directors (including shadow directors), employees and their relatives. This will potentially create, for the first time, personal liability for the company's directors.

Although this may be of primary concern to directors' and officers' (D&O) insurers, pension trustee insurers may also be affected where trustees are also directors or senior employees, or where trustees are alleged not to have done enough to stop the acts or omissions complained of, for example, by reporting them to the regulator.

The same insurers may well simultaneously underwrite D&O and pension trustee policies and could potentially face claims under both. The current standard pension exclusions in D&O policies would not exclude these liabilities.

Underwriters need to be aware that the regulator may in practice issue a contribution notice even when the actions complained of are not necessarily dishonest. Therefore, the liability for payment may not be automatically excluded from cover under D&O or pension trustee policies.

For example, directors may decide to use a company's £100m cash pile to acquire another company, rather than remove a pension scheme's £100m deficit.

Similarly, paying dividends could be perceived as deliberately depriving a pension scheme of funding. While the directors may have acted in good faith in these instances, the regulator (looking at matters with hindsight, after things have gone wrong, and with the primary consideration of protecting the interests of the scheme members or the PPF) could still serve notice requiring them to compensate the pension scheme at a later date.

Directors and officers involved in or aware of such decisions are more exposed as a result of the Act and therefore so are their insurers.

The exposure that insurers face needs to be assessed in context. Mercers, the Human Resource Consultants, predicts the total deficit for all UK pension schemes to be £128bn, a figure that should send shivers down the spine of the insurance industry.

Deficit discoveries
The magnitude of the problem for individual companies has been highlighted recently by Rank Hovis MacDougall's announcement of a £525m hole in its pension fund and the discovery that Allders, the department store chain which has recently been put into administration, has a £15m deficit in its pension scheme.

Contribution notices for even a small proportion of deficits of this order could give rise to large insurance claims.

While it is unclear exactly how the new Pensions Act will work and just how aggressive the Pensions Regulator will be in practice, many in the insurance industry may not be aware that it could have any impact on them at all.

Barring a dramatic rise in the stock market, the issue of under-funded pension schemes is not going to go away.

Both D&O and pension trustee underwriters should consider, as a matter of urgency, whether they wish to cover or exclude the new potential liabilities created by the Act and amend their policies accordingly.

' Julian Aylmer and Simon Goldring are partners at Reynolds Porter Chamberlain