More DB schemes are approaching their endgame (whatever that may be) than ever before. As a result, the focus on residual risks and how these are managed is evolving.

The key message for trustees and employers is that dealing with residual risks will be a big part of any endgame journey. This is not something to leave until the eleventh hour!

When we talk about “residual risks” we are generally referring to risks which are not covered as part of a DB scheme’s endgame choice, which may arise after winding up has completed. In very broad terms, these risks can generally be categorised as either additional liabilities in respect of known members or additional liabilities in respect of unknown members.

From a trustee perspective, the best protection against such risks will be a combination of an employer indemnity that survives winding-up and some form of insurance (such as residual risks cover or run-off insurance).

Residual risks cover is generally only available to larger schemes (over £1 billion in assets) though smaller scheme offerings are starting to develop. It is also worth noting that residual risks cover involves significant due diligence of the risks by the insurer and that any issues identified as part of that due diligence will usually be excluded from the cover. In short, residual risks cover is never “all risks” cover.

In terms of run-off cover, the exact terms will need to be negotiated with the relevant insurer. However, it usually covers most things (breach of trust, missing beneficiaries etc). The main challenge with this type of insurance is that it will only be for a fixed term (usually 15 years) and subject to a financial cap.

How employers handle residual risks will depend on their appetite for risk, both from a financial perspective but also reputationally. An employer may wish to due diligence the risk before agreeing to provide a post-winding-up trustee indemnity. However, in doing so, there will be a balance to be struck between carrying out a thorough investigation on the one hand and letting sleeping dogs lie on the other. Employers should also have regard to the value and level of any available insurance cover options in respect of their scheme.

So, if it is an option, is residual risks cover always the right thing to do? Would an employer indemnity be better? There isn’t a straightforward answer to this question. Relevant factors will include whether a comprehensive sponsoring employer indemnity is even on the table (and, if it is, whether that employer is likely to be around for the long term). Residual risks cover will generally also come with a hefty price tag – how will it be paid for? To the extent that surplus scheme funds are used, would those funds be better used to enhance members’ benefits? Trustees (and employers) should think carefully about whether any residual risks cover on offer represents good value for money. A key advantage from a member’s perspective is that residual risks cover will likely result in a more streamlined experience should an issue arise as the relevant insurer will handle everything.

Turning to indemnities, the starting point for any conversation between trustees and their sponsoring employers will be the terms of any existing indemnity under the scheme rules. The next question is, will it survive the winding-up of the scheme? Most trustees will want an indemnity but not all indemnities are the same. Trustees and employers will need to negotiate something that works for both parties. From the trustee perspective, the key point is to make sure the indemnity covers everyone it needs to (former trustees/trustee directors, in-house pension team, scheme secretary etc). It should also be made clear how the indemnity fits with any insurance cover (ie which comes first). Covenant strength of the indemnifying employer will also be a relevant consideration.  Trustees may wish to consider covenant advice and also ask for the indemnity to include a mechanism to substitute in a new company in the event that the indemnifying company’s covenant deteriorates.

A sponsoring employer may wish to request a time limit or financial cap on any indemnity. Consideration will also need to be given as to whether shareholder agreement to the terms of the indemnity is needed. It may also be appropriate to make any indemnity conditional on trustee behaviour – eg include a proviso on trustees to not encourage member claims.

There will also be benefit to all parties in documenting what happens in practice if a claim arises post wind-up, particularly given the trustees may no longer be around at that point. To this end, we are starting to see more focus on who claims should be directed to and communication with insurers and other relevant parties being addressed in the terms of indemnities provided on winding-up.

The key takeaways here are that no single solution will cover all residual risks and that early consideration and engagement between sponsors and trustees is vital.