Auditors will often come across defined benefit pension scheme liabilities (or assets) on the balance sheets of entities that they audit. Defined benefit pension schemes are independent of the entities, and this has considerable implications for the audit of the entity.
For employers that provide defined benefit schemes or are part of multi-employer schemes (‘sponsor entities’), the net deficit or surplus is often a significant figure in their financial statements, as are the valuations of the underlying scheme assets and liabilities - UK private sector defined benefit pension schemes alone account for almost £1.9 trillion in gross assets (UK pension surveys, Office for National Statistics, 2019).
When an auditor carries out audit work on the assets, liabilities and disclosures relating to a defined benefit pension scheme in a sponsor entity’s financial statements, they will need to interact with a number of different parties in addition to the entity’s management – and understanding these parties is key to planning and making audit requests efficiently.
While the auditor is engaged by the sponsor entity, other third parties will have been engaged by the pension scheme trustee or trustees, who are independent of the sponsor entity. As such, other permissions and authority will be required by the auditor in order to obtain information relevant to completing their audit work.
This guide from ICAEW’s Audit and Assurance Faculty explains the roles of these parties, examines the relationships between them, and takes a look at what is good practice in managing auditor requests in relation to the assets, liabilities and disclosures of UK-based, funded defined benefit pension schemes. The guide has been developed through engagement by the Faculty with sponsor auditors, pension scheme trustees, pension scheme auditors, actuaries, pensions stakeholder groups, and others.
Part 1: Relationships and independence
A summary of the roles of the parties and the relationships between them. Further information on each of the below is available in the Glossary.
The pension scheme
The main activities of an occupational pension scheme include collection of contributions from the employer and members, the investment of contributions, and payment of benefits to members (Practice Note 15, The audit of occupational pension schemes in the UK, FRC). They are usually established under trust as a separate legal entity independent of the sponsor entity. Throughout this guidance we refer to independence representing this legal separation of the pension scheme from the sponsoring entity, rather than auditor independence requirements. The trust is governed by trustees, under a trust deed. The Pensions Regulator is responsible for regulating the areas where individuals access pensions via their employer.
Management (sponsor entity directors)
Sponsor entity management provides an ‘employer covenant’, which represents its willingness and financial ability to meet its legal obligation to support the pension scheme going forwards. The directors have a responsibility to ensure the sponsor entity’s financial statements comply with the reporting requirements of IAS 19 Employee benefits or FRS 102.
Management’s actuary
The sponsor entity’s directors will usually appoint an actuary (‘management’s actuary’) to enable them to comply with the reporting requirements of IAS 19 Employee benefits or FRS 102. Management’s actuary will advise on assumptions and assist the sponsor entity’s directors in fulfilling their responsibility to prepare the figures and disclosures in the financial statements and the related notes.
Trustees
Trustees run the pension scheme solely in the interest of participants and beneficiaries, ensuring it is run properly, and that members’ benefits are secure. They ensure there is sufficient money in the scheme to pay members’ pensions as and when they become due. Trustees do not necessarily have first-hand actuarial or accounting experience and frequently look to other advisers for advice and services to help fulfil their responsibilities. They are required to engage certain advisers such as a scheme actuary and scheme auditor, and they will also commonly engage custodians, legal advisers, and scheme administrators.
Administrators
Trustees of pension schemes delegate aspects of administration to a third party, which may be in-house with the sponsoring employer, or through a specialist third-party administrator. The scheme administrator will normally receive member and employer contributions, maintain member records, and calculate and pay benefits on behalf of the trustees.
Investment managers
Trustees appoint investment managers to manage the funds available for investment. A Statement of Investment Principles (‘SIP’) will be put in place, which governs investment decisions, and the level of risk that is acceptable to the trustees.
Custodians
If the scheme invests in direct securities, trustees will normally appoint a custodian to hold the scheme investments on their behalf. Custodians provide safekeeping of the scheme’s assets, but cannot buy, sell, or transfer assets unless instructed to do so by the trustees.
Scheme actuary
For most defined benefit schemes, the trustees are specifically required by statute to appoint a scheme actuary to provide them with necessary valuations and advice. The scheme actuary provides an actuarial valuation of the liability to pay pensions after the year-end date, as well as providing estimates for the valuation of scheme assets.
Scheme auditor
Most occupational pension schemes will be required to produce annual financial statements, and to appoint a scheme auditor in order to audit those financial statements.
Sponsor auditor
The statutory auditor of the sponsor entity’s financial statements. The sponsor auditor forms an opinion on whether or not the financial statements of the sponsor entity give a true and fair view. The auditor performs a risk assessment and determines whether or not there are risks of material misstatement related to balances, transactions, and disclosures, including where an entity’s financial statements include a defined benefit pension scheme liability (or asset), and related disclosures. Where risks of material misstatement are identified, the auditor will plan and carry out audit work in order to obtain sufficient appropriate audit evidence that there are no material misstatements.
Sponsor auditor’s expert
Sponsor auditors may engage an auditor’s expert, with actuarial qualifications, in order to review the actuarial assumptions and calculations provided to sponsor entity management by management’s actuary, and the figures and disclosures in the sponsor entity’s financial statements.
The sponsor auditor’s expert, if engaged by the sponsor auditor, may also be involved in meetings or communications with sponsor entity management and management’s actuary, in order to assist the sponsor auditor to understand and challenge assumptions used and judgments made by sponsor entity management.
Part 2: Auditor requests
Good practice in managing auditor requests in relation to the assets, liabilities and disclosures of UK-based, funded defined benefit pension schemes.
The employer’s auditor must obtain sufficient appropriate audit evidence on which to base their opinion. The audit of defined benefit pension scheme assets and liabilities can be complex – as the FRC highlights (The audit of defined benefit pension obligations, FRC, 2018), it brings together several complex areas of auditing including auditing accounting estimates, assessing the work of management’s expert and service organisations, and use of auditor’s experts.
When it comes to the IAS19 / FRS 102 reporting, other actuarial information, and confirmations of scheme assets, information received directly from a third-party is likely regarded as stronger audit evidence than information received from the sponsor entity. For this reason, the sponsor auditor and auditor’s actuary (if an auditor’s expert is engaged by the sponsor auditor) are likely to request that information is provided to them directly from management’s actuary, the trustees, the trustees’ investment managers, or the stated trustees’ service organisations, even if that information has already been provided by the sponsor entity. It is essential to recognise the independence of the trustees and their appointed advisers and service providers in making these requests.
These direct, external confirmations (ISA (UK) 500 Audit Evidence, A18, and ISA (UK) 505 External confirmations) serve several purposes in accumulating persuasive audit evidence: they provide corroboratory evidence and reduce the risk of manipulation of a report by management. They also provide evidence of the functioning of internal controls put in place by the sponsor entity, as the confirmations may identify deficiencies in the entity’s control over financial reporting.
There is therefore a balance to be achieved by the sponsor auditor in ensuring they obtain robust audit evidence, while not making duplicative requests. To the extent the requests ask for duplicative information, the sponsor entity, management’s actuary, and the sponsor auditor can work together to identify the information that has already been provided and what remains outstanding.
Because of the different parties described in Part 1, the auditor will also need to decide whether they can rely on the work of the auditor of one or more of these parties (or service auditors in the case of internal control reports) or whether they need to perform their own audit work. Therefore, in planning the audit, the sponsor auditor will need to carefully consider how they will use management’s and trustees’ experts and service organisations (ISA (UK) 402 Audit considerations relating to an entity using a service organization), and auditor’s experts (ISA (UK) 620 Using the work of an auditor’s expert). Where possible, the auditor should also consider if they can rely on any of the work of the pension scheme’s auditor.
The administrators, investment managers, and custodians, as well as the scheme actuary and scheme auditor, have a (contractual) relationship only with the scheme trustees, and not with the sponsoring entity, who they are independent of. As such, they are not under the same obligation as the sponsor entity (or its directors) to provide information to the sponsor auditor, and in fact, unless explicitly allowed by their contracts, they should not respond to requests made directly from the sponsor auditors (or even directly from sponsor entity management) – only to requests made by the trustees. The sponsor auditor should direct these requests via the sponsor entity’s management, who will in turn communicate with the trustees to seek their authority.
The sponsor auditor should factor in time in the planning process for entity management to request information on their behalf. It is critical for planning that the sponsor auditor considers the timing of communications - although the sponsor entity may have staff dedicated to the statutory audit, pension scheme trustees, their administrators, custodians, and investment managers will have other duties and priorities, and may also have the scheme audit to contend with. The sponsor auditor will also need to consider costs of obtaining information from other parties, and may need to consider the impact on the budget for the audit.
The above points are especially pertinent to local government pension schemes, where there may be large numbers of employers in one scheme, and many investment managers, for example.
For those entities reporting under UK GAAP, under changes brought about by FRS 102, the share of a subsidiary’s liability is accounted for separately in their own accounts, rather than only in the parent company accounts. This will also need to be considered in the planning process, including consideration of which entities in a group will be affected.
In situations where the auditor is unable to access the information they require and may therefore be unable to obtain sufficient appropriate audit evidence, there may be a limitation on the scope of the audit, and consequently, the auditor is likely to need to modify their audit opinion.
The following are areas where the sponsor auditor will look to gather audit evidence, along with good practice in how requests should be managed.
1. Assessing the objectivity and competence of management’s actuary
The sponsor auditor, having obtained permission from the sponsor entity’s management, will write to management’s actuary at the planning stage with a request for information on the actuary’s qualifications. The sponsor auditor’s assessment of the actuary may be more straightforward if the actuary is a member of a professional body such as the Institute and Faculty of Actuaries, as the actuary will be bound by professional standards governing the actuary’s objectivity and competence. Nonetheless, the sponsor auditor will still need to assess and conclude on the actuary’s competence and objectivity.
If the actuary is a member of an overseas professional body, the auditor is likely to need more information on their professional qualifications and whether the actuary is connected in any way to the reporting entity.
It may also be helpful for the sponsor auditor to gain an understanding of the terms of engagement between sponsor entity management and management’s actuary – the terms may cover for example, the extent of any work by management’s actuary in verifying data provided by sponsor entity management.
2. Assessing the actuarial assumptions used to determine the liability
Key to the audit work is the sponsor auditor’s consideration of whether the assumptions underlying the actuarial valuation are appropriate. Sometimes the sponsor entity’s directors are not in a position to give enough information to enable the sponsor auditor to understand the assumptions used in the actuarial valuation or to review the process followed to develop them. The sponsor auditor may, therefore, wish to communicate with management’s actuary.
Due to the confidentiality duty that both sponsor auditors and the sponsor entity’s actuary owe to the sponsor entity’s directors, the sponsor entity’s permission is obtained before communicating with each other (this may be provided for in the engagement terms agreed by the sponsor entity’s actuaries and sponsor auditors with the sponsor entity’s directors, rather than needing an ad hoc request during the audit).
Sponsor entity management is central to the communication process - both as the primary source of information, and as the authority for direct communication between management’s actuary and the sponsor auditor when this is considered necessary. Good communication is vital to avoid superfluous or irrelevant information requests that could lead to inefficiency and unnecessary costs for any of the parties involved.
The sponsor auditor, having obtained permission from sponsor entity management, will write to management’s actuary at the planning stage to request details of the draft and final assumptions, as they become ready. Sponsor auditors often request supporting information for demographic assumptions from management’s actuary. This supporting information may not have originated from management’s actuary and therefore they may not be in a position to share it with the sponsor’s auditor. This might include any assumptions not directly recommended by management’s actuary to the sponsor entity, where sponsor entity management might have used judgment to apply a different assumption. Inquiry of entity management will be required to understand the judgment applied in selecting these assumptions, and given the sensitivity of liabilities to small changes in assumptions, the sponsor auditor will need to use professional scepticism in understanding why entity management might have selected them.
The sponsor auditor will consider if the assumptions appear reasonable given their knowledge of the entity and the scheme. This might require the auditor to draw on the specialist technical knowledge of a specialist or expert (auditors should refer to ISA (UK) 620 Using the work of an auditor’s expert). The sponsor auditor will also consider the sensitivity of the calculations to changes in the actuarial assumptions, and assess whether any discrepancies identified may have a material impact on the scheme’s surplus or deficit.
3. Considering the accuracy and completeness of source data
The sponsor auditor will need to consider whether the source data provided to management’s actuary by sponsor entity management for the purposes of calculating the valuation of the defined benefit obligation is materially accurate and complete. The sponsor auditor will ask sponsor entity management about the procedures in place to establish the sufficiency, relevance, and reliability of the source data.
The sponsor auditor will usually also ask what procedures management’s actuary has undertaken to establish the sufficiency, relevance and reliability of the source data provided to them by sponsor entity management for the purpose of the valuation, and also considers the controls that the sponsor entity’s management’s actuary has in place to ensure that source data has been accurately inputted into their calculations.
The sponsor auditor’s considerations around completeness should also extend to ensuring all schemes that the sponsor entity is part of, are reflected in management’s actuary’s calculations.
Depending on the sponsor auditor’s assessment, they design procedures to obtain sufficient evidence about the accuracy and the completeness of the source data. These might include reconciling data such as the number of employees and pensioner members, as supplied by the sponsor entity to its actuary, to the scheme records requested from the trustees via the sponsor entity, or verification of current employee payroll data and the contributions paid over to the scheme, on a sample basis.
More commonly now, an auditor might request the full member data file. This may be to reconcile to the sponsor entity’s payroll data, for the sponsor auditor’s actuary (if applicable) to recreate actuarial calculations, or from which to select samples. This approach requires early and considered planning due to the time taken to obtain the files, potentially large file sizes, or files that the auditor will not be able to read on their systems, and GDPR and confidentiality issues.
The sponsor auditor should also be aware that there will be situations where the sponsor entity’s management’s actuary themselves are not in possession of the data, but instead may have been provided with access by the trustees to the scheme actuary’s systems in order to generate reports. In this situation sponsor entity management’s own controls over the information might involve obtaining and reviewing internal controls reports on the controls of the scheme actuary to satisfy themselves over the reliability of the reports which its actuary is using.
In terms of GDPR, although the trustees and scheme actuary will both be considered data controllers, the scheme actuary will need trustee approval to release data. Therefore, it is often more efficient for requests for member data to be made via the trustees (or their service provider) rather than via the scheme actuary so that only one data controller needs to consider what steps are needed to share data in a way that complies with the requirements of GDPR. The sponsor auditor has certain legal entitlements to obtaining audit information under the Companies Act 2006 section 499, and therefore the scheme trustees are able to provide information while still fulfilling their fiduciary duties.
4. Evidencing audit work done on the roll forward (if applicable)
Where the valuation of the defined benefit obligation has been calculated by rolling forward the last triennial actuarial valuation, the sponsor auditor will need to audit this roll forward, and may need to make additional requests.
Any conversations between the sponsor auditor (and sponsor auditor’s expert if engaged by the sponsor auditor), and management’s actuary, and related requests, will need to help the auditor consider if the roll forward estimate is reasonable. This might include details such as how the roll-forward was performed, what assumptions were made, including on the demographics of scheme participants, and what adjustments were made.
It should also be noted that the actuary’s estimation will likely be less accurate in the second and third years following the last triennial valuation, as greater estimation uncertainty is involved.
5. Testing the valuation and existence of investment and other assets
The sponsor auditor will need to gain assurance over the valuation and existence of assets.
The sponsor auditor should gain an understanding, as early as possible, of the types of investments held, and hence the risks associated with particular investments. In 2018 FRC published the report, The audit of defined benefit pension obligations, which represented findings from 2017/18 audit quality reviews. In that report, the FRC noted one area that it expects to see auditors addressing is “clearly analysing the different categories of investment assets and how they planned to obtain sufficient audit evidence for each of these categories so as to obtain a sufficient level of audit evidence for “harder to value” assets.”
The sponsor auditor will first need to ascertain what information is available to entity management. If further information is required that is not available to management, the sponsor auditor may then ask sponsor entity management to write to the trustees to request this information. This communication would generally be expected to cover the request itself and the authority required. The approach to sponsor auditor requests will be driven by which service organisations are engaged by the scheme, for example whether a custodian is safeguarding investment assets.
The approach to auditing pension scheme assets will also depend on whether a controls-based approach or a substantive approach is being taken. In planning, the sponsor auditor will also need to bear in mind that, perhaps depending on the size of scheme, there may be many investment managers, each managing many investments on behalf of the scheme. The sponsor auditor’s planning may include gaining an understanding of the work carried out by the pension scheme auditor, along with considering if internal control reports, signed off by service auditors, are available for the relevant service organisations, including investment managers, engaged by the trustees.
For example, if internal control reports on the investment managers’ controls have been issued, the auditor will seek to review these, and assess the adequacy of these reports and the significance of any deficiencies identified. This may help reduce the level of substantive testing of assets required. If no such reports are available, and the auditor is unable to gain assurance over the internal controls by alternate means, a substantive approach is likely to be required.
In order to test the existence of assets, the sponsor auditor may need to obtain a direct confirmation from the custodian of the investments (or the investment manager(s) themselves if a custodian is not used) and confirm that they are held either in the name of the scheme or as nominee. The sponsor auditor asks sponsor entity management to communicate with the trustees to request this information from the custodian and give the trustees’ authority to the custodian to provide it.
The sponsor auditor will agree the value of the scheme’s investments to the investment manager’s valuation report.
However, the FRC noted in its 2018 report notes that “Where the investment manager is the sole provider of the valuation for the investment, an investment manager valuation report does not provide any additional evidence and further audit procedures should be performed”. For equities, the sponsor auditor will usually agree a sample to 3rd party pricing information, performing additional testing if a price is not available for the period end date, such as extrapolating the price based on the movement of a comparable index.
For more complex investments alternative approaches will need to be considered. For example, for hedge funds and other pooled investment vehicles, the auditor may seek the annual financial statements of the fund to provide further evidence of the valuation of the fund.
The sponsor auditor might also consider using the work of the scheme auditor on investments, especially where the entity and scheme have the same period end. Sponsor auditors will need to be aware though that they may be making requests at a lower materiality level than used for the scheme. Materiality for the scheme and tolerance levels when considering controls are likely to be based on a proportion of scheme assets. This might result in the sponsor auditor needing to carry out more testing than the scheme auditor, but might also mean that the sponsor auditor expects a level of precision for controls that is not derived from the size of the pension scheme, and that the trustees, custodians, and investment managers cannot provide.
Additionally, there may be occasions when the trustee is not permitted (contractually) to disclose details of a significant investment to the sponsor auditor. The sponsor auditor will need to consider what alternative audit evidence might be available. This is particularly likely to be the case in buy-in transactions, where an insurance provider is responsible for paying the monthly pensions to the scheme. Where an insurance policy is in place that exactly matches the amount and timing of some or all of the benefits payable under the plan, FRS 102 stipulates that the fair value of the asset is deemed to be the present value of the related obligation. The auditor might review the terms of the insurance policy to ascertain the extent of benefits it will cover, and inspect evidence for the insurance premium.
The valuation (and the scheme’s rights to the assets) may be more challenging to ascertain where the employer is part of a multi-employer scheme, where the share of assets may be based on an estimate. Trustees, in some cases, such as with Local Government Pensions Schemes, may not be required to know the exact split of assets. Judgment will have been applied by the actuaries in determining this estimate, and accordingly, suitable judgment, professional scepticism and challenge will need to be applied by the sponsor auditor in assessing its reasonableness. It will not always be possible for the sponsor auditor to obtain a full listing of investments and the proportion which is attributable to the sponsor entity’s scheme may be based on an estimate at any given time. The FRC’s 2018 report on 2017/18 audits notes the work of the auditor will be in “obtaining sufficient audit evidence to support the allocation of the defined benefit obligation and pension scheme assets in a multi-employer scheme.”
The sponsor auditor may also need to test any cash forming part of the scheme assets. Usually, the sponsor auditor will request, via sponsor entity management, a copy of the bank statement(s) for the scheme trustee’s bank account(s) covering the reporting date. However, obtaining statements directly from the trustees will represent independent audit evidence. The sponsor auditor may also request statements other than at the reporting date, for example to gain assurance over benefits paid. They will need to be mindful of requesting only those statements required for that audit evidence, as schemes may have many transactions and statements, and this may be a very onerous request.
There may be alternative ways of avoiding duplication of audit requests to the trustees’ service providers. The trustees may be able to give permission for the scheme auditor to provide information to the sponsor auditor. Additionally, with early planning and communication, the scheme auditor may be able to perform their work earlier in order to better align with sponsor audit timeframes.
6. Evaluating the internal controls in place in the sponsor entity and trustees’ service organisations
The internal controls and information systems operated by the sponsor entity and trustees (and pension scheme administrator, custodian and other trustee service organisations providing investment financial reporting if applicable) will affect the availability and reliability of data used by actuaries and auditors. The sponsor auditor and management’s actuary may find it helpful to exchange information about anything they have reviewed that suggests the control environment is weak, and whether such matters have been drawn to the attention of the sponsor entity’s directors.
If the administration of the scheme is carried out by a service organisation, the auditor can obtain information about the internal controls from a report provided in accordance with AAF 01/20 Assurance reports on internal controls of service organisations made available to third parties, where the service organisation has commissioned such a report. Where this is possible, this may help reduce the need for the sponsor auditor to directly audit controls of the trustees’ service organisations. ISA (UK) 402 Audit Considerations Relating to an Entity Using a Service Organization provides details on the requirements.
For non-coterminous year-ends, the sponsor auditor will also need to consider how to gain assurance over the internal controls for any period not covered by the internal controls report obtained by the scheme auditor, as to place reliance on controls reports, the reports will need to cover the full accounting period.
Although AAF 01/20 controls reports may be available for certain outsourced service providers acting on the trustees’ instructions, they may not be available for other advisors. There may be other quality assurance processes in place that the auditor can assess.
7. Considering the completeness and accuracy of pensions disclosures
The sponsor auditor, as part of the initial request to management’s actuary, will request draft and final FRS 102 / IAS 19 reports are provided directly to the sponsor auditor. The report will be agreed to the pensions notes in the financial statements, and agreed to the confirmation of scheme assets received. The sponsor auditor’s expert (if engaged) will also review the final report to ensure it is consistent with the assumptions and other information that will have been discussed with sponsor entity management and management’s actuary. The sponsor auditor should discuss any errors, or other discrepancies, with sponsor entity management, and that will help indicate if further communication with management’s actuary is necessary, in order to receive explanations or to adjust figures.
8. Information on ‘special’ events
Where there have been particular changes to the scheme in any given year, the sponsor auditor may need to request additional, specific supporting information in order for they or the auditor’s actuary (if engaged) to understand the impact of these more complex changes.
These changes might include changes to the scheme benefits. Or if the employer proposes to restructure, there may also be impacts on the scheme. As well as the sponsor auditor’s expert considering these changes, the sponsor auditor may also need to factor in that, practically, trustees may take longer to respond to queries, as the trustees will be having to spend time considering whether the restructuring will have an adverse effect on the employer covenant, and the security of members’ benefits.
Glossary
This glossary provides more detail on the parties identified in Part 1.
The following are parties on the sponsor entity side:
Management (sponsor entity directors)
The relationship between the employer and trustees is key - employers should understand the funding position of the scheme, the trustees’ strategy for addressing funding shortfalls, and be willing to work with the trustees to achieve funding objectives. For schemes still open to accrual, they should also provide the trustees with timely and accurate member information in relation to active members. The trustees and sponsor entity will commonly seek separate, independent advice in order to avoid conflicts of interest.
The sponsor entity provides what is known as an ‘employer covenant’, which represents its willingness and financial ability to meet its legal obligation to support the defined benefit scheme going forwards.
Management’s actuary
The sponsor entity’s directors will usually appoint an actuary (‘management’s actuary’) to enable them to comply with the reporting requirements of IAS 19 Employee benefits or FRS 102. Management’s actuary will advise on assumptions and assist the sponsor entity’s directors in fulfilling their responsibility to prepare the figures and disclosures in the financial statements and the related notes.
Management's actuary will often be relying on an actuarial valuation provided by the scheme actuary, carried out at a different date and for a different purpose. The scheme actuary will perform a valuation of liabilities due after the scheme’s year end, but this liability does not form part of the scheme’s financial statements and is not audited by the scheme auditor. Management’s actuary will usually adjust this actuarial valuation for different assumptions and roll it forward to the sponsor entity’s period end. In addition, the scheme actuaries are likely not working to the same concept of materiality as used in the sponsor entity audit – often using a materiality or tolerance levels for the valuation of assets and liabilities expressed as a proportion of scheme assets.
The following are parties on the pension scheme side:
Trustees
Trustees of schemes offering defined benefits are responsible for ensuring there is sufficient money in the scheme to pay members’ pensions as and when they become due. Their primary responsibility is to run the scheme solely in the interest of participants and beneficiaries, ensuring it is run properly, and ensuring that members’ benefits are secure.
A ‘trust deed’ is put in place, which sets out the trustees’ powers and the procedures they must follow. It is a legal document that sets up and governs the scheme. There will additionally be scheme rules put in place, setting out more detailed conditions.
Increasingly, the independent trustees will be professional trustees, and a recent trend is for the professional trustee to be the sole trustee. Broadly speaking, an independent trustee is accepted as being an individual or a corporate entity not employed or otherwise associated with the scheme’s sponsoring employer, fellow trustees, or scheme beneficiaries. They will have no interest in the assets of the employer otherwise than as a trustee of the pension scheme, and will be neither connected with nor an associate of the employer (Pensions Act 1995, s 23). In addition to that independence, professional trustees also bring expertise.
Trustees – who, if not a professional trustee, do not necessarily have first-hand actuarial, accounting, or other relevant experience – frequently look to other advisers for advice and services to help fulfil their responsibilities to safeguard the interests of scheme members.
The Pensions Act 1995 requires the trustees to engage certain advisers such as a scheme actuary and scheme auditor, and they will also commonly engage custodians, legal advisers, and scheme administrators. It is important to note that the legal relationship will be between the trustees and these advisers, and although sponsor entity management will be involved to some extent in financial aspects, such as ensuring VAT efficiency, the employer will not have any authority to issue instructions to the trustees’ advisers.
Although the trustees delegate certain functions affecting the pension scheme, the trustees retain ultimate accountability, and so will ensure that internal controls are in place when interacting with these other advisers.
Administrators
Trustees of pension schemes delegate aspects of administration to a third party, which may be in-house with the sponsoring employer, or more usually, through a specialist third-party administrator. Some of the largest schemes may actually have their own administrator.
The scheme administrator will normally receive member and employer contributions, maintain member records, and calculate and pay benefits on behalf of the trustees. Administrators also provide other services, such as issuing member communications, and sending out annual statements and other member documentation.
Pension administration will generate additional personal information and, as separate legal entities from the sponsoring entity, trustees will in most circumstances have a separate registration with the Information Commissioners’ Office and will therefore consider sponsoring entities as external parties for the purpose of GDPR compliance.
Investment managers
Trustees appoint investment managers to manage the funds available for investment but, again, the trustees retain ultimate responsibility for the proper use of the scheme’s funds. A Statement of Investment Principles (‘SIP’) will be put in place, which governs investment decisions and the level of risk that is acceptable to the trustees. For periods commencing on or after 1 October 2020, schemes with 100 or more members are also required to include in their annual report, depending on the nature of the scheme, either a ‘whole SIP’ implementation statement which will include information about how the trustees have put the SIP into practice, or an ‘engagement policy’ implementation statement which will set out the trustee’s policy on the exercise of rights attaching to investments.
Custodians
If the scheme invests in direct securities the trustees will normally appoint a custodian to hold the scheme investments on behalf of the trustees. Custodians provide safekeeping of the scheme’s assets, but they cannot buy, sell, transfer, or otherwise move assets unless they are explicitly instructed to do so by the trustees.
Scheme actuary
For most defined benefit schemes, the trustees are specifically required by statute to appoint a scheme actuary to provide them with necessary valuations and advice. The scheme actuary provides an actuarial valuation of the liability to pay pensions after the year-end date, as well as providing estimates for the valuation of scheme assets.
Scheme auditor
Most occupational pension schemes will be required to produce annual financial statements, and to appoint a scheme auditor in order to audit those financial statements. Scheme trustees will be interested in the controls the audit firm has in place for managing conflicts of interest. This will especially be the case where the trustees engage a scheme auditor which is the same auditor as the sponsor entity has engaged. Understandably, independence requirements prohibit the auditor from also being a trustee of the scheme in question.
As per Practice Note 15, the scheme auditor will need to request, through the trustees, information for the audit from the administrator, investment manager(s), custodian(s), sponsor entity, and scheme actuary.
Sponsor auditors will need to be aware that they may be making requests that are at a level of granularity which was not required by the pension scheme auditor.
The following are parties on the sponsor auditor side:
Sponsor auditor
The statutory auditor of the sponsor entity’s financial statements. The sponsor auditor forms an opinion on whether or not the financial statements of the sponsor entity give a true and fair view. The auditor performs a risk assessment and determines whether or not there are risks of material misstatement related to balances, transactions, and disclosures, including where an entity’s financial statements include a defined benefit pension scheme liability (or asset), and related disclosures. Where risks of material misstatement are identified, the auditor will plan and carry out audit work in order to obtain sufficient appropriate audit evidence that there are no material misstatements.
Sponsor auditor’s expert
Sponsor auditors may engage an auditor’s expert, with actuarial qualifications, in order to review the actuarial assumptions and calculations provided to sponsor entity management by management’s actuary, and the figures and disclosures in the sponsor entity’s financial statements.
The sponsor auditor’s expert, if engaged by the sponsor auditor, may also be involved in meetings or communications with sponsor entity management and management’s actuary, in order to assist the sponsor auditor to understand and challenge assumptions used and judgments made by sponsor entity management.