A momentary lapse of reason
Author: Michael-Pierre Giraud, Head of Fiduciary Services, Jersey
I feel fortunate to be quite well travelled and to have experienced numerous different cultures throughout my life. Based on this, I am fairly confident of my next sentence. A rational person, no matter which culture they are from, would not buy an expensive new private jet and then hire an unqualified pilot and only insure one engine, the seats, the wheels and one wing. It would simply not make sense to do this as the unqualified pilot is highly likely to crash the jet and only a fraction of the value would be insured.
As simplistic as this example may seem, I have frequently witnessed something far too similar with families when they are selecting a trustee. It is not uncommon for a family to appoint a trustee with little or no experience in administering the settled assets, which is unfamiliar with the planning and does not have the infrastructure to cope with the administrative demands. This lack of experience can be further compounded by the trustee not having sufficient professional indemnity insurance (PII). Such policies tend to be group wide (unless special insurance has been sought for a single structure) and may not even cover a 10% loss in the value of the assets being settled onto the trust, never mind across the trustee’s entire client base.
The principal motivation when this decision is made is often fee based. A family will select a trustee offering the lowest annual fee with little consideration of the many other important factors which should be considered.
If a trustee is undercutting the market, you need to ask how are they able to do so and why are they doing so? When considering the infrastructure required to properly run a trust company, the demands of local regulators, the domestic and international legislation a trustee needs to adhere to and, not to forget, the fiduciary obligation a trustee has to its beneficiaries, it makes you wonder how they can run their business with a long-term strategy.
With the new jet scenario, it’s clear that underinsuring an asset does not make sense however what does it mean if a trustee is underinsured? Firstly, it’s important to remember that a trustee will be indemnified against losses incurred on the trust’s funds. This indemnity cannot be relied upon where there is a breach of trust caused by fraud, negligence or wilful misconduct on the part of the trustee and it is at this point that a trustee will need to draw on their professional indemnity insurance (PII) (assuming the claim is greater than the excess) Evidencing a personal claim against a trustee, with the assistance of an expert litigation team, can be a long, arduous and expensive process however such claims do occur on an all too frequent basis. Successful claims are typically either due to the trustee being a weak trustee (and overly keen to please), because of a dishonest individual or because of human error. This is more likely to occur in firms that do not have robust policies, procedures and controls, where certain persons are dominant in an office, where a client is a significant source of revenue or an error occurs on account of inexperience with a structure and its assets. Coincidently, it is also these firms who tend to have the lower levels of PII.
In practical terms, this means that if a trust company has a PII of GBP30m, across its entire group, but regularly works with ultra-high-net-worth families (whose trusts can easily be valued in excess of GBP200m) a single claim of a 15% loss would wipe out the trustee’s PII policy for the year (across its entire group of offices). Therefore, any claim in excess of GBP30m, or a claim by another structure, would not be covered by insurance. The claim would therefore be paid from the trustee’s provisions and reserves, or any other liquidity the business can source including funds needing to be injected by its shareholders (assuming they even have sufficient assets at their disposal).
Why would a trustee have lower levels of PII? Quite simply, they may be unable to pay the premium required for a decent PII policy or they may be unable to source a robust premium on account of a poor track record with regards to historic claims against them. There are however also firms who, following a review of their client book, are taking a short-term calculated risk and believe that they will not need to make a large claim in the short to medium term. The owners/management may be of the view that when a claim is made it will be someone else’s problem (i.e. there is an intention to sell the company and its bottom line will look much better if it is not paying a large insurance premium).
With regards to the unqualified pilot, how can this be applied to a trust? At a very rudimentary level, if the trustee is neither experienced in administering similar structures or if they do not have strong policies, procedures and controls in place then there is a higher likelihood that there will be a set-up, administrative or structuring error. As set out, if this loss can be evidenced to be on account of fraud, negligence or wilful misconduct by the trustee then there is a potential claim on the trustee’s PII. If this is not the case, then the cost of remediating the position is most likely to be borne by the trust fund and the remediation can be both a long and costly exercise. It is also worth considering that once this has happened, depending on the circumstances of the loss, there is likely going to be a breakdown in the relationship between the trustee and beneficiaries. If this happens then there will be a need to appoint a successor trustee to remediate the situation.
Taking all of this into account, it may be wiser to buy a new jet, hire an unqualified pilot and underinsure it as clearly the cost of appointing a trustee which is inexperienced, or underinsured, may prove to be very much more severe.
Standard Bank Offshore Trust Company Jersey Limited is regulated by the Jersey Financial Services Commission, to provide corporate and trust services. Registered office address is Standard Bank House, 47-49 La Motte Street, St Helier, Jersey, JE2 4SZ and registered in Jersey under No 9153.
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