Protect Fiduciaries with the Right Insurance

The ERISA fidelity bond guards against fraud or dishonesty on the part of the plan’s fiduciaries, explains Jackson, vice president and consultant of Segal Select Insurance. Every fiduciary of a plan and every person who handles funds or other property of a plan must be bonded.

“ERISA only mandates that a plan maintain fidelity bond coverage,” at a minimum of 10% of a plan‘s assets for any person or entity that has control over the plan assets, says Philip J. Koehler, chief executive of ERISA Fiduciary Administrators LLC. This includes any party that has any control of either assets going in or distributions going out—both situations contain the potential for fraud or embezzlement. He adds that bonds can be used by an insurance company for subrogation rights where the fiduciary is found liable, in some cases, then sue the insured to reclaim costs.

Koehler notes that ERISA creates exposure, but doesn’t actually require any insurance against this exposure for fiduciaries. Scouting all possible insurance options is a practical matter. “If you’re a fiduciary, you’ll feel a need for fiduciary liability insurance and any other source of indemnification,” he says, pointing out that ERISA prohibits a benefit plan from indemnifying the fiduciaries.

ERISA also prohibits the use of plan assets to cover losses, so plan fiduciaries need coverage. Most available is fiduciary liability insurance, which provides defense settlement and judgment coverage for two areas, Jackson tells PLANSPONSOR. The insurance covers allegations of breaches of fiduciary responsibility and errors and omissions (E&O) in benefits administration. Examples of E&O might be errors in determining eligibility or benefit levels, calculation of benefits, or the various administrative functions that every plan deals with on a day-to-day basis, he explains.

Plan sponsors must first identify who are the plan’s fiduciaries. “This begins with the false notion that when the employer establishes the plan and hires a third-party administrator (TPA) or recordkeeper or trustee, somehow these people are the fiduciaries,” Koehler tells PLANSPONSOR. “Nothing could be more incorrect. Most of these providers go to great lengths to ensure that they are not fiduciaries, and they demand that the corporation indemnify them.

It is something of a paradox, but Koehler says these providers can often be quite firm that they have no fiduciary status or responsibility to a plan, yet at the same time do little to disabuse employers of this notion. 

For many fiduciaries, an important aspect of the coverage is that it protects the personal assets of the trustees. “They can be held personally liable,” Jackson points out. “The policy provides defense costs and falls under the broader scope of indemnity.” Policies do have a waiver recourse premium, which protects personal assets and which is usually paid out of non-plan assets. Jackson says many fiduciaries pay for this premium using personal assets. It is usually around $25 per trustee, but is generally paid as a lump sum per plan.

Coverage for What?

The most common claim Jackson sees is a benefits due claim. Whether from a retirement plan or health plan, a participant or group of participants says they didn’t receive the proper benefit, or it was denied, or wasn’t calculated properly, he explains. Eventually the claim can become a lawsuit, and at issue is the difference in benefit amount. The value of a fiduciary liability policy is that it will protect the defendants while they are fighting the dispute; it is not designed to pay the benefit.

Other claims come from regulator action. “We’ve seen a more aggressive regulatory landscape,” Jackson says. The Department of Labor (DOL) looks at expenses, policies and procedures in an investigation. What was the due diligence that trustees put in? Disputes over fees, vendor selection and all aspects of the plan can become the subject of an investigation.

Jackson points out that it is not necessarily the end result but the process that is important. As in 2008, nearly every fund can lose money, so fiduciaries and plan sponsors must be sure that due diligence was carried out, and that they received expert advice and consistently monitored fees and vendors. “That’s the best way the trustees can protect themselves,” Jackson advises. “Have good policies in place and follow procedures.” 

Coverage to consider other than for ERISA claims are employment practices liability insurance to cover wrongful acts that arise from wrongful termination, discrimination and sexual harassment. A growing field, adds Jackson, is cyber liability for data protection on the retail side.

Know What You’re Getting  

Insurance companies pick and choose the areas for which they feel comfortable offering coverage, Jackson says. A good broker can walk the plan sponsor through what a policy does and does not cover. Scope of coverage is key, he cautions, because the policy won’t cover everything.

The cost of the premium is also important, because it comes out of plan assets. “It is completely valid to be aware of and sensitive to cost,” Jackson says. “But the cheapest plan might not have good coverage. For large asset bases, you are not going to have 100% coverage. You need a level of risk tolerance you’re comfortable with. Individual carriers can offer from $1 million to $25 million in coverage.” Asset size might warrant towers of coverage, he says. Policies can be “stacked” on top of each other.

One aspect of fiduciary liability policies—recourse—goes against standard insurance concepts, Jackson says. Built into ERISA is the ability to use plan assets to purchase a policy if the insurance carrier retains recourse against the fiduciary. In other words, the insurance company agrees to cover the fiduciary, but has the right to sue the fiduciary to recover the costs.

Koehler points out that one of the first out-of-pocket costs, in a worst-case scenario, is going to be hiring a lawyer. A good policy should cover advancement of defense costs, he says. This covers the immediate reimbursement or direct payment of legal fees for the defense. He calls this clause a must-have, and warns plan fiduciaries to be on the lookout for crafty exclusions. 

Policies may also have exclusions for willfulness or gross negligence. Koehler calls these exclusions unacceptable, but admits that battling with an insurance company to remove such clauses is only occasionally successful. “If you are adjucated liable, and your liability stems from something you willfully did, the insurance company won’t cover it.”

What are the definitions for gross negligence or willfulness? Koehler cautions that the insurer sometimes does not define these terms, or uses a vague definition. The best way to handle this for the fiduciary’s interests is to restrict definitions to be as narrow as possible, and objectively based on a court’s findings

Clawback clauses are another risk, Koehler says. You want to make sure the insurer is not going to claw back any defense costs if the fiduciary is adjudicated liable.

Another area to be wary of are settlements. “What if, instead of going to trial, the case is settled, never adjudicated?” Koehler says. It happens frequently and plan sponsors want to make sure the policy covers this situation. “The fiduciary liability insurance carrier needs to be notified in advance and will look at the terms of the settlement agreement,” he says. They have to review the terms and be a part of the process, and if the fiduciary fails to notify them—usually with 30 days or 60 days advance notice—they can use it for the basis of an exclusion.

Interior limits in the policy deserve scrutiny, Koehler says. With per-transaction limits, the insurer will not pay more than $5 million (as an example) per violation or per breach. The figure and limit should be related to a percentage of the plan’s assets.

“Most of the time no one ever thinks anything will ever happen, and when it does, the situation can be enormously difficult and troubling... and big,” Koehler says.

The policies are almost custom-built for qualified retirement plans, Jackson says. “We’ve found that fiduciary policies are really designed around ERISA, and they do work. Every fiduciary needs to consider this insurance,” he concludes.