Retirement plan sponsors are more exposed to litigation by plan participants than ever before. Under the Employee Retirement Income Security Act of 1974 (ERISA), plan fiduciaries can be held personally liable for any breach of fiduciary duties, errors, or omissions.
Hiring an outside advisor or other vendor to oversee fiduciary functions often offers no refuge because plan sponsors and fiduciaries, both individually and collectively, have a responsibility to monitor the actions and inactions of any service providers engaged on the plan’s behalf.
Because litigation exposure has grown, many plan sponsors have no idea of the magnitude this uncovered risk may pose. Plan advisors that understand the current industry landscape are in a unique position to provide valuable perspective and to help make sense of the current environment.
Fiduciary liability insurance (FLI) offers a practical way to help protect plan sponsors and their employees against fiduciary-related claims. Typically, it covers the sponsoring organization’s officers, directors, and other individuals acting as fiduciaries in a plan benefit, investment, or administrative capacity.
If a claim of plan mismanagement is made against an insured party in areas including poor investment practices, inadequate diversification options, excessive fees, enrollment, or termination administrative errors that result in lost benefits, the insurer will typically pay for legal defense expenses, financial losses, judgments, or settlements, up to policy limits.
FLI is different than standard plan sponsor coverage, which is normally a first party policy sometimes used to restore losses caused by errors, even when no wrongful act has been alleged by a participant.
Intended as an extension of that coverage, FLI is a third party policy, which means that it generally requires a claim of wrongdoing to be made against the insured. FLI policies generally include duty to defend provisions that outline the insurance carrier’s right and obligations to defend against the claim, often preserving the right to select defense counsel. This can be a benefit to some sponsors, and for others may be an important consideration.
For plan advisors looking to help their plan sponsors, three reasons that FLI may make sense include:
Reason 1: Indemnification agreements may provide little shelter
Under ERISA Section 410, plans are prohibited from indemnifying a fiduciary for a breach of duty. However, the plan’s sponsor, typically the fiduciary’s employer, may choose to enter into an indemnification agreement with its fiduciary employees. This kind of agreement, while useful to employees, can provide a false sense of comfort for everyone involved.
For starters, indemnification agreements generally remain valid only if it can be established that a fiduciary under scrutiny has acted in good faith and in the best interests of plan participants. Even when that is the case, there is the risk that indemnification proceeds may not be available because:
- Plan sponsor employers may not have the strength, liquidity, or expertise to protect its fiduciary employees.
- Plan sponsor employers may not be on the hook to cover defense expenses up front. In fact, many won’t cover defense of an employee until (and unless!) there is a favorable outcome in litigation.
- Courts are increasingly questioning the legality of indemnification agreements, whether or not cases involve allegations of willful wrongdoing.
- Some jurisdictions prohibit indemnifications outright and some state corporate laws disallow or limit fiduciary indemnification.
Reason 2: Required fidelity bonds only cover theft and fraud
Fidelity bonds and FLI policies are designed to work hand-in-hand, since these two safeguards cover don’t cover the same risks. ERISA fidelity bonds are required by law and are meant to protect plans against loss resulting from acts of theft and/or fraud.
Typically, anyone who handles plan assets individually or as part of a group must be bonded. This coverage can be paid for out of plan assets and is subject to detailed requirements to satisfy ERISA guidelines.
Fiduciary liability insurance specifically protects against claims of fiduciary breaches and is not required by ERISA. Indeed, the decision to purchase it is a fiduciary act in itself. Coverage can be paid for by the plan but, if so, the policy must allow recourse by the insurer against the fiduciary in the case of actual duty misconduct. Fiduciaries may individually purchase a non-recourse rider from the insurance carrier. If the fiduciary or employer purchases the insurance (not using plan assets), no recourse provision is necessary.
Reason 3: Traditional plan insurance won’t cover breach of fiduciary duty
Employee benefit liability (EBL) insurance generally protects against a wide range of errors or omission claims in plan administration (also often covered by fidelity liability insurance), but it usually excludes breach of fiduciary duty under ERISA. It is also typically more restrictive in its terms and conditions.
Directors and officers (D&O) liability policies are not intended to provide ERISA-related coverage. These policies typically only apply to company directors and officers acting in those capacities but not as plan fiduciaries, even if both roles are filled by the same individuals. Many policies also exclude any claims of ERISA violations, but even when that is not the case, they often fail to protect the plan, company, and any non-officer fiduciaries.
Checklist for fiduciary insurance provisions
For plan advisors assisting plan sponsors considering fiduciary liability insurance as part of a comprehensive risk management program, the questions below offer a starting point to help begin reviewing options.
Who is buying the policy?
The buyer matters here. If the plan purchases the policy, then the insurer will reserve the right, through a recourse provision, to come after the insured to recover the amount of a paid claim, plus costs, under certain circumstances.
Typically, the insured will be required to purchase a non-recourse rider to ensure the insurer does not seek to recover the cost of paid claims from the insured. If the employer or the fiduciary purchases the insurance policy, this kind of recourse provision is not necessary.
What are the cost considerations?
Any purchase of insurance by the plan must be prudent and solely in the interests of participants and beneficiaries, with no greater expenditure of plan assets than necessary. Also consider deductibles and policy limits.
Who is insured?
Be sure the definition of insured also includes the plan and the employees of the plan or corporate plan sponsor who may functionally act as a fiduciary to the plan.
How broad is the coverage?
Verify that the policy is broad enough to cover more than just breach of fiduciary duty, as errors, omissions, or negligence may not necessarily be breaches of fiduciary duty.
How is the “duty to defend” provision defined?
Consider a broad “duty to defend” provision that is triggered at the time any claim is made. Similarly, there are some instances where “gap coverage” that is, coverage that commences at the time the plan receives a notice of investigation, may be preferable.
Also negotiate the right to select counsel, if it makes sense, and consider that it may be appropriate to have separate counsel for multiple insured defendants. Coverage should also extend to nonmonetary as well as monetary claims, and defense costs should be reimbursed as incurred, rather than at conclusion of the matter.
What is considered a claim?
The definition of the claim should not exclude coverage for nonmonetary claims, such as suits for injunctions, nor should it be too limiting in other aspects (e.g., covering demand in court but not a demand made in a DOL letter).
What are the notice requirements?
Providing “notice of potential claim” may extend the discovery period because otherwise, the claim would be deemed to have been filed at time of an actual “claim notice” to the insurer.
Plan advisors are wise to encourage plan sponsors not currently covered by FLI to consider adding the insurance. Advisors can provide much needed support to their plan sponsor partners by being able to discuss the significant elements shaping today’s industry and knowing the right questions to ask.
By Jon Blaze is with the Institutional Intermediary Business of MainStay Investments.
With more than 20 years serving financial markets, John Sullivan is the former editor-in-chief of Investment Advisor magazine and retirement editor of ThinkAdvisor.com. Sullivan is also the former editor of Boomer Market Advisor and Bank Advisor magazines, and has a background in the insurance and investment industries in addition to his journalism roots.
