The Ins and Outs of ERISA Fiduciary Insurance

Fiduciary liability insurance is an important, but often overlooked, aspect of a company’s risk management plan.

This type of insurance covers liabilities resulting from fiduciary errors or omissions when operating employee benefit plans.

The insurance is optional and not a permissible substitute for a fidelity bond nor is it typically covered in a corporation’s director and officer, or D&O, liability insurance policy.

In the following article, we’ll cover:

• ERISA Fiduciary Duties Generally
• ERISA Fiduciary Insurance
• ERISA Fiduciary Insurance Policy Provisions
• Indemnification of ERISA Fiduciaries

ERISA imposes personal liability on fiduciaries who are determined to have breached their fiduciary duties.

This requires them to make the plan whole for any losses incurred by such breach or to restore any profits the fiduciary gained by the use of plan assets.

ERISA also imposes joint and several liability among multiple fiduciaries who are responsible for a breach and, in some cases, on a nonbreaching co-fiduciary for another co-fiduciary’s breach.

Fiduciary liability can arise from a host of reasons related to a fiduciary’s activities. These include:

• The selection or retention of imprudent investments;
• Engaging in transactions that present a conflict of interest;
• Failing to pay a participant the benefit amount due under the plan; or
• Participating in an act of self-dealing.

A fiduciary will also be liable for the acts of any agent it hires and must be prudent when selecting any plan vendor.

For example, an ERISA fiduciary may be challenged in its choice of an insurer that is chosen to satisfy plan liabilities in a terminated plan or the investment manager that it selects to manage all or a portion of plan assets. Further, the duty does not end at the selection process as there is a continuing duty to monitor service providers after selection.

ERISA defines the term fiduciary for purposes of applying the ERISA statutory fiduciary duties and obligations. The term includes any person (including any entity) to the extent such person is identified in the plan as a named fiduciary or, under ERISA 3(21) performs the following activities:

• Manages or invests plan assets: The individual or entity exercises any discretionary authority or control over the management of the plan or exercises any authority or control, whether or not discretionary, over the management or disposition of the plan’s assets;
• Provides investment advice: The individual or entity renders (or has the authority or responsibility to render) investment advice regarding the plan’s assets for a fee or other compensation, whether direct or indirect; or
• Administers the plan: The individual or entity has any discretionary authority or responsibility in the plan’s administration.

Even if a fiduciary is not identified as such in the governing documents, an individual or entity may still be a fiduciary based on functional terms of control and authority over plan assets.

ERISA fiduciaries are increasingly exposed to liability in making decisions relative to ERISA employee benefit plans and, given the risk of personal liability, require financial protection in the event they incur liability as a result of their activities. Unique issues exist both with respect to the types and extent of that protection.

To learn more about ERISA fiduciary duties, see ERISA Fiduciary Duties. Also, see Prohibited Transactions and Parties in Interest Checklist (ERISA Rules) when identifying various prohibited transactions which, if violated, may lead to fiduciary liability.

ERISA Fiduciary Insurance

Buying fiduciary insurance protects employers and their plan fiduciaries from fiduciary-related claims for the alleged mismanagement of plan assets or failure to follow ERISA rules when controlling or managing plan assets and paying plan benefits.

The coverage is not required but is highly recommended due to fiduciary liability exposure. For example, the following claimants may bring a civil action against the plan and its fiduciaries:

• Plan participants and beneficiaries;
• Plan fiduciaries; and
• The U.S. Department of Labor.

The DOL may also work with the Internal Revenue Service, and for most defined benefit plans, the Pension Benefit Guaranty Corporation, or PBGC, in bringing an enforcement action. On limited occasion, the U.S. Securities and Exchange Commission, the U.S. Department of Justice or state attorneys general may initiate lawsuits against a plan or plan sponsor under statutes separate from ERISA.

Coordinating D&O and Fiduciary Insurance Coverage

At first glance, employers may believe that their D&O insurance policies extend coverage to claims against ERISA fiduciaries. However, most D&O policies do not and some only by endorsement.

As a first step in evaluating the adequacy of fiduciary liability coverage you can review the client’s D&O policy to confirm whether it covers fiduciary claims.

If it does not, assist the client in adopting a fiduciary insurance policy or, if you identify an existing fiduciary policy, commence review for the adequacy of fiduciary protection.

Many D&O policies set forth an explicit ERISA exclusion. The exclusion may be absolute or provide partial coverage. If you identify this provision, coordinate the scope of coverage afforded under a fiduciary policy as closely as possible with the scope of the D&O policy’s ERISA exclusion.

Do this with an eye to eliminating any coverage gap existing between the two.

Where the plan sponsor or its ERISA fiduciaries already have fiduciary insurance, evaluate the sufficiency of that coverage, gaining insight from the plan sponsor’s risk management group, if possible.

Consider that fiduciary liability exposure may have grown since the plan sponsor last purchased or assessed fiduciary liability or its D&O insurance policy coverage.

Advise the plan sponsor about the general need to reevaluate coverage periodically. For example, if the client is a publicly traded company that added an employer stock investment to its 401(k) plan, the policy should have coverage limits sufficient to address a possible “stock drop” challenge.

For a further discussion on D&O coverage, see Director and Officer (D&O) Insurance.

Other Insurance

While ERISA fiduciary liability insurance protects plan sponsors and their ERISA fiduciaries (officers, directors and other individuals), plan sponsors may need to control other risks related to their employee benefit plans.

The following sections also discuss other types of insurance that you may instruct your client to consider that are similar to, but provide coverage distinct from, fiduciary liability insurance.

Employee Benefits Liability Insurance

While fiduciary liability insurance covers claims alleging breach of ERISA fiduciary duties, employee benefits liability insurance covers claims involving administrative errors not treated as breaches of fiduciary duty.

For example, a failure on the part of plan or sponsor personnel to name a beneficiary on a life insurance policy is an administrative act normally not covered under fiduciary liability insurance.

Some fiduciary liability policies automatically include employee benefits liability coverage, or make it available as an endorsement. Explore whether the fiduciary insurance coverage extends to administrative errors and fill any gaps in coverage.

IRS Liability Insurance

Under the Employee Plans Audit Closing Agreement Program, or audit CAP, which is part of the Employee Plans Compliance Resolution System, or EPCRS, for correcting qualified plan operational errors, the IRS can impose monetary penalties on trustees for failing to operate a retirement plan following its terms.

The IRS may impose penalties even if a plan operates along Internal Revenue Code qualification requirements.

Civil penalties, like audit CAP monetary sanctions, are not covered under a standard fiduciary or employee benefits liability policy. And most standard fiduciary liability policies do not cover the costs of correcting disqualifying defects for which a plan fiduciary is responsible.

In both instances, plan sponsors bear the liability. Even where a fiduciary liability insurance policy includes audit CAP coverage, the coverage typically doesn’t exceed a nominal amount (e.g., $100,000).

Plan sponsors may want to consider purchasing a separate IRS fiduciary liability insurance product to protect themselves and their internal fiduciaries against liability resulting from disqualifying plan operational failure.

Some carriers offer enhanced audit CAP coverage as well as coverage for the cost of making IRS audit corrections.

Cyber Insurance

Fiduciaries may wish to explore the possibility of purchasing insurance policies explicitly covering cybersecurity and privacy risks. The risk may extend to employee benefit plans like retirement plans.

The likelihood is that existing fiduciary liability insurance coverage will not cover risks relating to state law causes of action (that are not preempted) for data breaches as opposed to ERISA fiduciary liability resulting from a privacy or security breach.

Cybersecurity insurance may provide coverage not only for liability resulting from a security breach, but may help cover the costs of required notifications and other recovery steps associated with a privacy or security breach.

For a further discussion on a plan sponsor’s exposure for cybersecurity risks, see Privacy Risks for Retirement and Other Non-Health Benefit Plans.

ERISA Fidelity Bonding Insurance

A fidelity bond involves a contract with an insurance company or other issuer agreeing to reimburse a benefit plan for losses resulting from dishonest acts (e.g., theft and fraud) by persons handling plan assets. ERISA requires all plan trustees and employees who handle plan funds to be bonded.

Unless an exception applies, ERISA plan officials must be bonded for at least 10 percent of the amount of funds they handle, subject to a minimum threshold and maximum amount of $500,000 per person. The maximum may be higher in circumstances involving employer securities.

An exception to the bonding requirement exists for corporate trustees and insurance companies that have a combined capital and surplus of at least $1 million. Certain exceptions apply.

For a further discussion of the ERISA bonding requirement, see ERISA Bonding Requirements.

ERISA FIDUCIARY INSURANCE POLICY PROVISIONS

Fiduciary liability insurance protects benefit plans and plan fiduciaries from losses caused by the unintended acts or omissions of fiduciaries.

While fidelity bonds are mandatory and cover intentional wrongdoings, like embezzlement, fiduciary liability insurance covers unintentional acts. Coverage is optional and discretionary.

Fiduciary liability policies generally:

• Pay for the cost of defending a plan and plan sponsor (or other fiduciary) when there are allegations of a fiduciary breach; and
• Indemnify (compensate) the fiduciary for monetary liabilities that result from a legal settlement or adverse judgment.

As plan or plan sponsor counsel, consider the following issues when evaluating fiduciary liability insurance.

INSUREDS UNDER ERISA FIDUCIARY INSURANCE POLICIES

The insured protected by a fiduciary liability policy are the benefit plan and specific persons affiliated with the plan, like the employer.

The Benefit Plan

All fiduciary liability insurance policies include the benefit plan as an insured. Such coverage is critical because ERISA specifically provides that an “employee benefit plan may sue or be sued as an entity.”

In most ERISA suits, common practice is to sue not only the plan sponsor and other fiduciaries, but also the plan itself.

In some cases, an employer sponsoring multiple plans may purchase one policy to cover several plans it sponsors. Although this arrangement may result in some premium savings compared with insuring each plan separately, whatever limit of liability is selected applies to all plans combined and not to each plan individually.

Consequently, if there is a major claim against one of the plans resulting in substantial defense and/or settlement costs, it may leave the other plans with less protection for the remainder of the policy period.

Most carriers do not permit restoration of the liability limit during the policy period, even with the payment of an additional premium.

Another problem with multiple-plan coverage is that policy cancellation can result when a carrier experiences a significant loss on behalf of any one of the plans. Since that result leaves all the plans without coverage, this is another risk of covering multiple plans under one policy.

Specific Persons as Insureds

Past, present and future directors, executives or employees of the plan sponsor in their capacity as plan fiduciaries, and the plan, are typically protected from claims filed during the insurance policy period.

Normally, the coverage does not include the specific name of each fiduciary for coverage to be in effect. New fiduciaries contemplated by the terms of the policy are automatically covered if fiduciary changes occur during the policy period.

The initial application form, however, usually asks for the names of the present fiduciaries and sometimes the names of all fiduciaries who have served for the preceding five or six years.

This information may become a factor when a carrier is determining whether to underwrite coverage, especially if any of the trustees has been involved in prior litigation or wrongdoing.

FIDUCIARY INSURANCE PURCHASER

Fiduciary insurance is usually procured by:

• A plan sponsor for itself and/or its committees, directors, officers or employees acting in a fiduciary capacity for any of its benefit plans;
• A plan, for the same purpose; or
• By third parties that act as fiduciaries as part of the services they perform on behalf of employee benefit plans.

While employers want to protect their fiduciaries in fulfilling their fiduciary responsibilities, recognize that ERISA generally prohibits a benefit plan as a matter of public policy (but not an employer) from purchasing insurance to relieve a fiduciary from responsibility or liability.

ERISA does allow fiduciaries to use plan assets when purchasing fiduciary liability insurance to cover losses resulting from plan fiduciaries’ acts or omissions. Thus, the plan may be the insured. For a fiduciary to use plan assets for the payment of premiums:

The plan must explicitly permit the use of plan assets for the purpose of paying fiduciary insurance premiums; and

The insurance policy must have a recourse provision.

The recourse provision gives the insurance carrier the right to seek reimbursement directly from a breaching fiduciary for costs incurred by the carrier arising from the breach. The fiduciary is also permitted to purchase the liability coverage using its own assets. Most notably, an employer may do the same (using corporate assets) as may a union (using union assets).

Waiver of Recourse Provision

While insurance carriers must comply with the ERISA requirement, they recognize that recourse provisions (where a plan pays the policy premiums) significantly undermine the value of such coverage. Most carriers permit benefit plans to buy a waiver of the recourse provision which restricts the insurance company from recovering a covered loss from a fiduciary.

The provision is either a part of the basic policy or an endorsement (i.e., an amendment or addition) to it. Notably, to meet ERISA 410(b(1) requirements, the extra charge cannot be paid out of plan assets. Either each fiduciary must pay for it individually or (as is common) the employer pays for the endorsement from its corporate assets.

SCOPE OF COVERAGE

The beginning of a fiduciary liability policy typically sets forth a primary insuring clause. This clause reflects the carrier’s basic intent about what actions, omissions and losses will be covered by the policy and describes coverage limitations.

A typical primary insuring clause states that the carrier will cover damages, settlements, judgments and defense costs up to the policy liability limit for any claim provided the claim meets three criteria:

• The claimant alleges the insured has committed a wrongful act;
• The claimant seeks monetary damages; and
• The claimant files with the carrier during the policy period (typically, renewable one-year periods).

Defense costs are usually included in the limit of liability; they involve the costs of investigating, defending and settling claims, and include attorney fees, adjuster services, court costs, bonds and related expenses required as part of the claim settlement process.

Generally, policies do not cover fines and penalties imposed by law, taxes and punitive damages. Increasingly though, particularly in view of the IRS Employee Plans Compliance and Resolution Program, or EPCRS, and the DOL’s Voluntary Fiduciary Correction Program, or VFCP, insurer’s may be willing to issue policies that cover certain penalties that can be assessed under those agency programs.

In addition, policies have covered penalties under ERISA §§ 502(i), 502(l) and 502(c).

Remind the plan sponsor that outside organizations, such as service providers to the plan, are not insured under the sponsor’s fiduciary policy; these policies cover only plan and fiduciary liability for the acts of inside entities.

Accordingly, be sure that service provider agreements require that entity to maintain its own fiduciary liability coverage for its activities and errors in dealing with the sponsor’s plans.

Wrongful Acts

The key to determining what is covered by a fiduciary liability policy is understanding what the insurance carrier considers a wrongful act. Generally, a wrongful act is “any alleged or actual violation by the insured of any of the responsibilities, obligations or duties imposed on fiduciaries pursuant to employee benefit law.”

Some policies extend this language to include “any alleged or actual errors, omissions, or negligence on the part of the insured in the administration of the plan.”

This additional language provides coverage for mistakes in the day-to-day operations of the plan (such as record-keeping) even if there is no allegation of a fiduciary breach. This is the type of omission discussed in ERISA Fiduciary Insurance — Employee Benefits Liability Insurance, above.

Filing a Claim

Policyholders should file a claim as soon as possible after becoming aware of a cause of action. A claim under the policy may arise from any of the following:

• A written demand or a civil, criminal or arbitration proceeding for monetary, nonmonetary or injunctive relief;
• A formal agency or regulatory adjudicative proceeding;
• A fact-finding investigation by the DOL; or
• A written request to toll the statute of limitations relating to an ERISA violation.

In addition, most fiduciary policies cover any actual or alleged act, error or omission by an insured while acting in a settlor capacity with respect to a plan.

A settlor act is an act done in a corporate capacity, not a fiduciary capacity, such as establishing, amending, or terminating a plan. See ERISA Fiduciary Duties “Duties and Obligations of ERISA Fiduciaries” for a further discussion on settlor versus fiduciary duties.

DUTY TO DEFEND

Most fiduciary policies are written to provide for a duty to defend. This provision means typically that as long as there exists a single coverable allegation against an insured, the carrier must defend the entire claim.

However, the duty to defend may be a point that you wish to explore as a policy provision. Some fiduciary insurance policies provide that the insurer has the right to defend any covered claim.

This can lead to awkward results and you may wish to negotiate a choice of who is to defend (like from a list of available counsel). One problem that occurs is where the insurer selects defense counsel for fiduciaries in an ERISA stock drop class action while those defendants (the registrant) selects their own counsel in the tandem securities class action.

When evaluating a policy, consider advising the plan sponsor or its fiduciaries either to seek to:

• Eliminate the insurer’s right to defend covered claims; or
• Provide the insured with a consultation and consent right when selecting defense counsel.

TIE-IN LIMITS

ERISA “stock drop” class actions arise out of and allege essentially the same wrongdoing as alleged in securities class actions. Since D&O insurance policies insure against losses in those class actions, some insurers require coordinated (i.e., tied-in) limits when they issue both types of policy to the same company.

Advise plan sponsors to weigh the advantages and disadvantages of placing their D&O insurance and fiduciary insurance policies with different insurers against using a single insurer that subjects the coverage to tie-in limits.

Consider two particular issues if the insurer attaches a tie-in of limits endorsement:

• Whether the tie-in applies only to a single claim covered under both policies or to all claims covered under one or both policies.
• Whether the excess policy coverage (i.e., the liability coverage limit of the primary policy) in the D&O and fiduciary policies drops down if the underlying policies are exhausted by reason of the tie-in limit.

Even if the insurer does not require a tie-in limits endorsement, it may require allocating loss between the two types of policies, which may lead to insufficient coverage. These limits, and the potentiality for insufficient coverage, further recommend that the plan sponsor have two insurers, not one.

LOSSES

For a claim to be covered under a fiduciary liability policy, carriers generally require that the claimant be seeking losses. Losses typically include: damages, settlements, judgments, defense costs and certain covered penalties. Claims that do not meet this definition include benefit claims, wages, taxes and nonpecuniary claims.

Benefit Claims

Benefit claims are participant disputes limited to whether the participant is owed a benefit and the nature of that benefit. Normally, the dispute is limited to issues like eligibility, benefit amounts, type of benefit payable or interpretation of plan provisions.

Benefit claims generally do not include claims for damages. The claimants merely seek payment of a benefit and if they win, the plan simply pays the amount it is deemed legally obligated to pay.

While a fiduciary insurance policy will not cover benefit claims, the policy will cover requests by a claimant for damages and/or attorney fees appended to a benefit claim.

For example, a claimant who contends he was entitled to a higher monthly pension benefit, and wins in court, the plan will be responsible for that increase in monthly payment, not the insurance policy. However, the policy will provide coverage for defending that claim.

Nonpecuniary Relief

Fiduciary liability losses generally do not include claims for nonpecuniary relief. This includes actions under ERISA § 502 which section specifically authorizes participants, beneficiaries, the DOL and fiduciaries to take civil action to enforce or clarify a participant’s rights or obtain equitable relief for an ERISA violation.

An example would be a situation where the DOL prohibits fiduciaries from making certain real estate investments considered imprudent or a court order removing a fiduciary and prohibiting that person from acting in any future fiduciary capacity.

CLAIMS MADE

Fiduciary liability policies are usually claims-made policies, under which claims are covered for conduct taking place prior to or during the policy period.

Under ERISA, the statute of limitations period is six years for a fiduciary breach, unless the claimant had actual knowledge, which reduces the limitations period to three years. Thus, a viable claim can potentially arise five years after the alleged breach of fiduciary act occurred.

The submission of such claim in the current year would be covered under the current policy. In effect, fiduciaries have retroactive coverage.

REPORTING A CLAIM

As indicated above, a claim has to be first asserted against the plan/plan sponsor during the policy period. The covered party must then report the claim to the carrier as soon as practicable during this same policy period.

An otherwise covered fiduciary claim not reported in a timely manner and in accordance with the policy’s reporting provisions, may not be covered. Instruct your clients accordingly. Where an opportunity is missed the client may have to purchase extended coverage, although this may exclude known omissions.

ALLOCATIONS

On occasion, a claim may be made against both the insured and against uninsured parties such as third-party administrators or other plan vendors. Here, the insurance carrier may seek to allocate defense costs. The policy may also include a coverage coordination clause which operates where more than one insurance policy applies. Thus, different insurers may have to allocate defense costs between or among them.

An employer who has employee benefits liability insurance, discussed above, may also have to allocate defense costs between its policies (for example, where an omission in plan administration occurs in tandem with a claim alleging fiduciary breach).

Another time where allocation is required occurs when an ERISA § 510 claim is made. ERISA § 510 makes it unlawful to take an adverse action (i.e. discharge, discriminate) against a participant for:

• Retaliation: Exercising their rights under an employee benefit plan;
• Interference: For the purpose of interfering with the attainment of a right the participant may become entitled to; or
• Whistleblower: Where the participant has given information or is about to testify in a proceeding.

An ERISA § 510 claim may also include claims under other statutes such as the Age Discrimination in Employment Act, Family Medical Leave Act, American with Disabilities Act,

Fair Labor Standards Act, or Pregnancy Discrimination Act. These other claims may be covered under another policy such as an Employment Practices Liability Policy (a policy covering claims made by employees alleging discrimination wrongful termination, or harassment). Coordination of policies is required.

OTHER FIDUCIARY LIABILITY INSURANCE EXCLUSIONS

Exclusions specified in policies may result from:

• Definitions of terms;
• Specific exclusions in the basic policy; or
• Endorsements attached to the basic policy.

Regardless of how and where they are presented, exclusions can have a significant impact on the scope of coverage and require your careful examination.

Exclusions by Definition

Some policy exclusions are expressed via policy definitions. For instance, fiduciary policies usually define loss as not including:

• As discussed above, (1) damages for routine benefit claims unless the claimant seeks compensatory damages and/or the fiduciaries are held personally liable, and (2) nonpecuniary claims based on ERISA § 502 (e.g., a DOL injunction).
• Taxes or tax penalties (other than covered penalties).
• Punitive or exemplary damages.
• Matters which may be deemed uninsurable under the law.

Exclusions by Enumeration or Endorsement

Other policy exclusions apply for:

• Contractual liabilities, such as hold harmless clauses.
• Benefits payable to participants.
• Fraud, illegal personal profiting, criminal or malicious act, if such conduct was determined in a final, nonappealable judgment or adjudication.
• Securities law violations.
• Racketeer Influenced And Corrupt Organizations Act, or RICO, violations.

José Jara has over 20 years of employment, ERISA and employee benefits law experience and is a partner and the ERISA and Employee Benefits Practice Group Leader at CKR Law.