Trustees and Fiduciaries Liability Insurance

TRUSTEES AND FIDUCIARIES LIABILITY INSURANCE

(March 2020)

A fiduciary (one who manages the affairs of another) who manages a pension or employee benefit plan faces substantial liabilities that are, primarily, framed by the Employee Retirement Income Security Act (ERISA.). Private pension and employee benefit plans sponsored by single employers, multi-employers, unions or joint labor-management trusts, are subject to ERISA. The following discusses the key provisions of a typical policy written to cover the fiduciary liability of those persons and organizations performing such duties under ERISA.

Analyses of ERISA

ERISA is one of the most important pieces of federal legislation related to insurance that has ever been enacted. The legislation does the following:

·         Guarantees workers pension benefits

·         Establishes a private pension plan control system

·         Provides tax reporting requirements for plans

·         Creates penalties that can be sought against Act violators

·         Sets vesting rights for plan participants 

·         Expands trustee and fiduciary responsibility to entities that exercise any control or authority over the operation of pension or employee benefit plans.

The types of plans covered by ERISA are pension plans, profit-sharing, thrift and savings plans, such as 401(k) plans, employee stock ownership plans (ESOPs). In addition, welfare plans, such as life, health, dental, accident and disability, prepaid legal and other benefits are covered.

Some plans are exempt under ERISA, usually because they are subject to other, more specific laws, such as workers compensation, unemployment compensation and disability benefits laws. Plans of federal and state governments and their subdivisions do not fall under the law. Other exemptions exist for church benefit programs, worker voluntary programs (which are funded entirely by employee-purchased insurance) and plans covering nonresident aliens. A final exception is granted to benefit payments that are handled via traditional (and documented) payroll practices.

Fiduciaries Defined Under ERISA

An individual or corporation is considered a fiduciary if that person or entity exercises discretionary authority or control over the management of any employee benefit plan. [Section 3 (21) (A)] The term would apply to the parties named on a corporation's written instrument, officers and directors of a corporation, members of a trust which administers the plan and certain outside organizations that provide administrative services to those that manage the plan.

Outside organizations would include consulting firms; administration firms (that perform functions required by benefit plans, such as enrollment, claims payments, record keeping and filing), actuarial consultants, accounting firms, attorneys, investment advisors, investment managing firms and bank trust departments.

A pension or benefit plan must be established and maintained in accordance with a written document to be eligible under ERISA. Such a document must specifically designate one or more fiduciaries and also outline a procedure for carrying out the funding policy to achieve the plan's objectives.

Also specified under the documents are methods for allocating operational and administrative responsibilities, a means of amending the document if necessary, and the basis on which payments are made to and from the plan.

Standard for ERISA Fiduciary

Under ERISA the fiduciary must discharge his or her duties "with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent (sensible) person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims." This standard is higher than what is imposed by common law since the Act requires the fiduciary to perform at the level of care and skill of a person who has expertise in such matters.

Responsibility of ERISA Fiduciary

Applying this higher standard, a fiduciary is responsible for performing his or her duties with respect to the plan solely in the interests of the participants and beneficiaries for the exclusive purpose of providing benefits to such participants and beneficiaries. A fiduciary must minimize the expenses of administering the plan and must diversify the plan's investments in order to reduce the risk of large losses (unless diversification is the less responsible course of action).

 

Example: A group of employees sues their company’s pension plan administrator for failing to diversify their plan's investment portfolio. The suit fails because the administrator has documentation showing that he had investigated switching funds to the other investment vehicles authorized by his employer’s plan and found that the costs substantially outweighed the possible return.

 

Prohibited Transactions

Forbidden transactions between a plan and a party at interest (fiduciary, service provider, employer or owner) are outlined by ERISA. Principal examples of prohibited transactions are:

·         The sale, exchange or leasing of property

·         Lending money or extending credit

·         Furnishing goods, services or facilities

·         Transfer to or use of plan assets by or for the benefit of a party of interest

·         Acquisition of qualifying employer securities or real property in excess of certain limits.

A fiduciary may not handle plan assets in his or her own interest or his or her own account, nor involve the plan on behalf of any person having an adverse interest.

In the event that a plan engages in a prohibited transaction, the IRS may levy a 50 percent excise tax. This tax may be increased if the violation is not corrected within a certain period of time. The Department of Labor may also levy a penalty based on the amount of the fiduciary's breach of duty.

According to the law, all fiduciaries and persons who handle plan funds or assets must be bonded for 10 percent of the aggregate amount handled, with the minimum bond being $1,000 and the maximum, $500,000. Bonding is handled by attaching an ERISA Rider to the insured's crime insurance policy.

Note: The Department of Labor has the authority to increase the bond amount required for a given plan.

A fiduciary that breaches any of the responsibilities, obligations, or duties imposed upon him by the Act, may become personally liable to reimburse the plan for any losses that result from this breach.

Common instances of fiduciary breach include:

 

Example: Beth works full-time as Acme Furnishing’s COO. She administers her company’s benefits plan and the company’s investment advisor is Faithful Investors LLC. However, Beth does not disclose that she holds 35% ownership of Faithful Investors.

 

A fiduciary is obligated to restore to the plan any profits which he or she has made through the use of the plan's assets. Fiduciaries are also subject to other equitable or remedial relief considered appropriate by any court, including removal of the fiduciary. (Such liability is outlined in Section 409 of the Act.)

The Act in Section 405 also makes provision for a fiduciary's liability for a breach of fiduciary responsibility of a co-fiduciary with respect to the same plan. He or she is liable when knowingly participating in or undertaking to conceal an act or omission of another fiduciary or enabling such other fiduciary to commit a breach. He or she is also liable when there is knowledge of a breach of a co-fiduciary, unless a reasonable effort is made under the circumstances to correct such breach. However, under Section 405 (D) (1), if an investment manager or managers have been appointed, then no trustee or fiduciary is:

The above Section 405 also limits the personal responsibility of a trustee to only the responsibility provided in the plan's trust instrument.

Section 502 D of the Act provides that the employee benefit plan itself may sue or be sued as a legal entity for violation of provisions of the Act.

Exculpatory Clauses

Another way that ERISA imposes greater liability on fiduciaries is to disallow exculpatory clauses. In other words, the section voids any agreement or instrument of a trust or plan provision that attempts to relieve a fiduciary from responsibility or liability for any responsibility, obligation or duty since such clauses would, essentially, operate against public policy.

ERISA Permitted Fiduciary Liability Coverage

The Act permits the purchase of insurance to protect a fiduciary or trustee against his or her personal liability for negligent errors and omissions under Section 410 B. Insurance may be purchased out of the assets of the plan or trust to protect the plan itself and its fiduciaries for losses occurring by reason of the act or omission of a fiduciary. The latter is permitted only when the insurance permits the carrier to subrogate against the fiduciary or fiduciaries for a loss caused by a breach of a fiduciary obligation.

The Act further permits an individual fiduciary to purchase insurance to cover his or her own personal liability. ERISA also allows an employer or a union to buy insurance covering the potential liability of one or more persons who serve in a fiduciary capacity with regard to an employee benefit plan.

In a mid-1975 interpretation of the Pension Reform Act, the Labor Department interpreted the law as allowing corporations and labor unions to indemnify fiduciaries as an alternative to purchasing fiduciary liability insurance. The Labor Department said that while indemnification agreements do not violate the Act's ban on exculpatory clauses, parties entering into an agreement should consider whether the agreement complies with the Act's other provisions and with other applicable laws. The indemnification agreement must leave the fiduciary fully responsible and liable and permit another party to satisfy any liability incurred by the fiduciary in the same manner as insurance.

Two examples of indemnifications arrangements were cited in the Labor Department's interpretive bulletin 75-4.

1. Indemnification of a plan fiduciary by (a) an employer, any of whose employees are covered by the plan, or an affiliate of such employer or (b) an employee organization (union), any of whose members covered by the plan.

2. Indemnification may be carried out by a plan fiduciary of the fiduciary's employees who actually perform the fiduciary services.

The options of insurance and indemnification arrangements covering personal liability of fiduciaries or corporate entities are not mandatory. They are certainly desirable and probably necessary in cases where pension and employee benefit plans are managed by trusts under the Taft-Hartley Act. There are varying degrees of fiduciary responsibility, ranging from little or no discretion or control over the administration of the plan on the part of an employer who appoints representatives to a pension or employee benefit trust on the part of a multi-employer trust or union-management trust to absolute discretion or control by the employer and his board of directors.

Coverage

A number of underwriters, including Lloyds, have designed coverages to meet the needs of fiduciaries, sponsoring organizations or trusts and plans themselves. As dictated by the Act, the insurers providing for insurance of the plan's fiduciaries, and paid for by the plan, do provide recourse against the fiduciary in case of a breach of fiduciary responsibility. Several insurers have issued endorsements waiving this provision or have provided Recourse coverage separately for the benefit of the fiduciaries.

Policies written to protect fiduciaries under ERISA provide for liability protection for "wrongful acts" committed in administration and management of pension and welfare plans.

Typically, a wrongful act is defined as any breach of duty specified in ERISA or liability of fiduciaries as established under statutory or common law. Most policies also include specific coverage for administrative errors and omissions associated with managing pension and benefit plans.

Fiduciary Liability policies also cover breach of fiduciary duty by any other person for whom the insured is legally responsible.

This coverage is very important because, under ERISA, a fiduciary is held liable for acts, errors or omissions of a co-fiduciary, such as organizations outside of their own company. These organizations are not insureds under the policy, which only covers the sponsoring organization's liability for their acts, errors or omissions.

Parties able to file claims against fiduciaries are limited by ERISA and states laws. Authorized claimants include:

·         Benefit/pension plan participants

·         Benefit/pension plan beneficiaries

·         Government enforcement officials

·         Benefit and pension plan regulators

Parties that are likely (and authorized) to bring actions include the Department of Labor, the Pension Benefit Guarantee Corporation, State Attorneys General, the Internal Revenue Service, and the Securities and Exchange Commission.

Insured Parties

Persons and organizations covered under the Fiduciary Liability policy include:

·         The specific plan or plans designated in the declarations of the policy

·         The sponsoring organization

·         Individuals serving as trustees, directors, officers or employees of the plan or organization

·         Any other person or organization specified in the declarations or endorsed on the policy

Most policies provide for automatic coverage of pension or welfare plans of the sponsoring organization that the insured fiduciaries might control in the event of a merger or acquisition.

This provision further stipulates that this automatic coverage extends for a period of 90 days, during which the insured must notify the underwriter of such changes. If the insured desires coverage beyond the 90-day period, a separate application must be made and addition premium charged for this exposure.

What Is Covered

Loss is defined under the Fiduciary Liability policy as the amount of money that the insured is obligated to pay in satisfaction of a claim for a wrongful act. Such loss would include interest, attorney's fees and judgments.

 

Example: Several retirees join together to sue their former company’s plan administrator. They allege that the administrator, for several years, made delayed deposits into the company plan, resulting in thousands of dollars in lost interest.

 

The following would not be covered under the policy:

·         Civil or criminal fines, penalties, sanctions or taxes, other than a civil penalty levied under a section of ERISA

·         Benefits payable to a participant or beneficiary of an employee benefit plan

·         Contributions payable to the employee benefit plan

·         Damages based upon a court's determining that the insured engaged in conduct that it knew was  a breach of its responsibilities

·         Fiduciary liability policies also pay for defense costs for the investigation of claims, including attorney's fees, adjusters' services, court costs, bonds and related expenses

Under most policies defense costs are included in the limit of liability, and therefore reduce the policy's limit. Few insurers provide defense cost coverage in addition to policy limits.

The insurer may not settle any claim that has been agreed upon without the covered party's consent. If the insured refuses an insurer's settlement recommendation, the insurer is not obligated to pay any loss in excess of the recommended settlement or for any further defense cost coverage for the claim.

Exclusions

As previously stated, the policy is a nonstandard form. Exclusions vary among carriers, so it’s important that the insured pick the policy that most favorably fits into the insured risk.

The following are a few of the exclusions most commonly found in Fiduciary Liability policies:

Contractual Liability

This exclusion bars coverage for situations where the insured might hold harmless a third party, such as an accountant or actuary, for services provided in the operation of a pension or benefit plan. Such hold harmless agreements are excluded for at least two reasons. First, it is assumed that third party professionals carry their own insurance to cover their errors and omissions. Second, underwriters are reluctant to provide contractual liability coverage on hold harmless agreements unless they are aware of them at the policy's inception.

Criminal Acts

Fraud and illegal profiteering are excluded. However, an insured would have to be proved guilty (usually via a court decision) that criminal activity was involved, rather than just an allegation.

Punitive Damages

Damages awarded with the intent to punish or set an example are ineligible for coverage.

Known Events

This refers to facts or circumstances that, at the fiduciary liability policy's inception date, the insured had reason to believe that such circumstances or events might result in a claim. These are normally excluded because these prior events fall under coverage of a prior insurer or the current insurer's prior policy period.

Bodily injury, property damage or personal injury

However, claims arising out of (unfair) discrimination as described in Section 510 of the Act are not subject to this exclusion.

Other Excluded Items

Most policies typically deny coverage for losses involving:

Limit of Liability

The limit of liability is the total amount payable for settlements and defense costs in connection with a claim under the policy. This limit may not exceed the amount stated in the declarations as an aggregate amount.

Most Fiduciary Liability policies contain a non-accumulation or interrelated act clause that stipulates that if a series of claims made against one or more insureds results from a single wrongful act, error or omission, it is deemed to have been made when the first of such claims is made (so it is considered a single covered loss).

Deductible

Fiduciary liability insurance policies contain a deductible clause that applies to each wrongful act rather than to each separate claim. As under the non-accumulation clause, the deductible applies to a single wrongful act, even if two or more claims might relate to that act. The deductible applies to both loss and defense costs.

Coverage Trigger

Fiduciary liability policies are written on a claims-made basis. To be covered under a claims-made policy, a claim must first be made against the insured during the policy period. Claims made policies written on other types of professional liability policies often contain retroactive dates that bar coverage for wrongful acts occurring prior to that date. However, Fiduciary Liability policies are not usually written with retroactive dates, providing full prior acts coverage.

Note: This fact is tempered by the policy exclusion for a claim arising out of an incident known by the insured to have taken place prior to the policy's inception date.

If an insured becomes aware during the policy period of any wrongful act which could give rise to a claim and gives written notice of such act to the underwriter, then any subsequent claim is deemed to have been made against the insured during the policy period, regardless of when the claim is actually made.

Extended Reporting Provision

If the policy is cancelled or not renewed by the insurer, the insured has the right to purchase an extended reporting period option in which to report a wrongful act committed prior to the effective date of the cancellation or nonrenewal. There is no coverage for an act that takes place during the extended reporting period itself.

The extended reporting period can be elected by the insured within 10 to 30 days prior to the cancellation or expiration of the policy. The time limit is usually stipulated in the policy.

The length of the extending reporting period may be stipulated in the policy or in the declarations. Most underwriters provide one-year periods, although the insured may try to negotiate for a longer time period if the need arises.

The cost of purchasing an extended reporting period is usually stipulated in the declarations page or stated as a percentage of the expiring policy's premium in the clause itself.

Other Conditions

Cancellation

The policy may be cancelled by the insured at any time by written notice to the insurer. The policy may be cancelled by the insurer by mailing to the insured's address a written notice stating when cancellation is to be effective. The insurer must give at least 30 days notice, or 10 in the case of non-payment of premium.

Subrogation and Recourse

In the event of the payment of a claim under the policy, the insurer is subrogated to the extent of the payment to the insured's rights of recovery from others.

If premium for the insurance is paid out of the assets of the employee benefit plan, the insurer has right of recourse required under Section 410 B of ERISA, unless the individual insured has paid a waiver of recourse premium.