New Year's Resolution: Does Your Fiduciary Liability Insurance Need a Check-Up?

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The Alert:

The role of a fiduciary to an employee benefit plan regulated under the Employee Retirement Income Security Act of 1974, as amended ("ERISA") has become more precarious in recent years.  Litigation against plan fiduciaries is on the rise, especially with respect to fiduciaries to 401(k) plans.  Claims against fiduciaries – individual claims as well as class actions – are becoming more common.  Participants are seeking relief for excessive fees and expenses, inappropriate investment options, and harm resulting from fiduciaries' misrepresentation of the risks of investing in employer stock and/or failure to comply with plan terms.  Under ERISA, plan fiduciaries are personally liable for breaching their fiduciary duties, which can put their personal assets at risk.  However, ERISA also provides that insurance may be purchased to cover fiduciaries who risk personal liability exposure.  As a result, plan sponsors typically purchase fiduciary liability insurance to protect the employees who serve as fiduciaries of their retirement plans.

It is important for plan sponsors and fiduciaries alike to understand how fiduciary liability insurance works and to periodically review their policies to ensure adequate protection.  Orrick's compensation and benefits attorneys and insurance practice attorneys can provide assistance with this review.

A.     What Is Fiduciary Liability Insurance?

Fiduciary liability insurance is not to be confused with executive liability insurance (or directors and officers (D&O) insurance) or the fidelity bond required by ERISA [1].  D&O insurance typically only
covers directors and officers when they are acting in their capacity as directors and officers, not when they are acting as ERISA plan fiduciaries.  D&O insurance may also specifically exclude ERISA violations from coverage.

The fidelity bond required by ERISA protects plan assets from losses arising from misuse or misappropriation by those who "handle" the plan assets.  Its purpose is protection of the plan; it does not protect fiduciaries.  The U.S. Department of Labor (DOL) has specifically stated that the mandatory fidelity bond is not the same as fiduciary liability insurance [2].  Fiduciary liability
insurance is typically sold as a policy separate and distinct from a fidelity bond.  A fiduciary liability policy may be sold on a stand-alone basis, or bundled with another policy such as a D&O policy.

Fiduciary liability insurance typically protects "insureds" against "loss" resulting from "claims" arising from "wrongful acts."  "Insureds" can typically include the plan sponsor's officers, directors and employees who act in a fiduciary capacity (e.g., as plan trustees, plan administrators or members of administrative or investment committees).  "Loss" can be broadly defined and include damages (such as damages awarded flowing from investment loss) and certain fines and penalties awarded under ERISA or the Internal Revenue Code.  "Claims" can similarly be broadly defined to include demands, judicial or regulatory proceedings, filing of orders or notices of investigation.  "Wrongful Acts" generally include breaches of fiduciary duty in plan administration. 

While "insureds," "loss," "claims" and "wrongful acts" can be broadly defined, every policy is different and each policy contains exclusions.  It is important for plan fiduciaries to understand exactly how what the policy covering his or her actions covers and does not cover.

B.     Why Is It Important For Plan Sponsor and Fiduciaries To Review Their Fiduciary Liability Insurance Policies?

A review of a fiduciary liability policy typically unearths details relating to the following significant issues (which are not exhaustive). Plan sponsors, after considering these issues, are better informed when discussing insurance options with their brokers if they determine to amend or renew their policy.

1.      Exclusions.  As mentioned above, the typical terms used in fiduciary liability insurance policies ("insureds," "loss," "claims" and "wrongful acts"), although broadly defined, contain exclusions.  For example, fraudulent acts are often excluded from the definition of "wrongful acts."  "Loss" can include some statutory penalties imposed under ERISA, but not others.  Plan sponsors and insureds should understand how the exclusions of their particular policy affect them.

2.      Defense provisions.  Fiduciary liability insurance may or may not include coverage for defense costs.  As well, the insurance policy may include a "duty to defend" provision which provides the insurance carrier with the duty to defend claims against insureds, including the right to select defense counsel, typically from a panel (which may consist of counsel that the insured considers inferior to their regular counsel).  Again, plan sponsors and insureds should consider whether a "duty to defend" provision is appropriate, and whether the policy should cover defense costs.  Plan sponsors and insureds should also take into account that defense costs may be capped or otherwise subject to limitations if they select non-panel counsel.

3.      Retentions. Retentions are similar to deductibles.  Retentions generally equal the amount the insured assumes of any loss and can include the cost of defense.  The amount and scope of retentions varies from policy to policy and will affect coverage for plan sponsors and insureds.

4.      Amount of Coverage.  Like retentions, the total limit of liability varies from policy to policy.  A limit of e.g., $25 million may be appropriate for one plan sponsor, but inappropriate for another.  Plan sponsors should consider the particular needs of their business and plans.

5.      Errors and omissions that do not constitute breaches of fiduciary duty under ERISA.  Some insurance policies provide coverage for errors and omissions that do not constitute fiduciary breaches.  Plan sponsors and insureds should consider whether this coverage is available under their policy.

6.      Coverage for Costs of Voluntary Correction.  Many policies do not provide coverage for fees, penalties or sanctions imposed under any voluntary compliance resolution program or similar program administered by the DOL or the Internal Revenue Service; however, some policies offer this feature.  Plans sponsors and insurers may want to consider including this feature, if available to them.

C.     Fiduciary Liability Insurance Policy Review.

Orrick's Compensation and Benefits Group and Insurance Practice Group can provide assistance with reviewing plan sponsor clients' fiduciary liability insurance coverage to ensure adequate coverage.  Our review provides plan sponsors with a useful, practical resource that better informs plan sponsors and equips them to better negotiate and plan with insurers and brokers.  Our review, generally offered for a nominal fixed fee, provides detailed recommendations to help plan sponsors ensure that the insurance policy provides adequate coverage to the intended persons.

[1] ERISA Section 412 requires that every person who handles plan assets subject to ERISA be covered by a fidelity bond.

[2] DOL Field Assistance Bulletin 2008-4, Q&A #2.