Fiduciary liability insurance is a popular vehicle for protecting individuals
charged with the responsibility of creating, managing, and administering
employee benefit plans within business organizations.
Acknowledgment
The author would like to acknowledge and thank
coauthor Sean Jordan, research analyst, IRMI, for his contributions to this
commentary.
The policies cover two broad areas of liability: (1) fiduciary liability and
(2) employee benefits liability under a single insuring agreement.
Fiduciary Liability
Fiduciary liability arises from the obligations set forth in the Employee
Retirement Income Security Act (ERISA) of 1974. ERISA was passed to assure that
employees participating in (1) employee pension benefit plans and (2) employee
welfare benefit plans receive the benefits promised by such plans. As a result,
the law created a variety of fiduciary liability exposures for employers that
offered these plans, and, in response, fiduciary liability insurance coverage
became available on a widespread basis during the mid-1970s.
No Requirement To Create or Establish Benefit Plans. ERISA
does not require employers to establish or create benefit or
pension plans for its workers. Nor does it decree minimum benefit
levels if such plans have been established. Rather, the essence of ERISA
is that it regulates the manner in which pension and benefit programs must
operate once they have been put into place. For example, under ERISA,
pension plans are required to provide vested benefits for employees after a
certain number of years. (Benefits are "vested" when they become the
legal property of the designated beneficiary.) Thus, under most corporate
401(k) savings plans, ERISA mandates that the portion contributed by the
employer be vested within no more than a 3-to-5-year period.
Employee Benefits Liability Exposures Existed Prior to
ERISA. It is also important to recognize that various liabilities
associated with employee benefits claims, such as those exemplified below,
existed prior to the passage of ERISA. This is because the liability
exposure giving rise to employee benefits claims originates from common law
rather than statutory law (of which ERISA is an example).
In contrast to the "ordinary" negligence associated with employee
benefits errors and omissions claims (described in Figure 2 later in this
article), fiduciary liability claims arise from "discretionary" or
higher-level decision-making functions. Figure 1 provides several claim
scenarios that fall within the purview of fiduciary liability coverage.
Figure 1
Fiduciary Liability Claim Scenarios
- Claims involving company stock—A business allows, and
in fact encourages, employees to invest 401(k) monies in company stock.
When the company declares bankruptcy and its stock is rendered worthless,
employee 401(k) plan balances are decimated. In response, the employees
bring lawsuits (Enron and RadioShack are two notable companies in which
this claim scenario actually took place).
- Claims from fees associated with 401(k)
plans—Employees bring a class action claim asserting that the fees
charged by the manager hired to administer the company's 401(k) plan
were 1 percent higher than the average rate for such services. However
innocuous this small disparity appears, over a long period of time (e.g.,
20–30 years), it can vastly reduce (often by as much as, or even more than,
$100,000) an employee's 401(k) balance.
- Claims involving healthcare plan administration—A
company offers its employees healthcare insurance coverage. The company is
sued when it fires an employee who needs a $500,000 liver transplant, which
he or she will now no longer be able to obtain using his or her own means.
Employer-provided healthcare plans are also exposed to claims alleging that
the plan (a) included incompetent medical providers in their network and/or
(b) wrongfully withheld treatment for certain illnesses or conditions.
- Claims from the selection of risky investments in a defined
benefit pension plan—A company's employees are covered by a
"traditional" defined benefit pension plan. The employees sue
their employer for selecting a manager who invests a large proportion of
the pension's funds in highly risky securities (e.g., "junk"
bonds, initial public offerings, "penny" stocks). The suit is
brought when these risky investments fail, rendering the plan insolvent and
thus unable to pay promised benefits.
Employee Benefits Liability
The employee benefits liability coverage (within a fiduciary liability
policy) is also known as "employee benefits errors and omissions"
coverage. More specifically, it encompasses errors and omissions committed
within the course of handling so-called nondiscretionary functions associated
with employee benefit programs. In essence, these are
"garden-variety" mistakes as opposed to errors involving
higher-level/discretionary functions, such as those described above in Figure
1.
Figure 2 provides several claim scenarios that fall within the purview of
the employee benefits liability coverage afforded by a fiduciary liability
policy form.
Figure 2
Employee Benefit Liability Claim Scenarios
- Failure to enroll—The human resources (HR) department
forgets to enroll a new employee in the company healthcare plan. The next
week, he or she is seriously injured in an auto accident for which he or
she now has no medical insurance coverage.
- Failure to change beneficiary designation—After his
divorce, an employee advises the HR department to make his son—rather than
his now ex-wife—his life insurance policy beneficiary. HR forgets to do so.
A month later, the employee dies. His ex-wife receives the proceeds of the
policy, instead of his son, as was the deceased employee's
intention.
- Erroneous benefits advice (#1)—The HR department
advises an employee that Dr. "X" is a network provider under the
employer's medical plan. Following major surgery, the employee learns
that Dr. "X" is not actually "in network" and,
therefore, receives a $25,000 bill from Dr. "X," rather than the
$1,000 fee the employee expected to pay.
- Erroneous benefits advice (#2)—An employee makes a
decision to retire based on HR's advice that his or her monthly pension
will be $2,250. He or she sues the company when his or her actual pension
amount turns out to be only $1,250.
Fiduciary Liability Insurance Policies in a Nutshell
As indicated above, the two broad areas the policies cover are claims from
(1) fiduciary liability (i.e., "discretionary" acts, liability for
which arises under ERISA) and (2) employee benefits liability (i.e.,
"garden variety" negligence, liability which stems from common
law).
Sources of Fiduciary Liability Coverage. Fiduciary
liability policies are written either (1) on a stand-alone basis or (as is
increasingly the case) (2) as one of several other coverages made available
under management liability "package policies," which also commonly
include: directors and officers, employment practices liability, and cyber and
privacy coverage.
Insuring Agreements. As indicated above,
the policies contain a single insuring agreement covering both fiduciary
liability and employee benefits liability.
In addition, the policies incorporate a second insuring agreement for
"settlement programs." These are programs operated by various
government organizations for the purpose of resolving disputes regarding
pension and benefit plans. For example, rather than litigate a claim against
one or more fiduciaries, an employee and the defendant company may voluntarily
agree to settle the claim. Settlement programs avoid the time and expense of
formal litigation and are administered by federal agencies such as the Internal
Revenue Service and the US Department of Labor. Most often, the policies are
written with either (1) a sublimit that applies only to claims
involving settlement programs or (2) a specific, separate limit of coverage,
generally $100,000.
Insured Persons and Insured Organizations. The persons and
organizations covered by fiduciary liability policies fall into the following
four distinct categories.
- Assets of the named insured organization
- Assets of the benefit plans scheduled in the policy
- Personal assets of the individuals serving as fiduciaries of the
insured's firm
- Personal assets of any additional persons named on the
policy
Covered Losses. Covered losses encompass damages (including
punitive damages), judgments, settlements, and defense costs that any insured
becomes legally obligated to pay on account of a covered claim. Losses excluded
by the policies are taxes, sanctions, criminal or civil fines, and
penalties.
Defense Coverage. The policies are usually written on a
"duty to defend" basis, which delegates responsibility for managing
the defense of a claim to the insurer (rather than the insured). For all but
the most sophisticated organizations, this provision benefits insureds because
few businesses have either the experience or the time to orchestrate the
defense of complex fiduciary liability litigation.
Also important is the fact that the expenditure of defense costs reduces
policy limits, thus making fiduciary liability insurance a "shrinking
limits" policy. Nor do the policies cover defense costs on a first-dollar
basis. Rather, the policy deductible applies to both indemnity and
defense costs.
Key Exclusions. Although coverage for dishonest acts is
precluded by the policies, the forms contain so-called innocent insureds
provisions. These provide affirmative defense coverage to insureds who, while
they may be named in a lawsuit, did not themselves commit (or were not
aware of) the alleged dishonest act(s).
The policies also exclude claims alleging failure to fund in accordance with
ERISA requirements. The rationale for the exclusion is that covering this
exposure would amount to providing coverage for intentional violations of
federal law. Nevertheless, the forms do provide defense coverage to
allegations that the insured(s) failed to fund in accordance with
ERISA.
A final key exclusion applies to coverage of claims seeking benefits payable
to a beneficiary. The purpose of this exclusion is to prevent the policy from
becoming a financial guarantor of benefits due under an insured
corporation's benefits program.
Claims-Made Coverage Trigger. As is also the case with
other types of professional and management liability policy forms, fiduciary
liability policies are written on a claims-made basis.
More information about fiduciary liability exposures and insurance coverages
can be found in Professional Liability
Insurance.