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.
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 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.
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.
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