A surprising number of employers offering employee benefit plans to their employees, including 401(k) plans, are refusing to purchase fiduciary liability insurance. Despite the dubious wisdom of refusing the insurance, the decision must be accepted if it was made with a complete and accurate understanding of all the facts. However, a significant number of employers may be deciding to forego fiduciary liability insurance because they believe their ERISA fidelity bond provides all the protection they need. Unfortunately, such a belief is wrong.
By virtue of offering an employee benefit plan, employers find themselves within the purview of the Employee Retirement Income Security Act (ERISA), thereby exposing their organization to significant risk. Although many of these risks can be covered by a fiduciary liability insurance policy, confusion and misunderstanding may prevent the employer from making an informed decision about whether to purchase the insurance. As a result, the employer rejects insurance that would otherwise have been accepted if the correct information was known and considered.
Given the significance of refusing such insurance, it is helpful to debunk some of the myths surrounding the meaning, need, and purpose of ERISA fidelity bonds and fiduciary liability insurance, so that those who may be in need of one or both of them, may make an informed decision.
Myth: There is little difference between a fidelity bond under ERISA and a fiduciary liability insurance policy. Fact: Although both may ultimately operate to replace a plan’s assets that were lost due to a wrongful act, any perceived similarities between the two are mostly superficial. The actual differences between the two, in terms of the purpose of the coverage, who is covered, what is covered, and coverage triggers, may render fidelity bonds and fiduciary liability insurance mutually exclusive in some cases.
Myth: Under ERISA, the fiduciary of a 401(k) plan has the option of purchasing a fidelity bond.
Fact: Fidelity bonds are mandatory. ERISA provides that “every fiduciary of an employee benefit plan and every person who handles funds or other property of such plan…shall be bonded.” ERISA generally requires the bond to be in an amount equal to at least 10 percent of the plan’s assets, as determined at the start of each fiscal year. However, the amount of the bond is subject to ERISA’s minimum of $1,000 and maximum of $500,000. [Note: Though not discussed in this article, ERISA does have defined exemptions to the bonding requirement.]
Myth: Every person involved with a plan must be bonded.
Fact: ERISA’s bonding requirement only applies to those described in the statute. If a person does not qualify as a fiduciary of an employee benefit plan or a person who handles funds or other property of the plan, then a bond is not required such person.
Myth: Fiduciary liability insurance is required by ERISA.
Fact: Although ERISA does not prevent a plan, a fiduciary, or an employer from purchasing fiduciary liability insurance, obtaining such insurance is not required by ERISA.
Myth: A fidelity bond protects a plan’s fiduciaries against liability.
Fact: Under ERISA, a fidelity bond must protect “the plan against loss,” not the fiduciaries. Although a fiduciary’s actions may serve as the trigger for coverage under the fidelity bond, the plan itself is the named insured.
Myth: A fidelity bond protects a plan against all losses, regardless of the cause.
Fact: A fidelity bond under ERISA protects the plan against losses caused only by “acts of fraud or dishonesty” on the part of a plan’s fiduciaries. If the cause of a loss is anything other than fraud or dishonesty, it will not be covered by the fidelity bond.
Myth: A fidelity bond protects plan fiduciaries from personal liability.
Fact: Under ERISA, a fidelity bond is limited to protecting only the plan against a loss, not the fiduciaries. This limitation is problematic for plan fiduciaries, since ERISA provides that “any person who is a fiduciary with respect to a plan who breaches any of the responsibilities, obligations, or duties…shall be personally liable to make good to such plan, any losses to such plan resulting from each such breach.”
Myth: I am not listed as a plan fiduciary, so I do not need to worry about fiduciary liability.
Fact: Under ERISA, a person may be deemed a fiduciary if that person uses discretion in administering and managing the plan, or controlling the plan’s assets. Indeed, fiduciary status is based on the functions performed for the plan, not just a person’s title with respect to the plan. Those who rely on their title to determine their own status may discover that, for purposes of ERISA liability, they are in fact a fiduciary.
Myth: It is unlikely that the fiduciary of a plan will ever breach the standards of conduct required by ERISA, so a fiduciary liability insurance policy is not necessary.
Fact: Since the responsibilities and loyalties of a fiduciary are strict and demanding, the chances of experiencing a breach cannot be fairly categorized as unlikely. The nature of the relationship requires that a fiduciary discharge his duties with respect to a plan solely in the interest of the participants and beneficiaries and with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man 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. For more information about the nature of a fiduciary’s obligations, read An Employer’s Liability under ERISA for 401(k) and Other Employee Benefit Plans.
Myth: Since the greatest risks to a plan’s assets always involve fraud or dishonesty, a fidelity bond is usually all that is needed to cover any losses.
Fact: While fraud and dishonesty pose a real threat to a plan’s assets, they are by no means the only threats. Breaches of the fiduciary duty can come in many forms which do not involve fraud or dishonesty, including: negligent errors and omissions; improper disclosures to plan participants; remiss investment advice; imprudent choice of outside service provider (OSP); faulty advice of counsel; and improper amendments to plan documents. None of these examples would be covered by a plan’s fidelity bond.
In addition to clearing up any confusion caused by the foregoing myths, these facts reveal that fiduciary liability insurance is necessary to maximize the level protection enjoyed by the plan’s fiduciaries, as well as the plan’s assets. The frequency of ERISA litigation involving employee benefit plans continues to increase as the economy remains sour. Expenses associated with defending these lawsuits, regardless of whether the plan breached its duties, can deplete critical assets. Moreover, in the event of litigation, plans electing to observe the statutory cap for fidelity bonds may discover the unfortunate fact that $500,000 is not nearly enough to protect the plan’s assets.
While the benefits associated with a fidelity bond should not be minimized, they should also not be exaggerated to justify a risk management profile that relies solely on the fidelity bond. In today’s financial climate, it is likely that a plan’s investments will decrease experience a decrease in value, with the predictable result being litigation. By combining a fiduciary liability insurance policy with any required ERISA fidelity bonds, two of the most significant vulnerabilities to the plan, fraud/dishonesty and a breach of fiduciary duty, have been addressed, so the plan’s fiduciaries are free to focus on increasing the value of the assets.