Insuring the Risk
Insurance coverage for breaches of fiduciary duty gets little attention in the advisory industry because a swath of retirement plan advisers has not considered themselves plan fiduciaries. The government, however, appears to take a different view. The Department of Labor (DOL) plans to modify what is deemed fiduciary conduct and, if the department has its way, many more brokers will be considered providers of fiduciary advice to plans, says Joseph C. Faucher, of counsel with Drinker Biddle & Reath LLP in Los Angeles.
If the DOL does rule to expand the definition of fiduciary, more service providers will need to insure for this liability, says John Little, senior vice president for federal affairs at the Insured Retirement Institute (IRI). But before any DOL action, advisers may want to review their current professional liability policies to ensure they have adequate coverage and, if they do not, they need to expand it to include fiduciary breaches, he says.
As a general rule, experts say, advisers should have their own policies covering potential fiduciary breaches to client plans. Even if the plan sponsor has fiduciary liability insurance for the plan, it might not cover the adviser, explains Faucher. “It’s usually a good idea for advisers to get their own fiduciary liability coverage on [a] separate policy,” he says.
CEFEX stresses that a best practice is for advisory firms to have insurance fiduciary duty liabilities, says Carlos Panksep, CEFEX’s managing director. As the industry gets more complex and more regulations are in place, participants and sponsors will grow more sensitive to these issues, he says. “Many of the advisers we assess only have basic E&O [errors and omissions] policies in place,” he says.
In light of potential regulatory changes, registered representatives working with retirement plans may want to review their coverage, says Faucher. Registered representatives traditionally obtain insurance coverage through their broker/dealers, and those policies generally provide coverage for some registered investment adviser (RIA) activities. However, broker/dealer policies vary, and coverage may be inadequate for an adviser’s particular business, he says, citing an example: Broker/dealer policies may exclude coverage for acts as a fiduciary when services are performed for Employee Retirement Income Security Act (ERISA)-regulated plans. Some broker/dealer polices also exclude coverage for services unapproved by the broker/dealer and products offered outside the broker/dealer. RIA coverage, too, may be limited to the individual and exclude the adviser’s entity.
Additionally, notes Faucher, while many brokers deny fiduciary status, they may still be sued for fiduciary claims and declared fiduciaries in court. Therefore, it is wise for brokers to have insurance to cover claims of fiduciary breaches, in the event of such a suit, he says.
Beyond Basic E&O
The usual route for retirement plan advisers to cover liability for fiduciary breaches is through their E&O policies, says Kenneth Golsan, president of Golsan Scruggs (see sidebar). However, a basic E&O policy may not adequately cover the adviser’s potential risk. Insurance companies want to sell more insurance, as well as identify the risk, notes Faucher, so it may be necessary to purchase additional riders to be fully covered. Advisers should determine how much potential risk they have and add on riders accordingly. And they have to ensure that the insurance they buy provides the coverage they need, Faucher says.
Advisers also need to review policy exclusions. A policy may exclude the sale of certain products, so if an adviser sells those, that risk is inadequately insured. Insurance contracts also may not cover certain types of investments, says Brian Francetich, vice president of Golsan Scruggs. For instance, there may be exclusions for foreign exchange or alternative investments. Some contracts do not cover investments in collective investment trusts (CITs), he says. If the insurance contract does not provide coverage for hedge fund investments but the adviser helps retirement plans invest in hedge funds, that adviser needs more coverage, Golsan says.
E&O policies can sometimes also exclude services such as third-party administration, adds Faucher. It is imperative that advisers get an insurance contract with language that matches the business they perform. So, when purchasing or reviewing insurance, advisers need to ask, “What am I doing for retirement plan clients?” and find out whether any of those activities fall within the exclusions, says Faucher. Advisers should never take for granted that the policy covers what they need. Faucher says he once reviewed a policy with an RIA only to discover the policy excluded claims for investment advice. “His core business was providing investment advice, but his insurance policy didn’t cover it,” he says.
Sometimes standard language must be amended or tweaked to make sure coverage is complete. Golsan recalls seeing a contract that excluded not only alternative investments but “anything similar,” as well. Language that broad, he says, could be used to deny coverage for breaches related even to more traditional investment classes.
To complicate matters, unlike with other business insurance, no industry standard insurance contracts exist for the investment advisory world. Every insurer has its own form for E&O, which makes it difficult to compare different insurers’ policies. So when purchasing insurance, every policy should be examined thoroughly, says Francetich.
In the absence of industry standard contracts, advisers should work with specialist agent/brokers who understand the investment industry, when buying coverage for fiduciary breaches, Golsan says.
Contracts that are not standardized, with their many little nuances, can also create problems should a claim arise, says Francetich, giving yet another reason to work with someone knowledgeable about advisers’ business practices. Advisers should also understand the extent of the coverage they are buying, he says. For instance, some insurance contracts will pay the entire expense of a suit, even if five allegations are made and the policy only covers two. Other policies merely will pay two-fifths of the defense.
Increased coverage for fiduciary claims has become more popular in recent years, Panskep says, but not ubiquitous yet.
However, getting the insurance they need may prove difficult for advisers in the current climate. In the last two or three years, the underwriting industry has pulled back from writing policies on investment advisers who work with retirement plans, says Francetich. The insurance industry became nervous due to the uptick in litigation in this area, so it has pulled back on writing new business, he says.
This is a challenging environment for securing good, solid insurance coverage, says Golsan. It can be done, he says, but it’s tricky.
E&O Plus Fiduciary Liability Insurance?
According to Kenneth Golsan, president of Golsan Scruggs, advisers may find it unnecessary to purchase separate fiduciary liability insurance to cover their client transactions, though they may still need it for their own plans. Technically, fiduciary liability insurance covers plan sponsors only for breaches in fiduciary duty caused by their own staff, he explains. Most errors and omissions (E&O) policies exclude fiduciary breaches by the adviser when acting as a plan sponsor regarding any ERISA [Employee Retirement Income Security Act] plans they themselves sponsor, he says.
By way of illustration, if an adviser with 15 employees installs an ERISA retirement plan for them, the adviser has personal liability for any fiduciary breaches relating to that plan. Those breaches are not covered by his E&O policy. To cover that exposure, Golsen says, the adviser would have to purchase fiduciary liability insurance.