Providing Protection

“Everybody is all agog about class action suits after LaRue,” says Jerry Kalish, President of National Benefit Services, Inc., in Chicago, acknowledging the 2008 Supreme Court decision that said individual participants could sue plan fiduciaries on behalf of their own accounts, rather than restricting that right to circumstances that affected the entire plan.

Under the Employee Retirement Income Security Act (ERISA), fiduciaries can be held personally liable for losses to a benefit plan incurred as a result of their alleged errors, omissions, or breach of their fiduciary duties. How can an adviser ensure that he and his plan sponsor clients are properly protected?

Fiduciary Liability Insurance

At the plan sponsor level, there is fiduciary liability insurance. In fact, those who handle plan funds or other plan property generally must be covered by a fidelity bond, a type of insurance that protects the plan against loss resulting from fraudulent or dishonest acts of those covered by the bond. However, the fidelity bond will not protect trustees from liability claims, which is why some plans choose to purchase fiduciary liability insurance.

That said, ERISA does not require plan sponsors to purchase this type of insurance, but this protects the plan fiduciaries, while an ERISA fidelity bond protects the plan assets (though not a fiduciary’s personal assets), Kalish says.

The fiduciary liability insurance coverage noted above is purchased by plan sponsors, and is designed to cover employees of the firm, as well as directors and trustees. It protects them if they are sued for fiduciary decisions they make for a retirement plan, says Rhonda Prussack, Executive Vice President and Product Manager, Fiduciary Liability Insurance, at AIG Executive Liability. Generally, fiduciary insurance policies are meant to respond to lawsuits and provide a defense and payout losses, she explains.

Fiduciary liability insurance provides protection for losses that the insured is legally obligated to pay because of a claim made for a wrongful act, which can mean any violation of the responsibilities, obligations, or duties imposed on fiduciaries by ERISA, as well as acts, errors, or omissions involved in plan administration, Kalish says.

One difference your plan sponsor clients should look at when considering policies is whether the policy limits coverage to “claims made” or “claims incurred.” Claims made means that the limits of coverage are applied to claims that are submitted to the insurer during the policy term, whereas claims incurred refers to incidences that occur during the policy regardless of when the claim is reported, Kalish explains. “As I understand most of these policies,” he says, “it’s done on a claims-made basis.”

Another point of concern for plan sponsors is how the insurer defines so called “wrongful acts,” Kalish notes. Although the policies will not cover known wrongful acts, Prussack says, the policy will cover those fiduciaries who make a mistake. When evaluating policies, look for the broadest definition of “wrongful act” and “loss” to cover everything possible that is going on and make sure there is adequate coverage, she continues.

When it comes to pricing these policies, there are multiple factors. “It is not like auto insurance,” Prussack says. Insurers will look at the overall exposure of the plan, including the plan’s asset size, and whether the plan offers company stock. The insurer also evaluates any plan issues, including whether the company has suffered major investment losses and whether it has a defined benefit plan and, if so, what its funding status is. “We look at the financial condition of the firm, because it goes directly to the health of the plan,” Prussack explains. She notes the insurer may ask whether the company has taken steps to help the bottom line, such as eliminating matches or undergoing layoffs. People may allege that the reason they were let go was because of the cost of the benefits, which can lead to discrimination or retaliation claims, she says. Insurers like to see good plan governance and fiduciary education, she says.

E&O Coverage

Sometimes, Kalish notes, the extended coverage of fiduciary liability insurance can extend to registered investment advisers (RIAs) and financial planners. However, since that is not the case most of the time, advisers frequently obtain E&O (errors and omissions) insurance to cover their fiduciary liability as a third party. E&O insurance covers an adviser’s “acts as a fiduciary” for the client. Again, this is not required, but an increasing number of advisers working with retirement plans are getting it, according to Kalish.

Historically, RIAs purchased their own policies, and registered reps were covered under their broker/dealer “master” policy. However, notes Tom Henell, over the last few years, there has been a question of whether the broker/dealer policy includes coverage for acts related to ERISA plans or products offered outside the broker/dealer. Henell is Chief Marketing Officer at the North American Professional Liability Insurance Agency (NAPLIA) in Framingham, Massachusetts.

Insurers issuing E&O policies generally use revenues and assets under management as the primary indicator of premiums says Gary Sutherland, CEO of NAPLIA. Whether those assets are discretionary or nondiscretionary also is considered, as are the types of investments held in the portfolio. A good starting point is 1% of revenues as the premium price—i.e., if an adviser has $200,000 in revenue, his policy will be $2,000 annually. Fee-based revenue tends to have a lower premium than commission-based revenue, he says.

An adviser purchasing this type of coverage buys a one-year policy with a per-claim limit and an aggregate amount of coverage. Claims cover expenses and actual damages, Henell says. As you add clients throughout the year, they are covered automatically and then advisers file new applications each year. Advisers who are looking to purchase this type of policy may be able to get discounts for having certain retirement plan designations or certifications, Sutherland notes.

Advisers should make sure they read the policies and “look out for the exclusions,” Sutherland says. For example, one company he worked with offered actuarial services and, although it appeared that would be covered under the general services, the specific description of actuarial services was buried in the exclusions list.

Overall, those in the industry expect the market for both types of coverage to grow. “If I am a fiduciary for a retirement plan, and I want an investment adviser, I am going to ask the adviser [if he has] insurance…and, if I am an RIA and I want to advise a plan, I want to know that a plan has fiduciary insurance,” Sutherland says.

Illustration by Jillian Tamaki