Employee benefit plan service providers sometimes make mistakes. When they do, they are sometimes tempted to “fall on the sword,” and agree to fix the problems that flow from those mistakes. For example, if a service provider has made a mistake that affects a plan’s qualified status, the service provider may offer to assist or represent clients before the Internal Revenue Service (“IRS”) during an audit or in the course of preparing a voluntary compliance program application pursuant to the IRS Employee Plans Compliance Resolution System (“VCP”). Service providers may also wish to reimburse their clients for any sanctions, costs and/or penalties that are imposed, and any additional professional fees (such as attorney and accountant fees) the client might incur due to the service provider’s mistake. There are right ways and a potentially costly wrong way to go about volunteering to rectify these errors.
Naturally, service providers want to “do right” by their clients. It is not always evident at the outset what the cost of an error might be. That is because the ultimate cost of correcting a mistake is often at least partially out of the service provider’s control. In our example, the IRS is likely to have a significant impact on how long the process takes, the amount of any penalties, and the professional fees that may be incurred during the correction process. Often, service providers carry errors and omissions (“E&O”) insurance because, as the Supreme Court has stated, “People make mistakes. Even administrators of ERISA plans.”
Some service providers may balk at notifying their insurance carrier of claims that their clients make against them. They may believe that the cost of correcting the mistake, and if necessary, paying the costs of an attorney to help the client navigate through a correction program, will be less than their insurance deductible. They may also conclude that notifying their insurance carrier will only cause their insurance premiums to increase. Only in the rare case would it make sense for service providers to avoid notifying their insurance carrier when clients make claims against them. This is true for several reasons.
First, E&O policies typically require the insured to notify the insurance carrier of claims within a reasonable time, sometimes within a specified period following receipt of the claim. And, most policies will not provide coverage for expenses that are incurred – such as attorney fees – before the claim is made to the insurance carrier. A failure to timely notify the insurer of the claim may even relieve the insurer of the obligation to cover the claim at all.
Second, E&O policies often exclude coverage for claims arising out of a contract, unless the claim would exist in the absence of a contract. In other words, if the service provider enters into an agreement to pay the costs associated with correcting a plan error before notifying its insurance company of the claim (and giving the insurance company an opportunity to investigate the claim), the insurance company may be justified in refusing to pay the claim. While the impact could be minor if the cost of correction is relatively low, service providers rarely know with certainty if that will be the case early in the process.
Finally, even if it is likely that a claim is within the deductible, the service provider may be required to notify the carrier that the claim was made during the annual renewal process. So, there may be little to gain — and much to lose — by not notifying the insurer at the time the claim is made, regardless of the likelihood that the claim can be resolved within the deductible.
We recommend that service providers carefully review their E&O coverage to ensure that it meets their needs and that coverage limits are adequate. This should be done at least annually. When evaluating how much coverage you need, resist the temptation to think you need minimal coverage just because you have never been sued.