There are two distinct types of insurance products that ERISA plan fiduciaries should be aware of. We get a lot of questions about these, so we thought a refresher may be in order.
First, there is the insurance product ERISA actually requires. This is the bond required by Section 412 that is intended to protect employee benefit plans from risk of loss due to fraud or dishonesty. This requirement applies to every person who “handles funds or other property” of an employee benefit plan, with certain exceptions. “Handles” is construed broadly and includes not just physical contact with plan funds or property, but also the power to transfer funds or property from a plan to a third party, or the authority to direct disbursements of such funds or property. The US Department of Labor (DOL) has said that a plan investment committee “handles” plan assets if the committee’s investment decisions are final (including, for example, the decision of which investment manager to hire), so each member of such committee should be bonded. On the other hand, fiduciaries who make recommendations that are subject to approval by other fiduciaries do not “handle” plan funds or property, and so on that basis, they would not need to be bonded.
The bond amount must be equal to at least 10% of the amount of funds the fiduciary handled in the preceding year, subject to a minimum of $1,000, with a maximum required bond of $500,000 for a plan that does not hold employer securities and $1,000,000 for a plan that does. In practice, the bond is typically issued for $500,000 or $1,000,000, as applicable, without regard to the 10% threshold. The DOL has also confirmed that it is permissible to use assets of the plan to pay the premium for the bond.
A plan’s insurance broker should be able to help fiduciaries identify an authorized issuer of the bond required by Section 412. Plan fiduciaries are also well advised to include confirmation of the bond’s good standing as part of its annual compliance checklist.
The second type of insurance is fiduciary liability insurance that expressly covers losses resulting from a breach of fiduciary duty under ERISA. ERISA does not require fiduciary liability insurance, but Section 410 of ERISA allows the purchase of such insurance (note that Section 410 is also the provision that prohibits a plan from using its assets to indemnify a fiduciary for a breach of fiduciary duty—hence highlighting one of the reasons many fiduciaries determine to have insurance from a risk management perspective). Plan assets can be used to pay for fiduciary liability insurance, but if plan assets are used the policy purchased must permit recourse by the insurer to the fiduciary in case of breach of fiduciary duty. As a result, some plan sponsors determine to pay for the fiduciary liability insurance with corporate assets to provide greater coverage to the fiduciaries.
Typically, commercial errors and omissions policies carve out losses resulting from a breach of fiduciary duty under ERISA. The fiduciary liability coverage often comes in the form of a rider. The appropriate amount of fiduciary liability coverage depends entirely on the circumstances—including the size of the plan, types of plan investments, risk tolerance of fiduciaries, and cost of coverage.
Plan fiduciaries may wish to have their insurance brokers perform a “checkup” on the fiduciary liability policy every few years, including an evaluation of how coverage levels stack up against what brokers are seeing in the market.