Fiduciary Liability: The Most Misunderstood of Management Exposures

In the early 1960s, life in the United States was lived at a slower pace. Transportation and communication required more time (and patience) and employees were more inclined to trust employers on issues relating to employee benefits. Yet, it was the closure of the Studebaker automobile manufacturing plant in South Bend, Ind., in 1963 that was the seminal event in the evolution of a liability insurance coverage that today’s knowledgeable human resources professional would consider essential to his personal asset protection.

Studebakers and employee benefits reform
From its origin as a carriage business in the mid-19th century to tough financial times before World War II and enhanced engine production during the war, Studebaker generated a “family of workers” who were assured by management they would be financially cared for in retirement. In 1963, after introducing the legendary Avanti, Studebaker was forced to close its doors. Unable to meet promised obligations to workers, many were left financially challenged in retirement, and the situation was the focus of federal legislation designed to reform the U.S. pension and retirement system.

Led by New York Republican Sen. Jacob Javits, Congress passed the comprehensive legislation known as the Employee Retirement Income Security Act of 1974. Signed into law by President Gerald Ford and effective Jan. 1, 1975, the legislation, also known as “the mother of all employee benefits legislation,” actually addresses virtually all employee benefit plans, not just retirement and profit sharing plans.

From an insurance industry perspective, the only insurance coverage mandated by this legislation is employee dishonesty insurance–which many sellers of insurance refer to as “ERISA bonds”–on individual employee benefit plan assets. The amount of coverage required is 10 percent of the assets of each plan, subject to a minimum amount per plan of $1,000 and a maximum amount per plan of $500,000.

Experts believe that even if a benefit plan has no assets–such as group medical or life insurance, or an HMO or PPO plan–in order to be in technical compliance with ERISA, the plan should still be scheduled for dishonesty coverage if omnibus coverage language cannot be utilized.

But the startling revelation to many buyers as well as sellers of insurance is that ERISA’s section 410(a) places strong personal liability on any person considered a “fiduciary” under the act’s broad definition of the term. The liability is stated as “personal” and affected persons are advised that corporate bylaws indemnification provisions are not applicable to this personal liability. Thus was created the need for a new insurance product, known as fiduciary liability insurance.

And according to ERISA’s section 410(b), an affected “fiduciary” is permitted to purchase liability insurance for this specific exposure.

The other liability insurance coverage
Pre-dating the ERISA legislation in the mid 1970s, several insurers had introduced a simplistic insurance coverage designed to address errors and omissions arising out of the administration of employee benefit plans. It had been recognized that human resource personnel could make mistakes when enrolling workers in group insurance plans, or when transmitting employee instructions for changes in benefits to the insurer. This coverage was known as employee benefits liability (EBL), and it came to be written as an endorsement to comprehensive general liability coverage policies, now known as commercial general liability forms.

Although this coverage is frequently confused with fiduciary liability insurance, the differences are many and critical.

There is very little, if any, underwriting of EBL insurance. Essentially, a small annual premium charge is made to automatically add this coverage to CGL policies. Like fiduciary liability insurance, it is generally written on a claims-made basis, and many underwriters pay little heed to retroactive dates, especially when the CGL insurer is changed.

In addition, little exposure is contemplated. Minimal premium charges will apply (as low as $50 to $100 annually), with minimum limits also applicable. Coverage forms are not uniform. Many specifically exclude any claims arising out of ERISA. Clearly, the purpose of coverage forms is to address non-bodily injury/property damage or personal injury liability arising out of the administration of employee benefit plans. Coverage forms are not meant to cover more critical discretionary judgment exposure.

Almost any insurer writing CGL insurance is willing to offer EBL as an extension of coverage. However, the total number of insurers willing to offer fiduciary liability insurance represents only about 10 percent or less of the total number of insurers writing CGL. There are simply far more insurers willing to offer EBL, as opposed to fiduciary liability.

Current and anticipated exposures
A valuable source of exposure information is a periodic survey conducted by Tillinghast Towers Perrin consulting firm. The current Fiduciary Liability Survey (2004) is the first to be released since 2000, and it contains some interesting and comprehensive information concerning exposures, claims amounts and insurers.

According to this leading source of objective information, the average defense cost per claim is $365,000, with average nondefense indemnity costs being just under $1 million (defense costs are up from $121,000 in 2000, and indemnity costs are down slightly from 2000’s $1.19 million).

The cause of claims most frequently cited in the current survey is “denial of benefits,” followed by “misleading representations” and “communication of plan benefits.” In looking at claims susceptibility (survey respondents reporting one or more fiduciary liability claims), business types of “durable goods manufacturing,” “merchandising” and “utilities” show the highest percentage of claims, and “transportation/communication” and “health services” show the highest frequency of claims (average number of claims per survey participant).

One could argue that our society has evolved to one where the slightest injury/damage triggers a potential legal process of attempting to fix blame. Never was this truer than with respect to financial losses. If employees see that 401(k) investments, for example, significantly decline over a given time frame, then the employer must be somehow shown to have some responsibility (this is reinforced by the Tillinghast survey results).

The allegations here could involve a lack of proper communication or historical investment return information, or a failure to warn of potential danger in a particular investment choice. If employer stock is utilized in 401(k) plans, either as an investment option or for matching purposes, and the stock value declines, then it can be easy to assert “managerial malpractice” as a cause of action for 401(k) financial losses. Thus, the exposure of employer stock in a 401(k) plan is greatly frowned upon by fiduciary liability underwriters.

Employee Stock Option Plans are also cause for fiduciary liability underwriter alarm: allegations of company mismanagement can trigger D&O or fiduciary liability claims, or both. Recent employer use of managed care arrangements (in the form of HMOs, PPOs, POS or similar arrangements) can also trigger allegations under a fiduciary liability policy.

And just because an employer chooses to utilize a third-party administrator for 401(k) plans or managed care arrangements doesn’t relieve the employer of the personal liability imposed upon persons with discretionary judgment authority–the personal liability aspect of ERISA cannot be delegated to another person or organization.

Even if some form of delegation was possible, what knowledgeable TPA is going to both accept full responsibility for the actions of the employer, as well as provide errors and omissions liability insurance in an amount sufficient to fully cover the total asset base of any plan in question?

Should Congress re-tackle the issue of a so-called patient’s bill of rights legislation, this would likely significantly increase exposure to employers, and to those with discretionary judgment authority. So, the personal liability issue remains of paramount importance to those persons liberally described as “fiduciaries” by the ERISA legislation.

Yet, another recent exposure development is that of the Health Insurance Portability and Accountability Act (HIPAA) of 1996 with its “final compliance” in April 2004. This act promotes the continuance of health insurance benefits through individual employee-employer changes, and mandates safeguarding of employee health insurance related information, with significant fines for proven violations. Although not universal, many fiduciary liability insurers will provide HIPAA coverage through an endorsement to fiduciary liability insurance policies, for a reasonable premium charge. In our litigious society, such an extension can prove valuable.

Dick Clarke is a senior vice president in the Atlanta office of J. Smith Lanier & Co. He has authored numerous articles and two books, including The Three Faces of Executive Liability. The second part in this series in the Feb. 21 issue will examine the best coverages for these exposures.