Fiduciary Liability insurance & ERISA Bonds
Another quick question that needs to be asked is on Fiduciary Insurance. This type of insurance is to insure the plan against losses from breaches of fiduciary responsibility. As a 3(16) could be the super fiduciary for your plan, you need to know that they have all of their bases covered. You will be shocked at the responses you’ll hear on this one. There are two immediate issues to address, and you’ll do well to ask these up front. How does the 3(16) handle ERISA’s Fidelity Bonding requirement? What kind of Fiduciary Liability protection do they carry? To that aim, how far does the protection go—does it extend to their clients? I can hear you mentally thinking, ‘of course their coverage is for their clients…’ but I’ll give you a Lee Corso ‘Not-So-Fast-My-Friend’. Most fiduciary liability policies are ‘first party,’ which means that they don’t cover at all what you think that they do—they cover the company of the insured only! That means if ‘ABC’ is your 3(16), then ABC’s employees are covered—not any of your clients. This is a little known, but a very problematic issue. If you take a look at one of these insurance policies, which in my role I am forced to do, you’ll see that ERISA is, by default, excluded! That, my friends, is not kosher. So ask this question up front—you don’t need to add an uninsured fiduciary to your client book.
As in any field, some experts write this specific business and can properly address the insurance needs of a 3(16) fiduciary. Our policy is written through Lloyds of London, as we could not find a US carrier that could accommodate the coverage needs of our client base and the fiduciary services that we provide to them. But properly done, as in our Lloyds policy, our actions as a fiduciary to our clients are covered.
The ERISA Fidelity Bond
The ERISA Bond is also important. This Fidelity Bond is to “…provide protection to the plan against loss because of acts of fraud or dishonesty on the part of the plan official, directly or through connivance with others.” There are a few 3(16) fiduciaries that, like us, have taken the stance that both the 3(16) AND the Plan Sponsor need to be covered by an ERISA Bond. Here’s how we came to rest on that one: the Employee Retirement Income Security Act of 1974 requires that every person who handles ERISA plan assets be covered by a Fidelity Bond. Why is this important? Technically, there are two Plan Administrators. I will come back to this in a moment.
The Fidelity Bonds basic purpose is to protect against theft of ERISA plan assets. The limits on these bonds are 10% of plan assets, capped at a maximum payout of $500,000. It is crystal clear that a Plan Sponsor is required to have this Bond. If the employer chooses to outsource to a 3(16) Plan Administrator, does this trigger the need for a second Bond? Does the Plan Administrator have the authority to direct money and make decisions on your client’s plan? Yes, indeed.
The 3(16) needs to be bonded as well, for each company. As with fiduciary insurance, there is a very small population of people that know how to do this—but there are some great programs out there. NAPLIA runs a program wherein a 3(16) like us can offer an ‘umbrella’ bond solution that covers both the 3(16) and the Plan Sponsor; this is what we do. Again, ask the questions so that you know this basic risk is covered—by all parties!
ERISA Fidelity Bond is not Fiduciary Insurance
Now that we’ve discussed the basic Fidelity Bond and who needs to be covered by it, let’s talk through a real example. Suppose a CFO that catches a flight to Serbia. It’s also assumed that awaiting him is an account with $2,000,000 in plan assets that he’s quickly swindled prior to his departure. Serbia, by the way, is one of the few countries left that has no extradition with the U.S. (It did dawn on me as I searched this, how this was probably a bad thing for someone like me to be searching ‘extradition’ on Google.) So here we have a good test of Fiduciary Insurance and the Fidelity Bond.
Most small business owners purchase the Fidelity Bond as they are instructed to do. They are not from our business, so that small business owner seldom questions whether or not that is all he/she needs, nor if there is more to this risk that he/she needs to cover. In the example above, you have a business that just lost two things—a CFO and $2,000,000 in plan assets. For easy math, let’s assume the 401(k) plan has assets of $10,000,000. This means that the full amount of the Fidelity Bond would be paid. The ERISA Bond will kick in $500,000 for losses resulting from the CFO’s trip to Serbia—but what about the other $1.5M? The theft is covered—but the breach of duty (fiduciary oversight) of the business owner, the CEO, is not.
I called my insurance guru, Paul Smith to get a gauge on what percentage of Plan Sponsors carry fiduciary liability insurance. He reiterated how often small business owners confuse ERISA Bonds with fiduciary liability insurance, again that covers ‘theft’, not ‘breach.’ He estimated that it was as low as 20%, which is ‘horrific’ as he put it, considering how little it costs to have 1st party fiduciary insurance in place. (~$1,000 for a $1M limit on a $2M plan).
I also asked him to elaborate on why so many policies out there exclude ERISA coverage.
“Professional Liability (E&O) policies for small BDs just about always have ERISA exclusions, and nobody cared because they were not held to a fiduciary standard. The ERISA exclusion should have been very important to advisors working in ERISA space, but often they failed to understand the fine print. With things like 3(16) and 3(38) status put in writing, we see the coverage carved back into more and more policies—but again you have to know what to ask for when working with an underwriter—and this is rare.”
This might help you—here’s what we had to do for our policy with Lloyd’s: we had to take a TPA Policy and ensure that it affirmatively included coverage for our actions as a Named Fiduciary, with 3(16)/ 402 exposures, as part of our definition of Professional Services.