This interview was conducted with Gary Sutherland of North American Professional Liability Insurance Agency, LLC on July 26, 2013. Gary is a nationally recognized speaker on Fiduciary Liability Insurance. Gary is the “ask the expert” for the Center for Fiduciary Due Diligence and a founding member of the National Association of Plan Advisors (NAPA). In addition, Gary is charged with reviewing the insurance policies of all advisors wishing to work with TIAA/CREF.
Eric: Gary, thank you for taking the time to speak with us today about the differences between Fiduciary Insurance and ERISA Bonds. To start off, can you please explain what an ERISA Bond is and how it works and what the requirements are?
Gary: Sure, the ERISA bond is found under § 412 of ERISA. A Bond is not insurance in that there is no defense coverage. It is not defending you for a claim. An ERISA Bond only covers theft of 401(k) money there is no insurance component whatsoever. When there is a theft of money the bond makes the person whole and the insurance company then can go after whoever committed the fraud. It is designed to protect the Plan’s assets. But it’s really somewhat small in that the bond amount is 10% of plan assets up to $500,000 and then due to a new change in the Pension Protection Act of 2006 if you have company stock in the 401(k) plan you need $1M. These are for qualified assets. Unqualified plans have different requirements but for this purpose we’re just talking about Qualified. That means if you have a $10M plan the maximum bond is $500k unless there is company stock in which case it would be $1M.
Eric: Is that the same requirement for Defined Benefit as well as Defined Contribution Plans?
Gary: It is. Both defined benefit and defined contribution are the same.
Eric: Who at the company does it cover and what are some of the acts that it typically covers.
Gary: The bond is typically owned by the plan so the bond is going to cover anyone that handles plan funds. That could be the person who submits the money to the custodian. It could be someone who commits fraud on the payroll. So it can be an employee; it could be an owner of the plan; it can be a functional fiduciary – someone who is not named in the plan but acts in the human resources component for the company. What it doesn’t cover is outside people. So it doesn’t cover third party vendors unless specifically named on the bond. So your advisor and others should have their own bond to cover for them.
Eric: Some people have brought up the fact that employee dishonesty policies can cover this.
Gary: Employee dishonesty is a crime policy and you can add an ERISA bond to your crime policy. It has to be an approved company, so the Dept. of Labor has to be able to approve the company. And it has two nuances to a regular bond. The first one is that it can have no deductible. So, if you have an Employee Dishonesty policy with a $5000 deductible it has to be waived for the ERSIA bond. In addition to that, there has to be a feature that allows the amount of limits required to meet the 10% threshold. So if you have a $100,000 employee bond and the plan grows beyond that $100,000 it has to have an automatic increase to increase to $150,000 if the plan requires it even though on the face value it says $100,000.
Eric: Can you get a bond for more than $500,000
Gary: You can
Eric: Is it recommended?
Gary: Well, it’s unusual, I wouldn’t say it’s recommended but often times when you’re dealing with unions specifically where there’s been years and years of abuse a union will require a much higher bond. We’ve written bonds up to $20M. If you’re looking at a $25M plan $500,000 doesn’t seem like a lot. But that is what’s required and you can certainly buy more.
Eric: Let’s just say that there was a fraud and the bond has to pay out but the fraud was over the amount of the bond, who pays that other money?
Gary: Good question, it would depend on what the DOL sees whether there was no supervision of employees? Was there a fiduciary breach because of no checks and balances? They may come after anybody. It would really be from the DOL who would say to the business “it’s your fault that $1m was stolen, we understand that you’re bonded for $500,000 you’re responsible to make up the $500,000.”
Eric: So, if it was at the action of a fiduciary then that fiduciary under ERISA could be personally liable?
Eric: That brings us up to the next topic of conversation, can you explain what a Fiduciary Liability Policy is and how they differ from an ERISA Bond?
Gary: A Fiduciary Insurance Policy is your typical insurance policy. It provides a defense if you’re named in a suit for breach of fiduciary duty. The thing to understand about Fiduciary Insurance it not only covers the 401k plan it covers every health and welfare benefit that you offer your employees. It covers your dental, your health and life insurance, whatever benefit that you offer, if there is a mistake made, it covers you. It covers the fiduciaries of the plan, usually the owners of the business, who have a personal liability under ERISA. It also, by definition, covers anyone in the company who acts as a functional fiduciary. Someone who is not named in the plan but because of the duties of their job is a fiduciary. Someone who hires an employee and talks to them about benefits; Human resource people; payroll people; people who calculate benefits; all of those people would be covered under that policy. Fiduciary insurance is relatively inexpensive given insurances today. Just as an example a plan with $5m in assets a policy may only cost them $1500 per year. It is important to note that because in the event that a claim is made against you for a breach of fiduciary duty, instead of going to your corporate counsel or attorney, you are now speaking directly to an expert in ERISA law. Often times even on potential claims you can get the insurance company to come in and help you on the legal aspects and it is coming out of the premium you are paying.
Eric: Is there a limit on the amount of work that you get for that premium amount?
Gary: Some policies will limit it, but generally the idea of the insurance company is win-win, if they can get in and avoid a claim then they are going to do it. That is generally the attitude.
Eric: Without the policy you are going to have to go it alone?
Gary: Basically, you’re going through the yellow pages to find an attorney or calling friends and people you know to help you.
Eric: Right, not all ERISA attorneys are the same.
Gary: That’s correct, within ERISA there are your backroom attorneys that deal with plan documents and then there are attorneys who regularly defend people on claims, and we’re looking for the ones that are doing 25 claims a year.
Eric: What are the typical claims that you see under both the ERISA Bond and also Fiduciary Insurance.
Gary: On the ERISA bond, of course, it’s only theft so it has to be theft. Generally what we see is that someone in the company’s employment borrows from the money that should have been sent up to the custodian. So they take employee’s assets thinking that they can pay it back in two weeks. And then they use the next pay period to make up for the previous one and they’re always two weeks behind and it never gets made up. Fortunately, those cases tend to be pretty small. At some point in time the employer gets a letter that they are consistently late in deposits and that’s how it gets discovered. We see that quite a bit. We also see people who have done fraudulent loans. They borrow from someone else’s plan and forge their documents with the idea that it’s temporary and they’re going to pay it back. They recognize that people don’t look at their 401k statements so they won’t notice that suddenly there is a $50,000 loan. In one particular case there were multiple loans taken, the human resources person who was behind it said that it was a mistake and she would get it corrected. Then she would pay it off and borrow from someone else. In that case she stole about $300,000.
Eric: Wow, and under the fiduciary insurance?
Gary: Fiduciary claims break pretty evenly about 50% of the claims are 401k related and 50% are other benefit plans. That probably the thing that is a little eye-opening. Most people assume that it is all 401k, but the reality is that as many mistakes are made in the health and dental. People aren’t added in time, or they are put on the wrong plan. That is something that we see quite frequently, where they have three or four plans and the person chooses plan A, the higher plan, but they are put on C, the cheaper one, and then get denied coverage. These are typical claims that we see quite a bit.
Eric: Can plan assets be used to pay for the Fiduciary Policy and or the ERISA Bond?
Gary: The answer to that question is yes, they can pay both for the bond and the insurance policy. However, we don’t recommend it. On the bond it’s not generally a big issue because the premium is typically only several hundred dollars so at the end of the day it usually has no impact. On the Fiduciary Insurance if the plan assets pay the policy and then they pay out on the policy. The insurance company that writes the policy can subrogate against the owners. So the owners think that they are buying coverage for themselves but if the plan pays for the policy then the insurance company can turn around and go after the plan fiduciary say that they have to pay this. We never recommend it.
Eric: A lot of times when we bring on a new client we are told that the Fiduciary coverage is packaged in with other insurances. Often it will be tacked on to the D&O policy or BOP policy. Is that coverage similar to what you can buy in a stand-alone policy?
Gary: We hear that a lot too. The insurance companies have not done a great job explaining what the coverage’s are. They tend to throw these limited coverage’s on things like general liability or business owners policy. So they give the illusion of coverage. On many general liability policies there is what is called employee benefits liability. It is usually sub-limited and it only covers mistakes made in the health and welfare plans not the 401k, so that is a big gap. But often times it’s limited to $5000 or $25,000 and it is defense only, there is no damages coverage. You can add fiduciary coverage to the D&O policy and it is pretty common. For a small business where they have a $1M D&O and they have the fiduciary coverage generally that is fine. For a larger company where there is real D&O exposure we never recommend combining them because you are sharing limits. One D&O claim blows the limits and then there’s nothing left for fiduciary coverage. In addition to that, often times the problem with the D&O and fiduciary insurance is “which hat are you wearing when the claim was made?“ As a director you have a fiduciary responsibility to your shareholders or employees or owners but as a fiduciary for a 401k plan it is a different liability and you’re fiduciary responsibility to the 401k is at a higher level than your D&O. Which means that if it’s something that would actually hurt the company but it is right for the 401k, you have to do what is right for the 401k which puts you in a significant conflict. That is why you may not want to have those in one policy.
Eric: Is there a size of plan that dictates how much coverage you should have?
Gary: There is, as a general rule of thumb what we recommend, if a plan is under $100M in assets, generally speaking $1m in coverage is fine. The reason for that is the average claim for a plan of that size is about $774,000. So we’re covering the great majority of potential claims made against those plans. $100 to $500M in assets you’re generally looking for $2M and above. Once we get into the $1B in assets we are looking at about a $5M policy. You’re never going to be able to buy limits to match your assets, nor do we think the exposure is there. The good news is that we have been tracking fiduciary claims since the early 80’s and pretty much have a good sense of how many claims there are and what the litigation costs are. Currently, there are about 10,000 active fiduciary claims in the court systems today. This is interesting because it almost matches what is happening with sexual harassment in the courts and we all sort of feel like we need that coverage. Yet they are almost the same in terms of numbers.
Eric: And there isn’t the same uptake on the fiduciary liability policies, right?
Gary: No, and the issue is we typically only hear about the big claims, you know, the $42M claims. We don’t hear about the everyday $300,000 or $800,000 claims.
Eric: Are most of these claims the result of an audit or employee complaint? How do they typically arise?
Gary: Generally, they are employees that bring the claims. Often times it is when they go to retire and they meet with their financial planner and they find that there are significant problems with their 401k. For defined benefit we know that there are actuarial issues and they may find out that they have nowhere near enough to retire on. On the defined contribution plans we may find that the investment of their assets was not suitable to their age. We all read the newspaper stories of the grandmother who finds that 50% of her assets were invested in risky alternative assets. Generally, we don’t see claims from audits on a regular basis.
Eric: Is there a difference between fiduciary liability policies? How often should they be reviewed?
Gary: Yes, there is. Not every policy is written the same. They all have the same core components but they are significant nuances to each policy. You are looking for a policy that can be as broad as possible for functional fiduciaries. You want a policy that will cover anybody at the company that did any role that could have led up to a potential claim. You don’t want to have anybody excluded so you want it to be as broad as possible. In addition to that you want some language that covers any benefit plan even if it wasn’t named in the application. You don’t want to realize that you just added Long Term Care for the employees and find out that it was excluded.
Eric: Is there anything else that you want to add?
Gary: I think that the biggest thing to add is that as a fiduciary to the plan you know that you are required to be bonded. But what you may not know is that you are also required to have anyone that is a third party vendor be bonded. Anyone that handles plan assets is required to be bonded and if they are not bonded and you didn’t know it that could be a breach of fiduciary duty right there. So let’s say for example that you are working with an investment advisor that specifically handles plan assets and has the ability to steal and there is a theft by that person that could come back on you as a breach of fiduciary duty and you could be personally liable. In addition to that you want to work with vendors who have Errors and Omissions Insurance, more importantly than just them having it you need to make sure that they are covered as a fiduciary to the plan. Many policies out there exclude their activities as a fiduciary so you may think that they have coverage and it turns out that they do not. Again, that could be potentially a breach of fiduciary duties. What we tell plan sponsors is don’t rely on certificates of insurance to evaluate whether someone is covered. Rather get the policy itself and have an agent or ERSIA attorney review it to make sure that there is appropriate coverage.
Eric: Gary, thanks for taking the time to sit down with us today. I think that you have successfully explained the differences between ERISA Bonds and Fiduciary Insurance. If our readers have any questions can they get in touch with you?
Gary: Absolutely, I will be happy to speak with them directly. I can be reached at (508) 656-1350 or at GaryS@naplia.com. Also, for more information they can visit our website at www.naplia.com. Just make sure to let me know that they are working with you so that I know that there is no cost to that.
Eric: Thank you very much Gary. I really appreciate your time today.