This article is intended to help plan sponsors understand the difference between retirement plan fidelity bonds and fiduciary liability insurance.
Retirement Plan Fidelity Bonds
The Employee Retirement Income Security Act of 1974 (“ERISA”) generally requires all retirement plans to be covered by a fidelity bond. These bonds, which are often referred to as “ERISA bonds,” protect the plan against losses resulting from acts of fraud or dishonesty on the part of a plan official, a plan fiduciary, or any person who handles funds or property of the plan. ERISA bonds generally must be in an amount that is not less than 10 percent of the plan’s assets as of the beginning of the plan year. Higher bonding requirements may apply when the plan invests in unconventional assets, like real estate and personal property. The minimum required ERISA bond is $1,000, and the maximum required bond is $500,000. Retirement plans that only cover the owner of the business that sponsors the plan are typically exempt from the bonding requirement.
Fiduciary Liability Insurance
In certain situations, a retirement plan’s fiduciaries can be held personally liable for the performance (or nonperformance) of their fiduciary duties. The U.S. Department of Labor (“DOL”), which is the governmental agency that enforces ERISA, can impose significant penalties on fiduciaries who breach their fiduciary duties. In addition, plan participants who are harmed by a fiduciary breach can sue the fiduciary personally for damages. Fiduciary breaches under ERISA can include the failure to select and monitor appropriate investments, the failure to make certain that plan expenses are reasonable, and the failure to remit contributions to the plan in a timely fashion. Fiduciaries who breach their fiduciary duties can be held accountable to the DOL and/or the plan participants even if their breach was the result of simple negligence, as opposed to fraud or dishonesty. In such situations, the ERISA bond discussed above will not come into play. However, plan fiduciaries can obtain fiduciary liability insurance that covers these situations. Fiduciary liability insurance typically covers the legal costs of defending the fiduciary, and also covers damages in the event that the defense is not successful. It is important to note that, unlike an ERISA bond, fiduciary liability insurance is not required under ERISA.
It is important not to lump these two types of insurances together. If a plan sponsor obtains fiduciary liability insurance, but not an ERISA bond, then the plan sponsor will find itself out of compliance with ERISA. The key to identifying whether you have an ERISA bond or fiduciary liability insurance is to look at the policy and determine who is the insured. If the insurance protects the plan, then it is most likely an ERISA bond. If the insurance protects the individual fiduciary, then it is most likely fiduciary liability insurance.
ERISA Bond vs. Fiduciary Liability Insurance: A Real World Application
Rainy Days, Inc. is an Oregon corporation specializing in the sale of umbrellas and raincoats. It sets up a 401(k) retirement plan called the “Saving for a Rainy Day Retirement Plan.” The plan has $3 million in assets, a $300,000 ERISA bond (for which annual premiums are $150) and a $1 million fiduciary liability insurance policy (for which annual premiums are $2,500). Rainy Days, Inc. is owned equally by two shareholders, Cloud E. Sky and Hale N. Sleet. Both are named as trustees of the retirement plan. Mr. Sleet is intimidated by Ms. Sky’s stormy personality, so he defers to her on all matters regarding the retirement plan. In a whirlwind of imprudence, Ms. Sky invests $1 million of plan assets in a risky investment, and the value of that investment falls to $500,000 overnight. Depressed by her imprudence, Ms. Sky decides to head for sunnier skies and embezzles $500,000 in plan assets to fund her escape. When the plan participants learn of the situation, they file a $500,000 law suit against Ms. Sky and the plan for fraud, and another $500,000 lawsuit against Ms. Sky and Mr. Sleet for breach of fiduciary duty.The fiduciary liability insurance will cover the costs of Mr. Sleet’s defense and any resulting judgment because the claim against Mr. Sleet is for breach of fiduciary duty (i.e., the duty to monitor the investment of plan assets). The ERISA bond will cover the embezzled funds because Ms. Sky acted fraudulently when she stole plan assets, but only up to the $300,000 limit. The plan participants are still out $200,000. Although the fiduciary liability insurance provided $1 million in coverage, because the $200,000 shortfall is attributable to the embezzlement it is not covered.
For more information about ERISA bonds and fiduciary liability insurance, feel free to contact a member of the Employee Benefits & Executive Compensation team.