It’s not unusual to see litigation against retirement plans in the news. Sponsors of 401(k) and other defined contribution retirement plans should evaluate their fidelity bonds and fiduciary liability policies to make sure they have adequate protection.
Pension law (ERISA) generally requires that every fiduciary of an employee benefit plan and any other person who “handles funds or other property” of the plan be covered by a fidelity bond unless exempted under the law. This requirement protects a retirement plan against losses due to fraud or dishonesty (e.g., larceny, theft, embezzlement, or forgery). In contrast, fiduciary liability insurance — which is not required by ERISA — more broadly protects the plan (and typically the fiduciaries) against claims for losses resulting from the act or omission of a fiduciary.
Who Requires Fidelity Bonding?
A person “handles” funds or other property of a plan whenever his or her duties or activities might cause a loss of plan funds due to fraud or dishonesty. The general criteria for determining “handling” include:
- Physical contact with cash, checks, or similar property
- Ability to transfer funds from the plan
- Ability to negotiate plan property
- Authority to direct disbursements
- Authority to sign checks
- Supervisory responsibility for activities that require bonding
“Funds or other property” generally refers to all funds or property that the plan uses or may use to pay benefits to participants and or beneficiaries, including investments such as land and buildings, mortgages, and stock in closely held corporations.
Service providers may have to be bonded if they have access to plan funds or other property or have decision-making authority that can give rise to a risk of loss through fraud or dishonesty.
Parties to Fidelity Bonds
Usually, the insurer provides the bond and the plan is named as the insured party. The parties covered by the bond are those handling funds or other property of the plan. If a plan official causes a covered loss to the plan due to fraud or dishonesty, the plan can make a claim on the bond.
Bonding Coverage Requirements
Fidelity bonds must be purchased from a surety or reinsurer named on the Department of the Treasury’s Listing of Approved Sureties. Each person generally must be bonded in an amount equal to at least 10% of the plan assets handled during the plan’s previous year. The minimum required bond amount is $1,000, and there is a maximum requirement, generally, of $500,000. For officials of plans that hold employer securities, the maximum required bond amount is $1,000,000. Fiduciaries should review the adequacy of bonding amounts at the beginning of each plan year as plan asset totals change. Since the purpose of fidelity bonding is to protect the plan, plan assets may be used to pay for the bond.
Fiduciary Liability Insurance
Because plan liability may arise out of not only acts of fraud or dishonesty but also out of breaches of the many complex fiduciary duties involved in administering a plan, many plans maintain fiduciary liability insurance. These policies protect the plan and typically any fiduciaries against losses resulting from acts or omissions — particularly, for failures to observe the many complex statutes, regulations, court rulings, and other guidance that define a fiduciary’s obligations to the plan.
Other Aspects of Fiduciary Liability Coverage
Fiduciary liability insurance typically protects a wide range of plan fiduciaries, including administrators, trustees, committees, and the plan sponsor. Coverage of fiduciaries often includes past, present, and future trustees and all plan and trust fund employees who are fiduciaries.
Fiduciary liability insurance may also provide protection for situations when a fiduciary knew of a breach by a co-fiduciary and failed to remedy the breach. A plan may also maintain fiduciary liability insurance to protect itself from losses caused by a fiduciary’s involvement in a prohibited transaction, but it may not contain a provision relieving a fiduciary of liability in that situation.
When selecting the amount of fiduciary liability insurance protection for the plan, a fiduciary must purchase the most suitable coverage at a cost of plan assets no greater than necessary. To meet ERISA’s requirements, the insurance company should have a satisfactory rating from a reputable rating agency.
The plan can purchase fiduciary liability insurance for its fiduciaries or itself if the policy allows recourse by the insurer against the fiduciary where the loss was caused by a breach of a fiduciary obligation by the fiduciary. Alternatively, a fiduciary can purchase insurance (or an employer can purchase insurance for the fiduciary) to cover his or her liability from a breach of fiduciary duties. Where the employer purchases such a policy, there is no need for the policy to provide for recourse against the fiduciary.