Employee Benefit Plan Bonding & Fiduciary Liability Insurance

Posted by Michael E. Mast, CPA

The Employee Retirement Income Security Act (ERISA) section 412 requires plans to obtain an ERISA bond equal to the greater of $1,000 or 10% of the plan’s beginning of year plan assets, with a $500,000 maximum. In addition, if the plan assets include employer stock, then the maximum bond required is $1,000,000 (except in cases in which the employer stock is part of a mutual fund). These bonds are generally referred to as fidelity bonds.

The process of acquiring a fidelity bond is similar to obtaining any other insurance policy but ERISA requires plan fidelity bonds to meet the following requirements:

  • The plan must be named as the insured party.
  • A plan’s fidelity bond cannot have a deductible or exception that shifts the risk to the plan
  • The maximum amount of assets handled during the year preceding the coverage year defines the coverage amount
  • Plans must obtain fidelity bonds from one of the sureties approved by the Treasury Department as listed in Circular 570

Since obtaining the an ERISA bond is what plan sponsors must do, sponsors sometimes fail to consider whether that is all that they should do. The required fidelity bond will protect the plan in the case of financial losses resulting from theft or fraud on the part of persons who handle plan funds. On the other hand, a fiduciary liability insurance policy protects the plan’s fiduciaries from losses resulting from a breach of fiduciary duty.

For example, many plan fiduciaries rely on employees and service providers for the plan’s day-to-day administration. Although the plan fiduciaries remain responsible for monitoring employees and service providers, the fact is that oversight sometimes happens periodically, such that collusion between a payroll person and a third party administrator could result in a plan loss well before the fiduciaries are alerted to the fraudulent event.

If the plan employee succeeds in embezzling $1,000,000 of plan funds, the ERISA bond would cover up to $500,000, but what happens with the rest? Plan fiduciaries may have to pay the cost of defending themselves against a claim, even if they are not ultimately liable for a breach of fiduciary duty. Insurance companies offer fiduciary insurance designed to cover claims and losses arising out of claimed breaches of fiduciary duty. Executives who are expected to assume full or partial responsibility over their employer’s benefit plans should ensure that the employer or the plan itself has purchased liability insurance for its fiduciaries. Alternatively, the fiduciary him/herself can purchase the insurance.

Plan fiduciaries are charged with the following duties in operating the plan:

  • Acting solely in the interest of plan participants and their beneficiaries and with the exclusive purpose of providing benefits to them;
  • Carrying out their duties prudently;
  • Following the terms of the plan document (unless inconsistent with ERISA);
  • Diversifying plan investments; and
  • Paying only reasonable plan expenses.

Fiduciaries can limit any possible liability by taking the following precautions:

  • Maintaining documentation of process used to operate the plan and related decision-making
  • Providing participants with control over investments in accordance with Section 404(c)
  • For plans with automatic enrollment, utilizing one of the default investment options as defined by ERISA
  • Retaining qualified, independent, third party specialists such as third party administrators, legal counsel, plan auditors, and monitoring their performance

Although all these responsibilities seem logical, a lot of the fiduciary duties can be more easily said than done. Using specialized service providers is common practice, but fiduciaries remain ultimately responsible for the plan’s operations. Although not required by ERISA, it seems prudent for a plan official to obtain fiduciary liability insurance due to the potentially costly nature of a fiduciary claim. Better safe than sorry…