Beware the Pitfalls in Shopping for Fiduciary Liability Insurance
By Michael G. Kushner,
Esq.
Curtis, Mallet-Prevost, Colt & Mosle LLP, New York, NY
This is the time of year when many companies are in the process of
renewing their executive insurance policies, including their ERISA
fiduciary liability insurance coverage. Although many companies assume
that this coverage already is included under their general directors'
and officers' (“D&O”) liability policies, often such
coverage either is inadequate to cover fiduciary acts under ERISA by
such persons or excludes ERISA claims entirely. In general, companies
and their sponsored plans will need to purchase separate fiduciary
liability insurance to make certain that fiduciary acts performed by
officers, directors and employees of either the employer, its
subsidiaries or its sponsored pension and welfare benefit plans are
covered.
Due to the rapidly increasing volume of litigation against ERISA
fiduciaries, beginning with cases like Enron and escalating
rapidly due to participants' massive pension and 401(k) losses
incurred during the 2007-09 market collapse, however, fiduciary
liability insurers have been dramatically cutting back coverages that
used to be routine, often by adding exclusionary endorsements as old
policies come up for renewal. In some cases, alternative coverage
cannot be obtained; in other cases it can, but at the cost of an
additional premium charge.
Quite simply, many of today's fiduciary liability policies often do
not cover what employers believe they do and it is important to
scrutinize their coverage closely before renewing. The problem of
determining what a fiduciary policy does and does not cover is further
exacerbated by the fact that certain exclusions or limitations often
are placed in sections of a policy where one ordinarily would not
expect to find them. This can give insureds a false sense of security.
For example, a provision that operates like an exclusion might not
appear in the policy's exclusions sections but instead appear in the
policy's definitions section, declarations section, coverage section
or in endorsements to any of a number of provisions. In addition, most
fiduciary insurance policies today contain so many endorsements that
it is difficult to examine the policy as a whole to determine what is
and is not covered. I generally recommend that, rather than dealing
with this unwieldy mass of paperwork, clients and their advisors
create their own unofficial “integrated” version of the
policy document, incorporating all of the amendments and endorsements
to provide a clear picture of what the policy actually provides.
Often, this exercise yields surprising results. Sometimes, it will
reveal significant gaps in coverage. Sometimes, endorsements will have
been added in a confusing manner and may seem to contradict, or be
irreconcilable with, other provisions of the policy endorsements. It
is not uncommon for endorsements to amend other endorsements
repeatedly and imprecisely.
As an insured, the last position that one wants to be in when
defending a fiduciary liability claim against a company's employees,
officers or directors is to first have to sue the insurer to make sure
the claim is covered. Since insurers generally have wide latitude in
interpreting the terms of their own policies, so long as their
interpretations are not unreasonable, the insured can be at a
significant disadvantage. I remember arguing one claim and pointing
out to the claims representative that the claim clearly was not
excluded under the policy's language. The representative insisted that
it was excluded. I pointed out that, if that was the intent, it
certainly appeared nowhere in the policy or its endorsements, nor was
it reasonably inferable from the language. His response, forever
burned in my memory, was “listen, the policy says what we says
it says.” It was an eye-opening experience, even for a lawyer to
hear this level of bluntness. I stated that a court likely would view
this quite differently. He shrugged and gave me one of those “so
sue me” looks. And, indeed, if my client wanted to collect, he
would have had to do exactly that, in which case it would be necessary
to evaluate the potential costs and risks of suing one's own insurer
as well as defending the actual claim. Often, it may be less expensive
to simply settle or pay the claim. It is therefore important to get
things clear upfront, before signing a policy and paying the premium,
for in many cases, as a practical matter, the policy says what the
insurer says it does unless you are prepared to litigate the matter,
which not only is costly and time consuming, but also involves suing
the very party you are counting on to be your ally in defending a
claim. This is not a good position to find yourself in.
It is therefore imperative to bear in mind that insurers do not add
amendatory endorsements lightly. When they are added, they usually
cover areas in which an insured is more likely to incur a claim than
under a policy's general exclusionary provisions and reflect recent
trends in fiduciary litigation.
With that in mind, the following is a list of some of the questions
and considerations to consider when negotiating with an insurer over
the terms of a fiduciary liability insurance policy covering employee
benefit plans and their fiduciaries.
1. Occurrence vs. Claims-Made Basis.Does the policy provide
coverage on an occurrence basis or a claims made basis? An occurrence
basis is preferable, since it covers all occurrences within a
specified time period, regardless of when the claim was made.
Claims-made policies only cover claims made during the policy period.
Most policies, however, are written on a claims-made basis and
obtaining a policy on an occurrence basis can raise the premium
significantly.
2. Insurer's Right to Cancel.Policies generally grant the
insurer the right to cancel coverage in the middle of a policy term.
Formerly, absent fraud or criminal acts, most policies only allowed
the insurer to cancel during the policy period if the insured did not
pay the premium on time and, even then, after being given notice and
an opportunity to cure. Policies now, however, often permit an insurer
to cancel for any reason and with little or no notice. Theoretically,
an insurer could cancel a policy simply because the insurer viewed the
insured as a bad risk. Even the insured's traditional right to
purchase an extended reporting period for canceled or expired policies
has been undercut as most extended reporting periods now only cover
claims made in the extended reporting period that relate back
to acts committed before a cancelation or expiration date.
Furthermore, lack of adequate notice prior to cancelation (or
non-renewal) gives an insured little or no time to obtain alternative
coverage and can result in gaps in coverage just when the insured is
most vulnerable.
3. Renewal Terms.As few as five years ago, fiduciary
liability policies commonly guaranteed the insured the right to renew
the policy when coverage expired and guaranteed that the premium for
the renewed policy would not exceed the premium for the prior policy
term. Although many policies still provide a right to renew, they now
often allow the insurer to offer “renewal” at a different
premium and on different terms than the prior policy, making the right
to renew relatively meaningless.
4. Aggregation of Wrongful Acts.Many newer policies permit
the insurer to treat multiple wrongful acts as part of the same
wrongful act or as part of an interrelated series of wrongful acts.
Usually the terms “wrongful act” and “interrelated
series of wrongful acts” are either not defined in the policy or
are, at best, vaguely defined. Given that the insurer has first crack
at interpreting the policy, this gives an insurer great latitude to
determine, on a facts-and-circumstances basis, that a new claim is
part of the same claim or series of claims as a prior claim and
thereby allocate the new claim back to the period of coverage in which
the “first” act occurred. Often, the coverage for such
prior period has expired or, even if still in effect since the first
claim has already been made, very little of the policy's annual policy
limit may remain available to pay this claim. Insureds should either
attempt to negotiate the elimination of such aggregation provisions or
insist upon clearer, more objective, definitions of “wrongful
act” and “interrelated wrongful acts.”
5. Recourse Riders. Insureds should make certain that the
policy is written to not give the insurer recourse rights against
individual fiduciaries. It is not uncommon for issuers of fiduciary
liability insurance who have to pay claims on behalf of an insured
company or plan to exercise their subrogation rights against a
fiduciary who is a current or former corporate officer, director or
shareholder. Where the insurer does not waive recourse against
individual fiduciaries, it is imperative that the individual
fiduciaries purchase “recourse riders,” under which the
insurer waives its subrogation rights against them, at least in cases
that do not involve fraud, willful neglect or criminal wrongdoing.
Recourse riders, although more expensive than in the past, are still a
relatively low ticket item. Remember, however, that recourse riders
cannot be purchased with plan assets, without triggering a breach of
fiduciary duty. Section 410 of ERISA, however, does allow individual
fiduciaries to purchase such riders with their own funds.
Alternatively, the plan sponsor can purchase recourse coverage on
behalf of its individual fiduciaries.
6. Transactional Definition of Fiduciary. Under §3(21)
of ERISA, a fiduciary is defined by the acts or transactions that an
individual or entity performs rather than by reference to any official
title. Today's fiduciary policies, however, do not generally
incorporate the ERISA definition, but rather require the plan sponsor
or the plan to specifically name which of its employees, officers or
directors are fiduciaries. This can mean that someone who the insured
thought was not a fiduciary, but who becomes a fiduciary by exercising
discretionary authority or control with respect to the administration
of a plan or the investment of its assets (a so-called
“inadvertent fiduciary”) may not be covered. One example
of this would be when a member of a company's Compensation Committee
who is not part of the Plan Committee, nonetheless gives
“avuncular” advice to members of the plan committee
regarding plan investment policy. Even though the company may not
think of this individual as a fiduciary, his actions may have turned
him into a one, but not one who is covered under the company's
fiduciary policy. If possible, it is always better to negotiate for a
policy with a transactional definition of fiduciary to avoid this type
of unpleasant surprise.
7. Co-Fiduciary Liability.A fiduciary insurance policy
should specifically state that it covers imputed liability under
ERISA. Under §405 of ERISA, a fiduciary who aided and abetted
another fiduciary in committing a breach or who knew of such a breach
and failed to report it or take actions to stop it, can be found
jointly and severally liable with the breaching fiduciary. Unless the
policy specifically states that it covers co-fiduciary liability, the
insured should assume that it does not.
8. Defense Costs.Many fiduciary policies now count any costs
of defending an action against the overall policy limit. This means
that the insured never can be sure how much of the overall policy
limit will be available to any pay damages that may be due. In
addition, many policies require the insured to accept defense counsel
appointed by the insurer, whose interests may not be fully aligned
with those of the insured. Purchasers may wish to consider purchasing
a separate defense cost policy with its own limitations. This will
both assure that the full limit on liability coverage will be
available to pay any claims and can provide the insured the right to
name its own defense counsel. Note also that some policies require the
insurer to defend a claim even if it later becomes apparent that any
liability award will fall outside the scope of the policy, for
example, by virtue of one of the policy's exclusionary provisions.
Today, however, many policies do not provide separate rules for
defense costs and indemnity claims. It is not unusual to see a policy
today that allows the insurer to stop paying defense costs once it has
become apparent that the action falls outside the policy's indemnity
provisions. Again, the initial determination will be made by the
insurer and can turn on the interpretation of the surrounding facts
and circumstances. This is yet another argument for purchasing a
separate defense cost policy; preferably one that operates
independently of the fiduciary policy's indemnity provisions.
9. Coverage of New Plans. Formerly, many fiduciary policies
were written to automatically cover newly acquired plans if the
insured gave advance notice. Many policies no longer include such
automatic coverage. Newly acquired plans can come about either through
corporate transactions such as mergers and acquisitions or by an
employer simply adopting a new plan. If a policy does not provide
automatic coverage to new plans, it may be possible to either
negotiate this language or to purchase an endorsement that will
provide such coverage. Along similar lines, the insured should make
certain that when a plan that is spun off, merged or terminated,
coverage will continue for all wrongful acts up to and including the
time that the plan went out of existence. Again, it may be necessary
to purchase a special endorsement to achieve this result.
10. Naming Specific Plans. Many policies are unclear about
which plans they cover. For example, it may be clear that a fiduciary
policy covers plans that are subject to Title I of ERISA, but not
others, such as nonqualified compensation arrangements, certain
severance plans and certain welfare benefit plans. Purchasers should
attempt to negotiate the right to name specific plans as being covered
to make certain they are covered in the event that the general policy
coverage language is ambiguous.
11. Punitive Damages and Fines.Most policies will not pay
punitive damages, despite the fact that such damages are awardable
under ERISA. It may, however, be possible to negotiate coverage of
punitive damages with the insurer or to purchase an endorsement
covering such damages which, when rewarded, can exceed actual damages
under ERISA. Furthermore, many policies no longer cover fines and
sanctions under ERISA. Others cover the 20% penalty tax on fiduciary
violations that may be imposed under §502(l) of ERISA. Even if a
policy covers the 20% penalty tax, this may not be as meaningful as it
appears, as most fiduciary violations also constitute prohibited
transactions under ERISA and the Internal Revenue Code. Such
transactions, among other things, will be subject to the 15% initial
excise tax on prohibited transactions under Code §4975(b), which
generally is not covered. As any dollar paid to satisfy the initial
excise tax on prohibited transactions counts dollar-for-dollar against
the 20% penalty of ERISA §502(l), it is possible that the bulk of
the penalty will be paid in uninsured prohibited transaction excise
taxes rather than under §502(l). Insureds should attempt to
clarify that coverage of the §502(l) penalty tax includes
coverage of any prohibited transaction excise taxes that are offset
against it.
12. Penalties under VCR and CAP. Many policies either do not
cover, or contain substantially lower limits on, fines and sanctions
that may be imposed if a plan defect is submitted under the IRS's
voluntary compliance resolution (“VCR”) program or closing
agreement program (“CAP”), two programs available under
the employee plans compliance resolution system (“EPCRS”).
While it may appear on its face that a policy's VCR/CAP coverage limit
should be sufficient to cover most such submissions, this is the case
only if the insurer views the fine or sanction as being limited to
that imposed by the IRS and not as including any remedial actions that
the employer, the plan or a fiduciary may be required to take to first
cure the plan defect, such as a requirement to make the plan whole for
any losses incurred as a result of a breach or defect. Insureds should
clarify with insurers that the “make whole” portion of
relief under CAP and VCR is considered part of the general remedy
required by ERISA and therefore is fully subject to the policy's
overall coverage limitations and that the lower VCR and CAP limits
apply only to IRS fines and sanctions over and above such ERISA
“make whole” remedies, or else the CAP and VCR limits may
provide insufficient coverage to pay the claim.
These are some of the key areas of which customers should be aware
in purchasing fiduciary liability insurance. In today's litigious
environment, it is difficult to duplicate the scope of coverage that
has been available in the past and such coverage may only be
obtainable at a significantly higher premium. Insureds should be
particularly careful to scrutinize policy endorsements to determine
which rights are either being eliminated or limited by the insured and
how much of a problem this is likely to be for the purchaser. As a
practical matter, as well as a matter of fiduciary duty, it is
important to solicit competing bids and question insurers closely
before purchasing or renewing fiduciary liability coverage.
For more information, in the Tax Management Portfolios, see
Kushner, 359 T.M., Multiemployer Plans -- Special Rules, and in
Tax Practice Series, see ¶5520, Plan Qualification
Requirements.
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