ERISA FIDUCIARY INSURANCE: COMMON EXCLUSIONS AND OTHER CONSIDERATIONS. Allison Madan, Esq. SLEVIN & HART, P.C. WASHINGTON, D.C.

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1 ERISA FIDUCIARY INSURANCE: COMMON EXCLUSIONS AND OTHER CONSIDERATIONS Allison Madan, Esq. SLEVIN & HART, P.C. WASHINGTON, D.C I. Why Do Plan Fiduciaries Need Fiduciary Insurance? A. Personal Liability (Section 409 of ERISA) Section 409 of ERISA states that Aany person who is a fiduciary with respect to a plan who breaches any of the responsibilities, obligations, or duties imposed upon fiduciaries by this title shall be personally liable to make good to such plan any losses resulting from each such breach...@ B. Exculpatory Provisions and Fiduciary Insurance ( Section 410 of ERISA) Section 410 of ERISA specifically addresses the manner in which fiduciaries may be indemnified for liability or losses incurred as a result of breaches of fiduciary duty. That section provides as follows: (a)... [A]ny provision in an agreement or instrument which purports to relieve a fiduciary from responsibility or liability for any responsibility, obligation, or duty under this part shall be void as against public policy. (b) Nothing in this subpart shall preclude -- (1) a plan from purchasing insurance for its fiduciaries or for itself to cover liability or losses occurring by reason of the act or omission of a fiduciary, if such insurance permits recourse by the insurer against the fiduciary in the case of a breach of a fiduciary obligation by such fiduciary; 1

2 (2) a fiduciary from purchasing insurance to cover liability under this part from and for his own account; or (3) an employer or an employee organization from purchasing insurance to cover potential liability of one or more persons who serve in a fiduciary capacity with regard to an employee benefit plan. II. Typical Endorsements and Exclusions A. Exclusion For Administrative Expenses AIt is understood and agreed that coverage as provided hereunder specifically excludes any claim or allegation which, in whole or in part, directly or indirectly, arises out of the propriety or impropriety of compensation paid out of the Plan for administrative expenses for services that were or should have been rendered to the Plan.@ 1. Intended to eliminate coverage for suits alleging that fiduciaries allowed the payment of excess compensation to plan providers. 2. Insurers apply an arbitrary test of what constitutes excessive compensation or excessive administrative costs. 3. Generally, if you can demonstrate that the plan=s administrative expenses are reasonable under the circumstances insurers will consider the elimination of this exclusion. B. Exclusion For Investment Decisions Not Made By Qualified Professional Asset Manager (AQPAM@) 2

3 AIt is understood and agreed that coverage as provided hereunder specifically excludes any claim or allegation which, in whole or in part, directly or indirectly, arises out of any and all endorsements in other than U.S. government securities or obligations which are federally guaranteed, including FHA instruments, unless those investments are made by a qualified professional asset manager (AQPAM@) as defined by the Department of Labor.@ 1. A QPAM (Aqualified professional asset manager@) is an investment professional identified by the Department of Labor which, in the Department=s view, is both qualified in the investment field and independent. Usually, QPAMs are either banks or large investment houses or investment consultants. 2. In general, this exclusion does not create problems where plan assets are invested through investment managers. However, some plan fiduciaries occasionally make investment decisions themselves (for instance to invest in an index fund) without the help of professional investment consultants. 3. Insurers have agreed to eliminate this exclusion upon showing that the plan fiduciaries= decision making process is prudent. C. Co-Trustee Liability 1. Some fiduciary insurance policies specifically exclude, or by their terms do not provide coverage for, instances in which one fiduciary brings suit against another. The basis for the exclusion has been explained as a desire on behalf of the insurer to avoid becoming embroiled in what could be a political fight by one fiduciary or one group of fiduciaries against another. 3

4 2. However, such suits can easily arise where one fiduciary has engaged in wrong doing, and the innocent fiduciaries wish to pursue the guilty fiduciary in order to protect the plan. 3. Although the plan can be protected in other ways,for instance, a participant can bring a suit against the Abad@ fiduciary, such participant suits often also pursue the innocent trustees, at least until it becomes clear that there is no cause of action against the innocent trustees. 4. One example of co-fiduciary liability is where one fiduciary is responsible for completing the insurance application and he or she makes a misstatement of which the other fiduciaries are unaware. 5. Some insurers have agreed to eliminate this exclusion from coverage if they are convinced that the exclusion will discourage fiduciaries from reporting bad acts of co-fiduciaries. D. Exclusion of Coverage for Former Fiduciaries 1. Many Aclaims made@ policies do not cover fiduciaries once they have ceased to be fiduciaries to the plan -- for wrong doing that occurred while a fiduciary. 2. This is typically a fundamental policy design issue and it is unlikely that the insurer will agree to provide Aformer fiduciary@ coverage if the policy has not been designed to include this coverage. This is often a reason to shop for another insurer. 4

5 III. Deductibles and Elimination of Recourse A. How Important is the Deductible? Because fiduciaries are generally personally liable for any breach of fiduciary obligation, deductibles must be paid personally. This is a driving force behind negotiating low deductibles with the insurer. B. Why does Elimination of Recourse Matter? 1. Section 410 of ERISA requires that any fiduciary insurance paid for by the plan must permit the insurance company to pursue the fiduciary in where a fiduciary breach is determined to have occurred, so called recourse. However, since no one would ever serve as a fiduciary under such circumstances, the Department of Labor allows a fiduciary to purchase, with his or her own assets, elimination of recourse coverage. 2. The cost of elimination of recourse coverage is usually nominal. IV. Applications and Choosing a Carrier A. Complete and Accurate Applications are Important. It is imperative that an initial application for fiduciary insurance, or a renewal application, be read carefully and that there be no mistakes in it. Aggressive insurance companies often seek to deny coverage based on erroneous information provided in the application. B. All Fiduciary Carriers are Not the Same. 5

6 1. Check the Best rating. 2. Some carriers are particularly aggressive in denying coverage. For example, one commonly used fiduciary insurance company attempts to exclude nonbenefit suits against trustees on the basis that any recovery would ultimately be used to pay benefits. The same company has also been known to characterize intentional conduct on the part of a fiduciary into intentional violation of the statute. C. Who Appoints Defense Counsel? Another issues to be aware of is whether the policy allows the fiduciary to name their own counsel. Often policies require that insureds use a lawyer chosen by the insurance company thus diluting the control the fiduciary may have over his or her representation. V. What if Your Client Doesn=t Have Fiduciary Insurance or the Insurer Will Not Provide Coverage in a Particular Situation A. Indemnification Agreements. 1. Under certain circumstances, the Department of Labor (DOL) has concluded that the advancement of counsel fees to fiduciaries accused of fiduciary breach is proper if the fiduciary agrees to repay the advanced fees (plus interest) in the event the fiduciary is found to have breached his or her fiduciary duty and demonstrates that he or she is financially capable of doing so. (DOL Opinion Letter 77-67A). 2. The DOL has found certain indemnification agreements valid where the contract provision provided that the plan would indemnify and hold harmless certain plan fiduciaries for losses and liabilities they incurred and would reimburse each such 6

7 person for legal expenses reasonably incurred provided the following conditions were met: a. The plan will not be liable in any case where a court of competent jurisdiction has entered final judgment that the fiduciary has breached its duties under the contract; and b. Expenses incurred in defending a civil or criminal action may be paid in advance of the final disposition of such action only: (i) Upon receipt of an undertaking by the fiduciary to repay the expenses plus reasonable interest in the event a final judgment determines such fiduciary to have breached its duties, and (ii) Proof is given to the plan that the fiduciary is financially capable of repaying the advance in the event it is found liable for the breach. 3. The DOL has also pointed out that the plan may make payment pursuant to the indemnification provisions of the contract in settlement of pending or threatened litigation if the plan obtains a written opinion from independent counsel that the acts of the fiduciary do not constitute a breach of fiduciary duty. VI. Other Issues A. AFree@ Coverage -- Is It Really Free? Free coverage added to a policy by way of endorsement may simply be a dilution of coverage in lieu of a premium reduction. 7