MARKETING
Fiduciary liability moves into the limelight after Enron
By Dennis Pillsbury
Nicholas L. Bozzo is senior vice president and chief underwriting officer of Kemper Financial Insurance Solutions in Berkeley Heights, New Jersey.
"Corporate fiduciary liability is a product that has been around for a long time and has been profitable," according to Nicholas L. Bozzo, senior vice president and chief underwriting officer, Kemper Financial Insurance Solutions, Berkeley Heights, New Jersey. "Today, however, it is a line of business that has been attracting a lot more attention," he continues.
Certainly Enron has been part of the reason for the renewed interest, but Nicholas points out that a number of factors should make this "a very interesting time for all players in the field." But they all can be boiled down to a catch phrase that was much used in a recent presidential election: It's the economy, Stupid!
Among these interrelated factors are:
* Investment return issues--The lower rates of return are calling into question actuarial assumptions as to the adequacy of funding for defined benefit plans and also have led some companies to become more aggressive in their investments in order to achieve better returns.
* Significant underfunding--Because of strong returns in the past, many companies did not fund their pension plans on a current basis and now are finding that their plans are significantly underfunded.
* Weaker economy--The timing could not be worse as companies suffering through the current weak economy are being asked to pony up for underfunding.
* Layoffs--These can exacerbate the problem as more-than-anticipated numbers of participants seek to get their money, either for a rollover or for retirement; there also can be employment liability problems if the layoff is based on vesting.
* Bankruptcy--"Funding is viewed differently in a bankruptcy," Ann Longmore, Esq., fiduciary liability practice leader at Willis, points out. "Debts must be brought current and plans that are considered to be 100% funded will be underfunded to a significant degree. They've been averaging around 30% underfunded, and that money may come part from PBGC and part from the estate. This all could result in a very rude surprise for pensioners and could lead to claims against the plan's fiduciaries."
When you start ticking off each of these factors, you begin to see a row of dominoes with the economic downturn initiating the cascade. Of course, these are not the only factors of concern. A major one for defined contribution plans is investments in company stock. This probably is the biggest issue for defined contribution plans, but it also indirectly relates to the economic downturn and its impact on stock prices. A host of issues will undoubtedly be resolved in the courts including:
* When must fiduciaries tell participants to stop investing in company stock?
* Does the fiduciary have to use information that is not yet public?
* How many different investment vehicles need to be made available to plan participants?
* What are a fiduciary's responsibilities when a plan converts to cash balance?
The result of all this turmoil is that, like most of the commercial insurance market, fiduciary liability is hardening. "The good news," Ann Longmore reports, "is that premiums were very low compared to D&O, so the increases for fiduciary liability are easier for a company to swallow." She points out that many corporations are looking at increases in D&O premiums in the hundreds of thousands of dollars. "It's only in the tens of thousands for fiduciary liability coverage for those companies."
The irony is that the fiduciary liability is much broader than D&O and "you can go through the limits a lot faster," Ann continues. "When the big suits come in, most companies are vastly underinsured." As an example, she points out that the legal costs in the Continental Can case were
$92 million--and that was more than 10 years ago!
Recent economic conditions have created renewed interest in fiduciary liability, giving Nicholas Bozzo more opportunities to market the coverage.
This increased need for protection, Nicholas says, means there is an "opportunity to discuss this coverage with people who have never purchased it before. There's a real opportunity for us to sell fiduciary liability to more people," he says. However, he adds that there are some sectors for which coverage has become more constricted. Multi-employer (union and other plans) trusts "historically have been much riskier because of the larger number of constituents, and greater legal and regulatory issues. Losses have been more frequent for a variety of factors." He notes that, in the case of union plans, "you constantly have to make sure the plan is in compliance with the union contract and the law. There have been conflicts in that regard. Conflicts of interest involving pension plan fiduciaries also have plagued that sector." Some companies have left this market segment, and the largest carrier in this niche has had financial difficulties.
Underwriting considerations
"The fundamentals have not changed," Nicholas points out. However, "many carriers who considered this an add-on or secondary coverage have been taking a much closer look at submissions. Underwriters look at the composition of the plan and look at the larger economic issues at the company overall. Good companies rarely cut corners and their financial stability is a pretty solid indication of their insurability for this coverage." Other factors that will be considered include:
* The amendatory record. "Underwriters will want to know if amendments were made to the plan only to comply with regulatory changes or occurred more often and if so, why," Nicholas says.
* Number and maturity of participants. "We like to see more active than mature participants. It gives a sense of how many disgruntled people there might be in the event of a problem."
* Plan trustees. "We don't want to see just board people as trustees of the plan."
* Investment options. "We want to see diversification so that participants really have choices." Underwriters also are looking at how companies are educating employees about their options.
* Past claims. "We use these to help determine trends."
He continues by noting that "this is not a good line for peer comparison. Each plan is different; size doesn't matter. You can't use a broad-brush approach to underwriting. For example, mergers and acquisitions can have an impact. You have to look at what is happening to each company's plan after the acquisition. There could be potential liability if the succeeding plan is not as favorable."
Not just a severity problem
Ann Longmore adds: "Fiduciary liability has always been considered a high-severity, low-frequency line, but that is no longer true. There already are a large number of cases in the pipeline involving cash balance conversions. Most have not been adjudicated and some will wind up in the Supreme Court. The defense costs will wind up in the hundreds of millions of dollars."
She adds that a number of ERISA suits followed securities class action suits against the directors and officers. "The pension plans opt out of the class in order to bring suit under ERISA where defense costs are outside the limit."
Although the market has not dried up, Ann does point out that many clients "are having to purchase from companies who don't know the field very well. We have a lot of clients with $150 million in limits and we need 10 companies now to reach that. The last few companies of those 10 are well-financed, so we're not worried about their ability to pay, but they're not familiar with the field and may be in for a rude surprise when the claims start coming in."
Ann also expresses concern about those people in the industry who are claiming that fiduciary liability has to be worried about paying only for defense costs because benefits are excluded. "Losses to the plan itself are not 'benefits' and so do not fall under the exclusion. And even if they do, items like interest, plaintiffs' fees, IRS penalties and Department of Labor penalties would still have to be paid. In many cases, they can amount to more than the 'benefit' amount."
The key point is that, regardless of how courts decide, defense costs will be running in the hundreds of millions of dollars and the number of cases brought against fiduciaries is likely to increase in the future, making this coverage a necessity for any company that has a retirement or other benefit plan for its employees. Agents would be well advised to, at the very least, suggest such coverage for their corporate clients who currently do not have coverage and look at increasing limits for many who do have coverage. *