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Emerging fiduciary liability exposures

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Potential litigation perils may be arising from several emergent exposure sources

 

By Richard G. Clarke, CIC, CPCU, RPLU, CITRMS


Within the past couple of years, a number of legal and legislative developments have created conditions which could markedly heighten fiduciary liability claims activity.

Before getting into the details, some background on the evolution of the general fiduciary exposure and insurance coverage might be helpful.

Fiduciary liability insurance is a product born of federal legislation known as the Employee Retirement Income Security Act (ERISA). Effective on January 1, 1975, ERISA was signed into law on Labor Day, 1974, by President Gerald Ford. It was designed to protect U.S. workers through mandating a serious approach, with accountability, to employers' maintenance of employee benefit plans.

Despite the heightened employer responsibilities imposed by the new law, the only insurance actually required by ERISA is a "fidelity bond"—in effect a form of employee dishonesty insurance—in prescribed amounts, expressed as percentages of the assets of employee benefit plans, with a minimum amount ($1,000) and a maximum amount ($1 million) required per plan. [A recurring misconception is that ERISA applies only to pension, profit-sharing and 401(k) plans, when in reality, it applies to all employee benefit plans with the notable exception of non-qualified plans, such as executive deferred compensation plans, with only limited additional compliance exceptions.]

Although no liability insurance is mandated by ERISA, the language of the legislation makes it clear that there is personal liability imposed on "fiduciaries" and "parties at interest" (ERISA, Section 409), for discretionary judgment authority related to the establishment and maintenance of employee benefit plans. It was this imposition of personal liability that gave birth to the insurance product known as fiduciary liability insurance.

The cost for fiduciary liability insurance has historically been considered fairly nominal, and underwriters have required only relatively small per-claim retention amounts, applicable to covered claims. But in 2012, several significant events occurred that have the potential to change the face of fiduciary liability insurance forever.

The Patient Protection and Affordable Care Act (ACA) Although actually signed into law early in 2010, "ACA" (or "Patient Protection Act", or "PPACA") as it has come to be known, was somewhat contested but remained untested until the U.S. Supreme Court (SCOTUS) upheld most of its provisions in a decision in June 2012. Then, with Barack Obama being re-elected later that year, it became clear that the "health-care reform" represented by the many provisions of ACA is here to stay, although many of the critical aspects of ACA are not effective until 2014. [Some observers have noted that the ultimate effect of ACA will be significant insurance reform, but not significant health care reform.]

The new law applies to employers with more than 50 employees ("large employers"), as well as employers with fewer than 50 employees, and self-funded plans. The increased fiduciary liability exposure rests with employers grasping and grappling with the myriad aspects of this sweeping new legislation. In addition, employers are responsible for proper and timely communication to employees of options, alternatives and administration of employee benefit plans which are subject to ACA, as well as interpretation of the complex "tax" (as ruled by SCOTUS, in 2012) options which apply to non-compliance with the law, by both employers, as well as employees. The law also distinguishes between full-time employees (those who work 30 or more hours per week) and part-time employees (the latter not required to have coverage under ACA, while the former is required to have prescribed coverage).

Some employers will likely make some current full-time employees part-timers, to avoid the additional costs of compliance with ACA. In fact, this has already begun to occur. In addition to potentially disrupting business operations, such moves could also increase an employer's susceptibility to claims alleging denial of health insurance benefits, if such benefits were previously available to full-time employees.

Further, employers are incentivized under ACA to institute or upgrade employee wellness programs, by achieving described "health standards." The new regulations are detailed and onerous and do not address connected exposures which employers may face related to employee allegations of discrimination under a variety of federal or other laws. And, a recent Aon Hewitt survey of employers revealed that some intend to penalize wellness program non-participation by employees (in the form of increased premiums), which could add to increased fiduciary liability exposure.

There have been articles in human resources publications since the passage of ACA suggesting that self-funded plans are likely to encounter more frequent and intensive ERISA compliance reviews. Findings of errors in plan administration can result in fines and potential civil or even criminal action against the plan administrator. The trustee(s) of self-funded plans can also face significant personal liability for discrepancies, miscalculations or violations of guidance or rules. Some examples of these violations would include: failure to properly select or monitor plan services providers; use of plan assets to discriminate by benefiting selected parties relating to the plan; bringing action or retaliation against a plan participant for asserting or exercising his plan-given rights, such as termination of coverage, and several others.

No fewer than four federal agencies will be involved with the new federal guidelines relating to ACA: the Internal Revenue Service; the Department of Labor (which encompasses the legislative oversight of ERISA); the Department of Health and Human Services; and the Department of Housing and Human Development. [This new, significantly broader regulatory oversight is, in itself, a significant increase over the prior ERISA-related oversight by the Department of Labor and adds to potential fiduciary liability exposure for most employers.]

The ACA law is fraught with new reporting, recordkeeping, and benefits requirements, the combination of which will stretch and stress employers and HR staffs, and have the potential to generate regulatory fines and penalties. However, the ACA certainly doesn't preclude employee litigation—in fact, it follows the form of earlier federal legislation (Sarbanes-Oxley and Dodd-Frank), in providing whistleblower protections for employees who decide to approach regulators (and there are now more regulators to approach under the ACA).

Action item for insureds with fiduciary liability insurance: That coverage needs to be as broad as possible, especially entering 2014. Some insurers have developed new endorsement language which represents a sub-limit of coverage for payment of civil money penalties arising out of ACA. [Some insurers offer even broader coverage in this vein, and cover civil money penalties arising from HIPAA as well. Actually, the whole concept of the new legislation makes fiduciary liability insurance more relevant from the "propensity for claims payment" perspective, as well as liability protection for persons charged with decision making on internal employee benefit plans.]

Domestic Partnership Exposure. Although not originating in 2012, yet another potential emerging exposure for employers involves the issue of "domestic partnerships," and how insurance coverage will support (or not) this concept. This term can be loosely defined, or more rigidly defined, but there were (as of April 2013), seven states, plus the District of Columbia, that have formal domestic partnership status available to those persons who register for this recognition. The states are California, Maine, Nevada, New Jersey, Oregon, Washington, and Wisconsin (and the District of Columbia).

Employers will need to decide if they wish to recognize the formal, registered status of "domestic partners" and, if so, whether available employee benefits are to be extended to such domestic partners of employed persons. The argument could be made by such persons that granting formal legal status entitles them to domestic partner benefits. (The same argument could be made by persons not obtaining the formal status, as well, who nevertheless assert that they are entitled to benefits.) Regardless, the granting of "domestic partner" status in the context of allowing such persons to receive available employee benefits could well be an additional fiduciary liability exposure for employers.

Action item for employers with fiduciary liability insurance: Obtain confirmation from the insurer(s) that allegations/litigation relating to "domestic partner" situations will be considered a covered exposure under the fiduciary liability insurance.

Internal Revenue Code 4975 Penalties. Under Internal Revenue Service (IRS) rules, certain transactions involving investments are prohibited, with corresponding penalties potentially imposed, upon discovery of violations of the code. The purpose of prohibiting certain transactions is to encourage the use of Individual Retirement Accounts (IRAs) for accumulation of retirement savings, as well as prohibiting those in control of IRAs from receiving undue advantage relating to the tax benefits afforded under the personal accounts of such persons. Since the IRS (theoretically) granted a tax deduction to the individual making the contribution to the IRA, no personal benefit should be available, without payment of the prescribed IRS taxation.

IRS Section 4975 prohibits transactions between certain vehicles (such as a self-directed IRA, or a 401(k) plan, and a "disqualified person." [A "disqualified person" can be the IRA holder, or any successors or lineal descendants of same, and related entities in which the IRA holder has an equity or management interest. The prohibited transaction rules are focused on a person using IRA funds in a transaction that directly involves or benefits a "disqualified person." So, if an IRA transaction does not involve a disqualified person, there is little likelihood of encountering prohibited transaction rules under Section 4975 of the Internal Revenue Code.]

But how can a person with discretionary judgment authority (as defined under ERISA) really know all of the details, and exactly who the "disqualified persons" are, with respect to IRAs, or 401(k) plans, subject to these prohibited transactions?

Civil money penalties can be levied by the IRS, which may cause the harried employee benefits manager/human resources director to face further scrutiny from the IRS.

Action item: Many fiduciary liability insurers have developed specific endorsements designed to provide a sub-limit of insurance for IRS Section 4975 civil money penalties. Since many such endorsements do not involve an additional premium charge, obtaining this valuable fiduciary liability extension can be extremely beneficial to "fiduciaries," as defined under the ERISA legislation.

Additional Fiduciary Enhancements Available. Especially designed for those entities purchasing larger limits (with corresponding larger per claim retention amounts), some insurers have designed attractive additional coverage enhancements for fiduciary liability situations, (subject to underwriting, of course). These additional enhancements include the following:

• Although bodily injury-related claims are usually specifically excluded from coverage, the carveout of the exclusion for such allegations relating to ERISA-related claim situations will sometimes be granted by underwriters.

• The (usually) standardized policy exclusion for "failure to fund" plans in accordance with plan instruments (or the law), and the exclusion for failure to collect contributions owed to the plan, can be modified to provide coverage for defense expenses associated with these allegations.

• Specific coverage for Labor Management Relations Act Section 301 claims (an attractive enhancement in situations where labor unions have a presence in the workplace of an employer).

• And several other impressive extensions available from individual insurers.

Fiduciary liability insurance has always been a bit tricky—and there is additional exposure in the form of potential litigation just around the corner arising from several possible exposure sources, and SCOTUS decisions. It will become increasingly important to pay attention to specific details of fiduciary liability insurance, as well as utilization of newly created coverage enhancements.

The author

Richard G. Clarke, CIC, CPCU, RPLU, CITRMS, is senior vice president with the regional brokerage J. Smith Lanier & Co., headquartered in Georgia. He instructs CE programs for several professional insurance organizations and has written several books on management liability which are available on Amazon.com. Clarke was an original recipient of the CPCU Society's Distinguished Instructor in Insurance award, in 1999. He can be reached at dclarke@jsmithlanier.com.

   

 

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