To do a good job of risk mitigation, plan sponsors, and financial professionals need to understand the issues that create the greatest exposure and the steps that can be taken to reduce that exposure. By properly managing those high-risk issues, plan sponsors can reduce their fiduciary liability insurance costs and, more importantly, reduce their chances of being sued. 

A study by Aon, “What Drives Fiduciary Liability?,” sheds light on the steps that plan sponsors can take, and financial professionals can help with, to identify and mitigate the factors that fiduciary insurers deem the most important. The Aon analysis was based on a survey of 12 top carriers of fiduciary liability insurance. As explained by Aon:

While there are many ways to assess this risk [of fiduciary liability], one way is to ask insurance companies providing fiduciary liability insurance coverage about what drives their pricing. Companies providing fiduciary liability insurance are well-informed of the factors that influence fiduciary risk and incorporate that into their pricing.

Our survey focused on areas within the control of fiduciaries, as opposed to other factors such as plan size. For each area, we simply asked insurers to characterize the impact on premiums into three options: 

• Significant
• Small 
• Nonexistent
  

Some of the answers were obvious, but others may be surprises.

There are six key factors that impact pricing for fiduciary liability insurance.

Let’s start with the factors that most impact pricing for premiums for fiduciary liability insurance:

Whether the investment committee does periodic plan administration fee bench-marking reviews.
Comment: The surprise here may be that the top issue wasn’t the quality of the investments. But, for a student of the ERISA fiduciary lawsuits, this isn’t unexpected. Quantitative issues are easier to litigate than qualitative issues. While the quality of investments is critical for the accumulation of retirement benefits by participants, that’s not where the lawsuits are. As a result, for fiduciaries who want to minimize their risk of being sued, the most important factor is to benchmark and negotiate the plan’s fees. Financial professionals can help with that process by explaining the importance of this process and by recommending a high-quality provider of detailed benchmarking data for peer plans, of similar type and size.

Company stock held in the plan with no cap on investment limits.
Comment: No surprise here. There has been a lot of litigation over company stock in participant-directed plans. The moral of this story is that non-diversified investments are risky, both legally and in terms of possible investment losses.

Whether the investment committee takes formal minutes.
Comment: It probably wasn’t expected that minutes would be given this much weight by the insurers. The Aon report didn’t say why minutes were so important to fiduciary liability insurers, but it did say that minutes were a factor for all of the responding companies...But, why? As a guess, committee minutes may be indicative of a committee that takes its job seriously and that engages in a process to study and deliberate the issues that fiduciaries must address.  Financial professionals can support their plan committees by educating them on the importance of keeping formal minutes and could help draft the minutes for review by the committee members.

Mutual funds generating revenue sharing or sub-transfer agency (sub-TA) type revenues.
Comment: The report doesn’t say why this was considered important in pricing the premiums, but based on a review of fiduciary lawsuits, there are often allegations that (i) the investments were too expensive for a plan that size (e.g., that could afford institutional share classes or collective investment trusts), and (ii) the recordkeeper’s compensation was excessive when considering the 12b-1 fees, sub-TA fees, and other indirect payments received from the plan’s investments.  The first of these reasons can be managed by a review of the share classes available to the plan and, absent other considerations, the selection of the lowest share class of the mutual fund (or, possibly, the selection of a collective investment trust if the fund manager has a CIT investing in the same style). The second can be managed through use of a benchmarking service that takes into account both the recordkeeping fees paid directly from the plan assets, and the indirect (e.g., 12b-1 fees) payments to the recordkeeper. If the total compensation to the recordkeeper is excessive, the plan fiduciaries should negotiate a return of the excess payments to the plan.

Whether the plan has an investment advisor on retainer.
Comment: It isn’t remarkable that this is on the list. Many, if not most, plan committees lack the investment industry knowledge to understand the nature of share classes of mutual funds and which share classes are available to their plans. Similarly, few plan committees are aware of benchmarking services or of how to access those services. For those reasons and others, financial professionals can offer plan committees the expertise that the committee members lack, but are required to have. A prudent decision under ERISA must be based on the information “relevant” to a particular decision. It is difficult for committee members who are not in the financial services sector to know what information is relevant, much less to know how to obtain that information and prudently evaluate it.

Mutual funds using retail share classes.
Comment: This is similar to the point above about mutual funds that generate revenue sharing. An increasingly common allegation in fiduciary lawsuits is that the fiduciaries—the committee members—breached their duties by selecting the wrong share class. For example, a committee might select a retail share class of a mutual fund when a less expensive share class is available. But there may be a defense to claims of imprudence if the additional cost of that share class is offset by “revenue sharing” payments that are used to pay other reasonable costs of operating the plan or if those payments are allocated back to the accounts of the participants whose investments generated the payments.

As a concluding thought, let’s look at the factor that the insurers said had virtually no impact on pricing:  

ESG-type investments.
Comment: While the last administration generated controversy about the use of ESG factors for selecting plan investments, that controversy has, by and large, settled down for at least two reasons. The first is that, for the most part, investment managers use ESG factors to select investments that are expected to outperform or that are anticipated to reduce volatility. Those are accepted and prudent practices and will continue to be. Second, the new administration is issuing revised guidance that supports the use of ESG factors in a fiduciary context. As a result, there is little reason for the use of ESG factors to be a consideration for pricing fiduciary liability insurance.

Concluding Thoughts:
What should plan fiduciaries do with this information? The first, and most important, message is to follow the money: benchmark the direct and indirect compensation of plan-service providers on a regular basis. The second message is also based on money: use the lowest cost share class available to the plan, unless a higher share class can be justified by revenue sharing that offsets the higher expense ratio and the revenue sharing is used for the benefit of the participants. 

The other lessons learned from the Aon survey are: plans should use experienced financial professionals, and fiduciaries should keep minutes that describe their processes, the information reviewed, and the decisions made.

These steps may seem difficult to committee members, but experienced financial professionals can help committees understand the issues and implement the types of practices described in this article.