Insurance Policies

It’s possible that, notwithstanding the best efforts to satisfy ERISA’s legal requirements, plan sponsors and the executives and managers who serve as committee members will be sued for breach of fiduciary duty. And it’s possible that, even if the law was satisfied, it would make sense to settle the lawsuit to avoid years of litigation. To provide protection in those scenarios, plan sponsors should consider, at the least, the following types of insurance coverage:

• Fiduciary breach liability insurance: This protects the plan sponsor and committee members by providing coverage for damages, settlement amounts, legal fees, and court costs.
• Cybersecurity insurance: Cybersecurity breaches related to retirement plans are becoming more common. The information needed by the cyberthieves can be obtained from the plan sponsor, from transmission of data by the plan sponsor or participants to the recordkeeper, and from the recordkeeper. Any losses occurring from cyber theft related to that data would likely result in a claim against the plan sponsor and the committee members. Plan sponsors should consider insuring against this risk.
  
• ERISA bonds: ERISA requires that all persons who handle money or investments for an ERISA-governed plan be bonded. For example, if an employee who is responsible for transmitting the deferrals and contributions to the recordkeeper or custodian embezzled that money, the bond would cover the loss. Unfortunately, some plan sponsors may not be aware of this requirement or may think that their fidelity bonds cover this requirement. The failure to obtain and maintain an appropriate ERISA bond is a violation of ERISA and could be a fiduciary breach, resulting in liability for the plan sponsor and the committee members.

Written Policies for Plan Investments and Administration

The most common claims in ERISA fiduciary breach lawsuits are about expensive investments, excessive compensation for recordkeepers, and imprudent and underperforming investments. 

Plan sponsors and fiduciaries can protect themselves by establishing prudent processess.

Plan sponsors and fiduciaries can protect themselves by establishing prudent processes for evaluating those expenses and the investments. The development of a prudent process starts with a description of the issues to be considered, the information needed to evaluate the issues, and the process for performing that evaluation and reaching decisions (for example, quarterly meetings and the use of a knowledgeable financial professional). It also includes the implementation of the decisions and then the ongoing monitoring of the issues. While, at least in theory, the process can be verbal, fiduciaries would be well-advised to reduce that process to writing a policy statement. Here are three important policy statements:

• The Investment Policy Statement (IPS): An IPS should describe both the qualitative and quantitative decisions to be made. The qualitative process is to select and monitor investments based on the quality of investment management, which should be reflected in the investment performance. The quantitative process is, as the name suggests, to make decisions on the numbers—and the most important number for our purposes is the investment expense. While the investment expense, standing alone, is important, most of the recent litigation has been about whether the appropriate share class has been selected.
• The Fee and Expense Policy: This policy should be paired with the IPS. For example, a key expense decision is whether the plan will use investments that pay revenue sharing (perhaps retail shares)—and therefore bear that additional expense, or whether the plan will use lower cost (perhaps institutional) share classes without revenue sharing. With the former (the revenue sharing share classes), the cost of the plan will likely be borne by the investments. With the latter, the administrative costs will usually be paid by the plan and reflected as charges to participant accounts. The key is that the fiduciaries make the decision that is in the best interest of the participants. Similar to the investments, the Fee and Expense Policy should also describe the objectives and process for evaluating the compensation received by the plan’s recordkeeper. For example, that process would ordinarily be to calculate the total compensation—both direct and indirect (e.g., revenue sharing)-- received by the recordkeeper and then comparing that compensation to benchmarking data based on peer plans. If the total compensation is out of line with the industry data, the fiduciaries should negotiate for better fees.
• A Cybersecurity Policy: While less common, plan sponsors and their fiduciaries should consider developing a cyber security policy. It could be based on three pieces of guidance issued by the DOL. That guidance can be found at: US Department of Labor announces new cybersecurity guidance for plan sponsors, plan fiduciaries, record-keepers, plan participants | U.S. Department of Labor (dol.gov)

Policy to Adopt Fiduciary Safe Harbors

Congress and the DOL have provided fiduciary safe harbors for certain important decisions. Plan sponsors and fiduciaries should consider having a policy of taking advantage of those safe harbors in order to obtain their protections. Some of those “safe harbors” are:

• Qualified Default Investment Alternatives (QDIAs): ERISA requires that, if a participant does not make an investment decision, the fiduciaries must prudently invest the participant’s investment savings. To protect fiduciaries, Congress directed the DOL to draft a safe harbor regulation for fiduciaries when they make those “default” investment decisions. That regulation, popularly known as the QDIA regulation, requires that fiduciaries select an investment or strategy that creates the opportunity for long-term gain balanced with risk mitigation. The investments and strategies that qualify are target-date funds, balanced funds, and managed accounts that consider the participant’s age. In addition, there are notice requirements. Plan sponsors and fiduciaries should consider, as a matter of policy, reviewing their default investments and notices to ensure that they satisfy the safe harbor’s requirements.
• 404(c) Protection for Participant Investing: The popular perception is that, while fiduciaries are responsible for selecting and monitoring prudent investments of good quality and reasonable costs, participants are responsible for their investment decisions about how to use those investments. However, that is not the full story. From a legal perspective, fiduciaries remain responsible for participant decisions….unless the plan satisfies the requirements of the 404(c) regulation. The regulatory requirements are mainly that the participants be provided with information and disclosures about the plan’s investments. Obviously it is important for fiduciaries to obtain that 404(c) protection. While most plans are already doing what they need to do, the only way to be sure is to “audit” compliance with the regulation’s requirements.
• Use of 3(38) Discretionary Fiduciary Investment Managers: If plan fiduciaries prudently select and monitor a discretionary investment manager for the plan, the fiduciaries will not be responsible—or potentially liable—for the plan’s investments. The process for prudently selecting the manager primarily involves the qualifications, experience and licensing of the manager. The use of nondiscretionary investment consultants also affords some protection, but not to the same degree as that afforded to investment managers.

Concluding Thoughts

Plan sponsors and their officers and managers act as ERISA fiduciaries when they make investment and administrative decisions about their retirement plans. That’s a significant responsibility. In effect it requires that they make informed and reasoned decisions that are in the best interest of the participants. However, some of those decisions are about matters where the fiduciaries may not be informed by education or experience. For example, fiduciaries are expected to know about investments, expense ratios, share classes, revenue sharing, and indirect compensation. Unfortunately, the law is unforgiving. The standard is of a hypothetical person who is knowledgeable about the decision and the factors to be considered.

To protect themselves, plan sponsors and their fiduciaries should consider reducing their risk by working with a knowledgeable financial professional and by using the policies that can protect them, including those discussed in this article.