Challenges associated with the economic turmoil occurring in 2008 have driven many companies to cut back on expenses. Many cost-cutting decisions and changes can positively impact your bottom line, but they may also have a much more adverse effect on your employees, partners, investors and business. A few areas of concern highlighted in this article are fiduciary liability, employee benefits liability and directors and officers liability.
Fiduciary liability is generally an insurance coverage that holds a questionable value to many business owners and is an important coverage if you offer employees a retirement or welfare plan. Since you are choosing the plan’s third-party asset manager and the investment options available, you hold a personal fiduciary responsibility to the plan’s participants.
A fiduciary bond is required by the Employee Retirement Income Security Act of 1974 (ERISA), which protects the employer from theft of employee benefit-plan assets. However, a fiduciary bond does not protect the individual fiduciaries and the retirement plan from liability arising from errors in plan administration and breaches of fiduciary duty under ERISA. That is where fiduciary liability coverage picks up the slack.
Most employers offer defined retirement plans including employer-provided pensions, where the assets are controlled by fiduciaries and plan sponsors, or the more common “defined contribution” plans, commonly referred to as 401(k) plans.
Typically, the difference between these two is who has discretion over the investments. The pooled assets of employer-sponsored pension plans are controlled by the fiduciaries with little or no intervention by participants or employees. On the other hand, 401(k) plans are driven by the individual plan participant (the employee) who chooses the investments, sales timing and threshold for investment risk.
Fiduciaries generally believe they have no fiduciary liability exposure to participants of a 401(k) plan since the employee has virtually full control over his own individual plan. However, despite the employee’s control, these plans still have an exposure to lawsuits from the plan’s participants.
For example, participants are usually restricted to a small number of investment options chosen by the fiduciaries and/or sponsor. This creates a problem if participants feel they are not being given a good enough opportunity to place their funds into investments that should perform the way they are recommended.
Also, the plans are often managed by a third-party administrator chosen by the fiduciary and whose fees are negotiated by the fiduciaries, not the participants. This can often create a problem for the plan’s participants because they may feel they are being overcharged for administrative fees and the third-party administrator is not providing enough value or performing for what they are charging.
Lastly, fiduciaries often provide a company match to the employee’s contributions. In today’s economic environment, reductions or elimination of company matching is occurring more frequently. This could potentially be considered a breach of fiduciary duty to participants if they were not properly notified of the change. Because of these roles taken by the employer or fiduciaries, they still hold the same liability as fiduciaries of employer-provided pension plans.
Due to the current economic conditions and the slumping of the financial markets, many employees have seen their nest eggs disappear almost overnight. It is essential to realize that these employees can or may be responsible for their losses. The importance of having fiduciary liability coverage or increasing current limits of coverage is at an all-time high. The size of your company does not eliminate you from litigation by a retirement plan participant if you are offering this benefit to your employees.
Employee Benefits Liability
The common misconception is that Employee Benefits Liability (EBL) is an insurance coverage that provides protection for many of the same exposures associated to fiduciary liability. It is often confusing to differentiate between the two, but the main difference is that EBL only protects against claims for errors and omissions in plan administration, not against any breach of fiduciary duty under ERISA.
In addition to retirement plans, EBL also extends to provide protection for errors in administration of other employee benefit programs such as group life, health, dental, automobile, educational reimbursement, workers’ compensation, savings and/or vacation programs. Errors or omissions in administration commonly include misinforming employees of the content in any benefit programs, giving advice about a program, handling records in connection with a benefit program, or an error in administration that affects enrollment, termination or cancellation of any employees under a benefit program.
Often, administrative errors go overlooked by principals and officers of companies, but the potential impact on employees when an error occurs can be significant. Employers who offer health insurance to employees are responsible for providing information regarding the enrollment period for their employees as well as ensuring they have properly been offered an opportunity to accept or decline coverage if they qualify.
Additionally, one of the core responsibilities of employers is to make sure they are in compliance with their group health providers’ requirement for the number of employee participants. Almost all carriers require at least 75 percent of qualified employees participating, or provide an acceptable waiver stating they are already insured under another qualified health plan (usually with their spouse’s company) and therefore decline coverage from their employer.
One example of an administrative error connected with this rule would be if an employer did not acquire the acceptable waivers from non-participating employees and a significant claim (such as a participating employee being diagnosed with cancer) was turned in to the group health provider. The insurance carrier has the right to review your records before accepting the claim and may potentially deny and cancel coverage to the diagnosed employee since the employer was out of compliance and did not administer the records of the plan properly.
Further, the employer could potentially be sued by the diagnosed employee for an error in administration of the company’s health plan, as well as the medical costs for the claim itself, which could amount to thousands, if not millions, in favor of the employee.
Administration of your company’s benefits programs should never be taken lightly as mistakes and errors do occur throughout a company’s lifetime. It is strongly recommended you consider this coverage as EBL is typically inexpensive and can be added to your existing policy with your general liability insurance provider.
Directors and Officers Liability
The last and likely one of the more important liability exposures to highlight pertains to directors and officers (D&O) of private corporations. As leaders of a company, directors and officers can be held personally liable to shareholders, employees, customers, partners, investors, creditors and other third parties for the decisions they make.
A common fallacy is that if a company is privately owned, it is not exposed to any type of D&O liability. This is completely untrue as directors and officers in both public and private corporations are required by law to act diligently and with due care, avoid conflicts of interest and activities that benefit them personally at the expense of the corporation, and to comply with the numerous federal and state statutes regulating management and corporate conduct.
As the credit crisis continues to increase the problems that most businesses face today, the most common form of D&O liability stems from the alleged decisions and wrongdoings officers and board members made for the use of corporate funds. Despite the warnings and foresight provided by many financial professionals regarding riskier finance instruments being touted, many corporations have found themselves holding on to much more debt and risk than they have ever had before.
Also, the failure of a business can ultimately lead to lawsuits by former employees against the officers personally since they may have breached their fiduciary duties to attempt to benefit themselves and ignore the affects it may have on the employees.
The disregard for D&O coverage is common throughout private companies. But officers of a corporation make decisions that may lead to a business failure. This failure could potentially affect the constituents you are responsible to, and protecting your own assets or personal investment into the business should be a significant concern.
As economic conditions continue to change, executive liability insurance protection comes to the forefront since these are the areas that most lawsuits are persistently occurring. There is no denying that there will be some bumps along the road ahead, but rational risk management and appropriate and adequate insurance protection will help your company find its way.
Note: This article is not intended to offer legal advice. Any descriptions of coverage provided herein are not intended as an interpretation of coverage. Policy descriptions do not include all the policy terms and conditions contained in an actual policy, and should not be relied on for coverage interpretations. An actual insurance policy must always be consulted for full coverage details.
Mike Gong is a real practice principal and self-storage practice leader for Arthur J. Gallagher & Co., an insurance broker and risk management firm. For more information, call 800.568.0833; e-mail [email protected].