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Protecting Trustees when Pensions Crater

Few small companies carry fiduciary insurance despite a rise in lawsuitsWARREN – You’re the chief financial officer of a small but growing private New Jersey business. A group of disgruntled employees is suing both you and your company, alleging dereliction of fiduciary duty based upon your investment choices for the company’s pension plan.

You call the company’s lawyer and the first thing he asks you is: “How much fiduciary liability insurance do you carry?”

You reply: “What fiduciary insurance is that?

After a long pause, your lawyer replies: “I think we need to meet very soon to talk.”

By now you’re probably asking yourself if you have fiduciary liability insurance and what it covers.

Unless you are your company’s designated fiduciary planner charged with making sure that all your fiduciary liabilities are covered, there’s a good chance that you may not even know what fiduciary liability insurance is.

You wouldn’t be alone. Insurance experts say many small businesses—especially privately held ones—are under-protected when it comes to issues of fiduciary liability. “The level of awareness on the part of a small-to-mid-sized company and the exposure and availability of the insurance is probably pretty low,” says David K. Bradford, co-founder and executive vice president of New York City-based Advisen, an online information service for commercial property and casualty underwriters.

“There have not been a lot of claims activity with the smaller companies,” says Bradford, “but that doesn’t mean that a lawsuit couldn’t be absolutely ruinous to a small company.

“While the trend has been for smaller companies to purchase the coverage, it still is a type of policy purchased by and large overwhelmingly by large companies,” he adds.

Christine Dart, vice president of the Chubb & Son unit of the Chubb Group in Warren, says, “A lot of times it comes down to confusion and not understanding that personal liability aspect of the Employee Retirement Income Security Act (ERISA) passed by Congress in 1974. “Some privately held companies think ‘Well, I only offer a medical plan so I don’t really have to worry about fiduciary liability insurance’—and that’s not necessarily so.”

Observers say the 2002 Enron scandal changed the liability landscape. It’s not that workers hadn’t had legal recourse before if their employers mishandled their retirement funds, but Enron drew national attention to the issue. Nationally, the number of breach-of-fiduciary-duty lawsuits filed under the ERISA rose roughly 25 percent to 11,500 in 2004 from 9,170 in 2000, according to statistics compiled by the Administrative Office of the U.S. Courts.

Many fiduciary-liability cases are brought by current or former employees who feel that those in charge of the company’s pension or benefit plans have mismanaged the fund. Meanwhile, costs for fiduciary-liability insurance, which includes coverage for trustees of pension funds and trusts, jumped by roughly 150 percent from 2001 to 2003, according to a survey of 750 corporations done by the Risk Insurance Management Society (RIMS).

“Fiduciary liability rates did shoot up,” says Bradford. “That was the Enron, the WorldCom and all the others that followed in their wake. And Sarbanes-Oxley was obviously big in the news. This was about the time that the new theories of [company] directors as fiduciaries and their liability were being exploited by the plaintiffs’ lawyers. There were a lot of fiduciary-liability lawsuits at that time.”

Fiduciary-liability insurance is designed to protect a business against lawsuits that accuse company officers of mishandling or misappropriating company funds that are used to cover employee benefit and pension plans. However, “the 800-pound gorilla in the room is that the insurance doesn’t relieve a fiduciary of his or her responsibility,” says Lawrence Adamo, an investment advisor with Fusion Financial Group in West Orange. “You still have to adhere to all those fiduciary issues whether you had the insurance or not.”

Under ERISA, companies are required to carry what is known as an ERISA bond that protects benefit plans against losses caused by dishonest employees. Fiduciary liability insurance, on the other hand, is a type of individual coverage that protects the fiduciaries of qualified employee-benefit plans that fall under the scope of ERISA.

Fiduciary insurance includes coverage for trustees of pension funds and trusts, as well as coverage for directors and officers of corporations. Roughly a dozen insurance companies dominate the fiduciary-liability niche, with Chubb being among the largest. Other major providers include Ulico Insurance Group in San Francisco; Philadelphia Insurance Co. in Bala Cynwyd, Pa., and AIG Insurance in New York City.

Industry experts say uninsured private companies are leaving themselves open for lawsuits, especially companies that are planning to reduce, eliminate or switch employee-benefit plans.

“Employees and retirees who see their pension savings and other company benefits wither away often respond by suing their employer, benefits administrators and plan fiduciaries,” says Dart.

Small firms are especially vulnerable to suits if they change their pension plans to a 401(k)-style arrangement. “Anytime you make a switch like that, and especially if it’s mandated by the company itself and something goes awry for whatever reason, the implication is that the company was negligent in some way in either making the decisions or changing administrators,” Bradford says.

However, he adds, proving deliberate gross fiduciary negligence on the part of a pension plan’s overseers can be extremely difficult. “It’s got to be a fairly egregious situation for a fiduciary-liability claim to stick,” says Bradford. “If the 401(k) declined just because the fund manager wasn’t as competent, there’s no loss there. It’s really got to be something that’s gross negligence or fraud before there’s a chance to really have a valid suit.”

According to Chubb, only about one third of privately held companies buy fiduciary liability coverage, compared with about 55 to 60 percent of publicly traded companies. “A lot of public companies [are] just more familiar with the exposure,” Dart says. She says directors of public companies “usually ask the question, ‘Well, do I have to have fiduciary insurance as well?’”

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