Understanding Fiduciary Bonds:
The Employee Retirement Income Security Act of 1974 (ERISA) introduced a new set of rules for fiduciaries as a safeguard for employee retirement plans and plan beneficiaries. Management or key personnel who oversee or have a fiduciary responsibility to the company’s retirement fund or plan are now required to have an ERISA bond. Federal law requires employees who have administrative access to the the fund to have a fiduciary bond, an ERISA bond specifically, which provides a minimum level of protection for the plan and its beneficiaries, the employees. Some companies choose a higher amount of coverage than required by law and funds invested in certain types of assets have special coverage requirements.
Read on to understand if this insurance coverage is right for you.
What Is Fiduciary Bond?
A Fiduciary Bond, commonly called an ERISA bond, is a specialized type of Fidelity Bond that specifically provides coverage for 401k plans, pension plans, or other employee benefit plans sponsored by the business. Larger businesses have teams who are well-versed in the legal requirements surrounding fiduciary bonds, but smaller and mid-sized businesses who offer benefits may find the requirements and similar-sounding terms to be confusing. The key is to understand the limitations of each type of insurance. Fiduciary bonds are limited in scope, with ERISA bonds providing coverage for the plan and its beneficiaries in the event of fraud, impropriety, or dishonesty on the part of the fiduciary or administrator covered by the bond. Proof of loss does not require a conviction to trigger a payable claim.
Do I Need Fiduciary Bond Insurance?
Any administrator or trustee of an employee benefits or pension plan is legally required to hold this type of insurance. This is coverage that protects the employees or clients of a particular investment or benefit plan, however, not the administration.
Individuals and companies who need Fiduciary Bond Insurance typically include:
- Plan administrators
- Financial advisors
- Investment advisors
According to Department of Labor rules, every person who handles funds or other property of a benefit plan for employees must be bonded — unless that person falls under an exemption for ERISA. Handling employee benefit funds without bonding is illegal. Funds, as defined by ERISA rules, aren’t just money, but also other plan assets, including land and buildings, publicly traded securities, privately held securities, exchange traded fund and mutual fund holdings, or any other plan asset. The goal of ERISA rules and fiduciary bond requirements is to protect the plan — and by extension its vested beneficiaries — against misappropriation or embezzlement, with protection beginning from the first penny.
ERISA bonds are available as 1st-party bonds, which the employer-sponsored plan acquires for itself, or as 3rd-party bonds, which are often purchased for service providers, such as plan advisors.
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What Does a Fiduciary Bond Cover?
At a High Level...
Fiduciary Bond Insurance provides funds to cover the result of mismanagement in the administration and/or investment of employee benefits and pensions. The funds in these bonds only go to the people who have money invested in a plan. They do not pay the legal or liability expenses of the fiduciary and have a specialized scope of coverage.
In the event that a policyholder is sued, Fiduciary Liability insurance will either pay for legal counsel or provide legal counsel. In the former, a policyholder would be on their own to find legal representation. The insurer would provide a set amount of money towards the lawyer’s fees or pay him or her directly. In the latter case, the insurance company would provide legal counsel to the policyholder; typically with a lawyer who is an employee of the insurance company. These lawyers often have a lot of experience with these types of cases, and are very motivated to keep awards and settlement amounts as low as possible.
In the event that a case is lost or a settlement is reached, Fiduciary Bond Insurance will pay a set amount towards the award amount. This amount is based on the term limits of the policy.
|Type of Claim||Description||Example|
|Fiduciary error||An investment error made by trustees of the account||Choosing an investment that was not in line with the needs of the employees.|
|Administrative Error||Mistakes made by administrative personnel||Failing to file an employee's paperwork.|
|Conflict of interest||Investments made to benefit the company instead of the investor||Excessive funds invested in companies owned by the advisor's firm.|
|Failure to fund||Not funding investor accounts||Pocketing money instead of placing funds into agreed-upon investments|
You'll Know It's the Right Policy If It Covers:
- Administrative errors
- Investment errors
- Paperwork errors
- Conflicts of interest
What Does a Fiduciary Bond Not Cover?
Fiduciary bonds do not provide any funding to the administrator of a benefit plan. It may be helpful to think of fiduciary bonds as the minimal required car insurance. In the event of an accident, only the victims receive any funds. The policyholder receives nothing to help with his or her expenses from the accident. With fiduciary bonds, the policyholder is on their own to cover their legal costs and any other liability expenses that are associated with the case.
A Fiduciary Bond does not cover:
- Imprudent investment
- Legal fees
- Administrative costs relating to the insured
- Professional misconduct
- Criminal charges
To make up for this gap, fiduciary liability insurance is offered. A liability policy can provide funds for legal representation, as well as funds towards any liability settlement or award granted to the plaintiff.
Liability policies can be written to exclude a number of different situations, but the most common is cases of imprudent investment. A different type of insurance policy must be purchased to cover these cases.Typically, however, the investment firm hired to handle the pension or retirement fund investments will carry this coverage.
What Are the "Limits" on a Fiduciary Bond?
Fiduciary Bond Insurance or ERISA bonds are required by law. The amount of the bonding, therefore, is also set by federal law. According to ERISA, “A plan official must be bonded for at least 10 percent of the amount of funds he or she handles, subject to a minimum bond amount of $1,000 per plan with respect to which the plan official has handling functions.”
This typically means that individuals have a required bond amount of $500,000 per plan. Starting in 2008, however, federal law changed so that plan officials (typically the company administering the plan) now need to carry a minimum of $1,000,000 in coverage. Of course, individuals and businesses may choose to carry additional coverage if they wish.
A plan with more than 5% of its holdings in certain types of investments, such as real estate or limited partnerships, are required to carry a bond that covers 100% of the plan assets.
Unlike many other types of insurance, an ERISA bond is not subject to a deductible, with the goal of providing protection for the plan from the first penny of loss.
How Much Does a Fiduciary Bond Cost?
ERISA bond insurance typically is priced based on the amount of assets controlled by a plan and the perceived risk by the insurance company. Typically, these bonds cost $200-$1,000 a year for policyholders.
What is the difference between a Fiduciary Bond and Fiduciary Liability Insurance?
Fiduciary liability insurance, a separate type of policy that is commonly confused with Fiduciary Bonds, is not legally required, but can protect the business as well as provide personal liability coverage for plan administrators.
Where a Fiduciary bond protects the plan, Fiduciary Liability coverage protects plan administrators, trustees and others in fiduciary roles who have access to plan funds and assets. While this insurance is rarely required by law, it is a good idea to protect yourself or your business. Fiduciary liability includes not signing up employees for benefits, mismanagement of funds, failure to diversify and other liability risks. Typically, these policies cover both legal fees and the award or settlement that comes from these cases, subject to your chosen coverage limits.
Fiduciary liability lawsuits are often difficult to prove. Unlike other crimes, investigating these cases requires interviewing dozens of employees and consultants and pouring through thousands of pages of legal documents.
Even with that work, these cases can be hard to prove and defend against. According to federal law, fiduciaries can be held liable for actions, such as not ensuring enough diversity in an investment plan or imprudent advisement. Those are broad terms that can be used to define a number of actions. That often means that these cases, and their accompanying legal fees, can drag on for years and require multiple paid witnesses. Fighting just one of these cases can wipe out a small business or individual. For that reason alone, this type of insurance is practically a requirement for businesses that don’t have a legal team on staff.