Shortly after Enron Corp. -- and its 401(k) plan -- imploded in 2002, premiums for fiduciary liability insurance for defined contribution plans went through the roof. Employer stock, which had dominated the energy company's 401(k), suddenly seemed a much riskier proposition for plan sponsors. Now, after three years of increases, premiums are beginning to level off -- albeit at far higher levels. Still, a nagging question remains for employers: Is their company adequately covered?
"Premiums on fiduciary liability insurance increased anywhere from 50 percent to 350 percent from January 2002 through the end of 2004," reports Sean Coady, a senior partner at Capstone Insurance, a Boston-based brokerage firm that specializes in management liability insurance. But Coady and other brokers, as well as underwriters, indicate that the increases have begun to taper off.
In any case, premiums remain a small proportion of defined contribution plans' expenses -- perhaps $3,000 a year for a 401(k) with $100 million in assets -- and recent developments suggest that the money is well spent. "Claims and settlements are not calming down," says Cathy Cummins, practice leader of consulting firm Marsh & McLennan's fiduciary liability programs. Rhonda Prussack, the product manager for fiduciary liability insurance at National Union Fire Insurance Co. (a member company of American International Group), concurs. "We've seen no plateau in settlement costs or litigation," she says. "The number of cases and size of settlements continue to rise."
Class-action lawsuits against corporate plan sponsors got a boost in late May, when U.S. District Judge Melinda Harmon, in Houston, approved a partial settlement of $85 million for former Enron employees who had sued to recover more than $3 billion in retirement savings. Among the defendants: Enron, certain current and former Enron directors and officers, accounting firm Arthur Andersen and Northern Trust Co., the trustee of the 401(k). The bulk of the settlement is to be paid by Associated Electric and Gas Insurance Services, better known as Aegis, and Federal Insurance Co. Enron had $85 million in liability insurance to cover employees acting as fiduciaries.
Marsh & McLennan's Cummins notes 11 other settlements since 2002 that have ranged from $5 million to $88 million. In every case fiduciary liability insurance was involved.
Who does the law deem a defined-contribution-plan fiduciary? And what is the nature of the liability? Fiduciaries include the plan sponsor -- that is, the company, the government entity or the nonprofit, including 403(b) sponsors; the legal entity that is the plan itself; and the trustees, directors, officers and employees of the plan. "Even within these categories there is a battle over who is a fiduciary and what constitutes their fiduciary responsibilities," notes Jeffrey DuFour, CEO of Tillit Group, a Princeton, New Jerseybased consulting firm that advises plan sponsors on fiduciary liabilities.
The chief concern of corporate 401(k) plan fiduciaries is company stock. "If ever there's a securities class-action suit and the company has a defined contribution plan with company stock, you can bet your boots there will be an ERISA class action too," says Linda Shore, an ERISA attorney who teaches at Georgetown University Law School.
Last year the U.S. Department of Labor resolved 4,399 civil cases and 152 criminal cases, resulting in close to $3 billion in fines and funds recovered. Plan sponsors' fiduciary liability policies generally cover defense costs and penalties related to DoL investigations. Enforcement activity is running at roughly the same level as it was last year, says Virginia Smith, the DoL's director of enforcement with respect to retirement plans.
Fiduciary liability premium increases have nonetheless been abating -- and in a few cases, premiums have even come down. The declines reflect a "confluence of factors," notes Capstone's Coady. First, there is now excess capacity, with several new underwriters having joined those in the niche already. What's more, the Sarbanes-Oxley Act of 2002 has offered "comfort to underwriters that the risks are somewhat diminished," says Coady. Last, in his view, underwriters are convinced that most of the corporate scandals that were going to be uncovered have been uncovered.
The federal government's Thrift Savings Plan is the country's largest defined contribution plan, with $152 billion in assets and more than 3.4 million participants, including all uniformed federal employees. Its premiums shrank from $375,750 in 2004 to $300,000 this year.
The respite in rising premiums has a number of causes. First, there's been a general softening in the price of management liability coverage. Insurance broker Coady estimates, for instance, that the cost of directors' and officers' insurance has declined by 20 percent to 40 percent in the past eight to 12 months, as corporate scandals have waned. (Fiduciary policy costs are modest by comparison with those of directors' and officers' coverage.)
The emergence of more vendors is further driving down fiduciary liability costs. The rich premiums relative to the risks that have prevailed over the past three years have enticed several new underwriters into the management liability marketplace. Among them: ACE Group, Allied World Assurance Co., Axis Insurance Services Co., Endurance Specialty, Max Re and Star Insurance Co.
Last, the DoL has been less aggressive in pursuing its most common form of 401(k) investigation: examining the speed with which participant contributions are forwarded by plan sponsors to the participants' accounts. "This issue accounts for the lion's share of the department's civil investigations," says ERISA attorney Shore.
The DoL is developing a "safe harbor" rule that will specify how much time may elapse between when a company makes a deduction from an employee's paycheck and when it forwards those funds to the employee's defined contribution account. The current rule of thumb: Participant contributions become plan assets for ERISA purposes "as of the earliest date on which such contributions can reasonably be segregated from the employer's general assets." That period cannot exceed 15 days. The DoL tolerates two- or three-day transfers, but it may crack down on longer ones. Shore says that "about 90 percent of audits by the Department of Labor find violations of these rules, and plan sponsors are fined." Fiduciary liability insurance by and large covers such penalities.
Fiduciaries have several other concerns, however: blackout periods (when a plan sponsor changes its recordkeeper, say, temporarily freezing participant accounts), the monitoring of operations and the prudence of investments.
In a twist, a tobacco company was sued last year for allegedly violating its fiduciary duty by selling off employees' company stock before the price rose.
Plaintiffs had their retirement plans with Nabisco/RJReynolds. When Nabisco spun off R.J. Reynolds Tobacco Co., Nabisco's stock price fell. The plaintiffs charged that management had violated its fiduciary duties when it liquidated funds with Nabisco stock just after the spin-off of the tobacco company. Several months later Nabisco's share price rebounded.
In December the Fourth Circuit Court of Appeals, in Richmond, Virginia, sent the case (Tatum v. R.J. Reynolds Tobacco Co.) back to the district court for retrial.
No wonder the confusion surrounding fiduciary liabilities is spawning an industry of explainers. Among the better-known: Pittsburgh's Center for Fiduciary Studies, Washington's Independent Fiduciary Services and Tillit. In the past year, says Peter Demmer, CEO of Sterling Resources, a Paramus, New Jerseybased consulting firm, "there are all sorts of start-up organizations -- law firms, accountants and educators or consultants -- that believe they are in a hot market."
