ERISA suits spark liability concerns: With litigation and payouts rising--and not expected to abate soon--employers need to take fiduciary responsibilities seriously, reviewing and revamping their coverage.

Litigation over Employee Retirement Income Security Act (ERISA) issues shows few signs of abating. Figures aren't in yet for 2003, but 2002 figures from the Department of Labor (DOL) showed 10,787 new ERISA civil actions filed, up 5 percent over the year earlier and 18 percent from 2000.

In 2003, meanwhile, new exposures were significant. These included the mutual fund market-timing and late-trading scandals, court decisions with significant ramifications for companies that have converted their pension plans to cash balance arrangements and a harshly worded amicus brief from the DOL, laying responsibility squarely at the filet of company executives for losses taken by employee benefit plans that hold employer stock.

Looking ahead, 2004 is shaping up to bring even more litigation, as the DOL cements its anti-executive position through the filing of additional amicus briefs in ERISA securities litigation cases, some of which are starting to settle for up to eight figures.

Enron, Global Crossing, First Union and IBM are just a handful of the many companies that have made headlines recently, for, among other things, huge class action lawsuits brought against them by employees alleging breaches of fiduciary duty or violation of ERISA with respect to their employee benefit plans. Suits alleging imprudent investing or misrepresentation by fiduciaries are now becoming commonplace. ERISA, the federal body of law that governs most employee benefit plans, calls for fiduciaries of employee benefit plans to be personally liable for restoring any damage caused a plan through their breach of duty.

The directors and officers of larger companies are typically protected against such personal liability, either through their company's indemnity or through a fiduciary liability policy. Virtually all large companies carry fiduciary liability insurance, and it's not uncommon for policy limits to exceed $100 million.

(Of course, neither indemnity by the company nor fiduciary liability insurance are infallible. Indemnity might not be available in the event of bankruptcy or when a lawsuit is related to an employee stock ownership plan. And now that fiduciary liability insurers are facing limits losses, the claims-paying ability of weaker carriers or those that have not been writing the insurance for very long has to be questioned.)

Directors, officers and owners of small to mid-sized businesses, however, are generally not so well protected. A sizable fiduciary liability suit can easily blow through a small company's cash and even force the company into bankruptcy, leaving the executives vulnerable to personal loss. Yet despite the increasing frequency and severity of fiduciary liability suits, many smaller businesses either don't purchase fiduciary liability insurance or purchase inadequate limits.

Who Is a Fiduciary?

"Fiduciary" is a functional title--anyone who exercises discretionary control over the management of the plan or the disposition of its assets is a fiduciary. For example, the person in human resources who assists employees only with enrollment and other administrative processes is not a fiduciary. However, if that same person is asked to sit in on a meeting and vote on whether to allow company stock as an investment option in the 401(k) plan, then that person is a fiduciary with respect to that decision.

In larger companies, the members of the pension or benefits committee are usually fiduciaries. The board of directors, as well as its chairman, are also fiduciaries since they are responsible for selecting and monitoring the performance of the members of those committees, or at least so go the arguments made by the ERISA plaintiffs' bar and the DOL.

In smaller companies, the owner and the top executives typically make decisions related to the employee benefit plans, and, thus, they are fiduciaries.

The Tillinghast-Towers Perrin 2000 Fiduciary Liability Survey Report found that in 2000, the average defense of a fiduciary claim cost $124,000. On top of that, the average indemnity payment per claim was $1.2 million, up from $900,000 in 1999. These figures do not include the rash of litigation that's hit companies (and insurers) in the last three years, and the trend toward increasing indemnity payments is not expected to abate any time soon. The survey also detailed the indices of fiduciary claims in the U.S., as shown in the chart on this page.

Fiduciary Lawsuit Triggers

The most severe ERISA liability claims are class actions, derivative suits and government actions (DOL and Pension Benefit Guaranty Corp.) related to the following:

* Perceived decreases in benefits

* Miscalculation of benefits

* Bad investment claims

* Employee Stock Ownership Plans (ESOPs)

* Lack of investment diversification

* Lack of prudence

* Failure to monitor investment performance

* Misrepresentation of facts

* Denial of benefits

* Conversions to cash balance plans

* Increased cost sharing in welfare plans (medical plans, life insurance benefits)

* Systematic miscalculation of benefits (miscalculation of lump-sum distributions)

* Independent contractors/temporary employees/leased employees seeking benefits

* Cutbacks in retiree welfare benefits

* Perceived interference with receipt of benefits

Choosing a Policy and Carrier

Most fiduciary liability policies are "duty to defend" arrangements. Under such an arrangement, the insurer's duty to defend can be greater than the duty to indemnify. Practically speaking, this means that when a claim comes in, the insurer will defend all counts in the claim, so long as at least one of the counts triggers coverage under the policy. (This is very different from a directors and officers (D & O) liability policy, where the insurer typically will allocate defense expenses if there are uncovered causes of action.)

When considering a policy, look for these features:

* A definition of "claim" that includes both monetary and non-monetary or injunctive relief. Not all claims are for monetary relief. In many instances, the suit demands that a change be made to the plan or that a fiduciary be removed.

* Coverage for penalties assessed under Sections 502(i) and 502(l) of ERISA. While coverage for penalties generally is excluded under fiduciary liability policies, often an exception is made for these penalties, which are for prohibited transactions and for breaches of fiduciary duty, respectively. The 502(l) penalty is of particular importance, and is assessed by the DOL in any fiduciary breach lawsuit in which the DOL is a participant.

The penalty is 20 percent of the amount recovered either in a judicial proceeding or through a settlement, and there doesn't even have to be a finding of guilt for the penalty to be assessed.

* Plan coverage. Coverage for most plans should be on a "blanket" or unlisted basis. There should be automatic coverage for welfare plans, and coverage should be available for nonqualified plans (such as supplemental executive retirement plans), as well as for qualified plans. There also should be automatic coverage for newly acquired plans, typically tied into some threshold (plans of newly acquired subsidiaries will be automatically covered, provided that such subsidiaries have total assets of less than 10 percent of the total assets of the company).

* The ability to purchase "runoff" coverage in the event of a buyout or change in ownership of the company. Some policies allow the insured to purchase a multi-year coverage option for wrongful acts that occurred prior to a "change in control" event; for example, the company is merged with another entity. This type of coverage affords protection for prior acts, which are unlikely to be covered under the acquirer's policy. Note, however, that most insurers providing this option will quote it only at the time of the merger or acquisition, and not at inception of the policy.

* A carrier with strong ratings and lengthy experience. While this seems obvious, many purchasers of fiduciary liability insurance still shop just for price and will often jump at the lowball number offered by an insurer new to the coverage or with less than stellar ratings. Just recently, many fiduciary liability and D & O policy-holders were left wondering whether their claims would be paid when a carrier went from an A- rating to insolvent in the course of a year and a half.

The first lines of defense are prudent choices, well thought-out decisions and scrupulous documentation. Employers should take fiduciary responsibilities seriously and periodically review plan documents, plan investments, plan-related employee communications and the expenses that are being charged to the plan.

Employing third-party experts whenever possible is usually a good move. (Although monitoring the performance of third parties is also critical, as is documenting the monitoring efforts.) Brokers and agents are a good source of information as to why and how much fiduciary liability insurance should be purchased.

Keep in mind that the fiduciaries of even the smallest, self-directed 401(k) plan administered by an insurance company, bank trust department or investment house carry no less responsibility than do the fiduciaries of larger, more sophisticated plans. Businesses expanding through mergers or acquisitions, facing unusual situations, sponsoring ESOPs or plans that hold employer securities, or that are not financially stable, generally will face higher premiums and the most restrictive policy terms.

Fiduciary Liability Claims

Other issues                            13%
Imprudent investments/services           4%
Administrative error in benefit plan     5%
Misleading representations               6%
Communication of plan benefits           7%
Reduction of plan benefits               9%
Civil rights, including discrimination   9%
Benefits disputes, including denial     47%

Source: Tillinghast-Towers Perrin 2000 Fiduciary Liability Survey

Note: Table made from pie chart.

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Rhonda Prussack is Vice President and Product Manager of fiduciary liability insurance for National Union Fire Insurance Co., Pittsburgh, Pa., a member company of American International Group, Inc. (AIG) and AIG Small Business. For information email [e-mail].