Fiduciary Liability Insurance: What Is It & How It Works

This content has been reviewed and edited by an Investment Advisor Representative working for Global Predictions, an SEC-registered Investment Advisor.

Managing employee benefit plans or retirement funds is a big responsibility. You’re trusted to act in everyone’s best interest, but let’s face it—mistakes can happen. When they do, legal claims might not be far behind. That’s where fiduciary liability insurance comes in. Think of it as your safety net, stepping in when things go wrong. But what exactly does it cover, and how does it work? Let’s break it down in simple terms.

Key Takeaways

• Fiduciary liability insurance protects individuals and organizations managing employee benefit plans against claims of mismanagement. Unlike ERISA bonds, which strictly cover theft or fraud, fiduciary liability insurance focuses on errors or oversights in plan management, offering broader protection.
• It’s different from ERISA bonds, which cover theft or fraud but not management errors.
• This insurance is critical for companies offering 401(k) plans, health benefits, or other employee welfare programs.

What Is Fiduciary Liability Insurance?

Fiduciary liability insurance is a type of policy that protects people like you—those managing employee benefit plans—from claims that you didn’t fulfill your duties properly. If you’re overseeing a 401(k) or health insurance plan, for example, this coverage can step in if someone accuses you of not acting in the best interest of the participants.

What Does It Cover?

This insurance typically covers:

• Breach of Fiduciary Duty: Claims that the fiduciary failed to act in participants' best interests.
• Errors in Plan Administration: Mistakes in recordkeeping, enrollment, or benefits distribution.
• Mismanagement of Funds: Poor investment decisions or failure to diversify funds.
• Legal Defense Costs: Coverage for lawsuits, including attorney fees and settlements.

What Doesn’t It Cover?

Fiduciary liability insurance does not cover intentional acts of fraud, theft, or criminal behavior. These are typically covered under ERISA bonds, which are separate and required by law.

Why Is Fiduciary Liability Insurance Important?

Managing benefits is no walk in the park. Even small mistakes can lead to financial losses or lawsuits, potentially putting you in violation of ERISA’s strict standards. Fiduciary liability insurance plays a critical role in ensuring compliance with these regulations, while also offering peace of mind and financial protection when the unexpected happens.

Real-World Risks

Imagine your company manages a 401(k) plan, and a participant alleges that improper investment choices caused significant losses. Even if the claim is unfounded, the cost of defending the case can be enormous. Fiduciary liability insurance steps in to cover these costs, ensuring your personal assets and company resources remain protected.

Legal Obligations

Under the Employee Retirement Income Security Act (ERISA), fiduciaries have a duty to:

• Act solely in the interest of plan participants.
• Avoid conflicts of interest.
• Follow plan documents consistently.

Failure to meet these obligations can lead to lawsuits, making fiduciary liability insurance a vital safeguard.

How Does Fiduciary Liability Insurance Work?

Here’s a step-by-step look at how fiduciary liability insurance functions:

1. Policy Purchase: A company or individual purchases a policy tailored to their specific compliance needs, often as part of their broader risk management strategy.
2. Coverage Activation: If a claim is filed, the policyholder promptly notifies the insurer.
3. Claim Evaluation: The insurer assesses the claim to ensure it aligns with ERISA and other regulatory requirements.
4. Defense and Settlement: The insurer covers legal fees, court costs, and any settlements up to the policy limit, ensuring adherence to compliance obligations throughout the process.

Who Needs Fiduciary Liability Insurance?

Fiduciary liability insurance is essential for:

• Businesses Offering Benefits: Startups introducing 401(k) or health plans to attract talent often overlook the risks tied to mismanagement, while larger firms managing pension plans face heightened exposure.
• Plan Administrators: Individuals tasked with compliance and day-to-day operations of benefit plans need this coverage to safeguard against administrative errors or unintentional breaches.
• Boards of Directors: Directors overseeing employee welfare programs carry fiduciary duties and can face claims if these programs fall short of ERISA standards or other compliance requirements.

Common Mistakes to Avoid

• Relying Solely on ERISA Bonds: ERISA bonds are mandatory but only protect against theft or fraud, leaving significant gaps in coverage for mismanagement or administrative errors.
• Underestimating Coverage Needs: Calculate exposure based on factors like participant numbers, plan complexity, and potential legal costs to avoid being underinsured.
• Ignoring Smaller Plans: Even small plans can lead to substantial claims if participants experience losses, making fiduciary liability insurance crucial regardless of plan size.

FAQs

Is fiduciary liability insurance the same as an ERISA bond? 

No. ERISA bonds protect against theft or fraud, while fiduciary liability insurance covers claims of mismanagement or breach of duty.

How much does fiduciary liability insurance cost? 

Costs for fiduciary liability insurance can vary significantly, influenced by factors such as the organization's size, the complexity of the benefits plan, and the chosen policy limits. For instance, smaller companies with straightforward 401(k) plans might expect premiums ranging from $500 to $2,500 annually. In contrast, larger organizations with multiple, complex benefits programs could see premiums exceeding $10,000. Insurers typically evaluate factors like the number of participants, the types of benefits offered, and the associated legal risks when determining premium rates.

Do all companies need fiduciary liability insurance? 

Any company offering employee benefits should consider it, but the necessity depends on the size and complexity of the benefits program.