Articles | June 15, 2016

Fiduciary Liability Insurance: the Right Policy Limit?

Fiduciary liability insurance premium rates for multiemployer plans have, on average, declined in recent years even as the scope of coverage has broadened and claims activity has picked up.

These trends may give trustees reason to consider reviewing the adequacy and cost of current limits of liability for fiduciary liability insurance, both of their policy and the limits available in the market.

Determining the appropriate limit for a given plan is rarely easy, but it can be done through careful consideration of the plan’s unique needs, priorities and circumstances ― often in combination with benchmark analysis of the limits chosen by other plans of similar asset size.

This publication discusses recent trends in fiduciary liability claims activity and insurance costs in the multiemployer market, as well as key considerations for trustees in determining the “right” limit for a plan.

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Claims Activity Tests Policy Limits The broadening scope of fiduciary liability policies, coupled with a surge in claims activity and mounting defense costs, have put multiemployer plans at greater risk of depleting or even exhausting their liability limit for a given policy period.

Typically, a fiduciary liability policy has a single, aggregate limit that represents the total amount of coverage the insurance carrier will provide during the policy period, which is usually one year.

Because this aggregate limit applies on a policy-period basis irrespective of the type, number, size or duration of claims filed, it is possible for one catastrophic claim or multiple smaller ones to exhaust that limit.

When that happens, coverage ceases under the policy and any outstanding or subsequent losses become uninsured. In some cases, if plan assets are not available to pay for defense costs or claims, trustees’ personal assets may be exposed.

The following three trends add to this risk:

  • Fiduciary liability coverage has become broader.
  • Claims activity is up.
  • Claims have become more severe.

Each of these trends is discussed below.

Fiduciary Liability Coverage Has Become Broader As new exposures have emerged over the last decade, including those from expanded regulations, insurance carriers have continued to broaden the scope and types of coverage available under fiduciary liability policies. These coverage expansions have occurred without a material increase in premium rates. While this is generally good news for trustees, a broader policy may also require reviewing the existing limit of liability to determine if it is sufficient to handle the wider array of claims covered. Among the most significant recent coverage expansions are: Pre-claim Investigation Coverage and Interview Coverage These policy enhancements allow plans to transfer to their carrier the legal costs associated with monitoring an active regulatory investigation. They have become widely available in the past few years as the Department of Labor (DOL) has pursued more lengthy and costly fiduciary-breach investigations and increased its cooperation with other investigating agencies, such as the Securities and Exchange Commission.2 Should the investigation or interview result in other claims under the policy, loss payments based on these types of coverage reduce the remaining available limit.3 Voluntary Settlement and Compliance Program Coverage  This type of coverage allows plans to seek reimbursement for the costs of correcting plan errors under the voluntary compliance and settlement programs of regulators, like the DOL and the Internal Revenue Service (IRS). As the number of compliance programs has grown, so have related claims. Expanded Penalty Coverage  Primary carriers4 today are providing coverage for a growing array of fines, fees and penalties imposed by the IRS, the DOL and other regulators. Typically, however, these types of coverage are available only up to a smaller sublimit5 within the overall aggregate limit. Carriers have responded by offering “drop-down” coverage, which responds to claims when primary sublimits have been exhausted, even if the overall primary limit has not been.6 Affirmative Settlor Coverage  Some carriers have broadened their definition of a covered “wrongful act” to explicitly include not only breaches of fiduciary duty but also “acts, errors or omissions” in establishing, amending, merging or terminating a plan. These so-called settlor functions7 have been the focus of recent lawsuits involving multiemployer plans. In addition, once-common restrictions are now rare in most fiduciary liability policies. For example: Self-insured retentions8 have largely disappeared from today’s multiemployer policies. This effectively means policies now provide first-dollar coverage for all losses up to the specified limit, even for small claims. Policy exclusions for insured-versus-insured litigation, such as when trustees sue employees, have become virtually non-existent. Claims Activity Is Up For clients of Segal Select Insurance Services, Inc., overall claims activity has been higher over the past five years and, in fact, rose sharply in 2015. The number of notices filed by Segal Select alerting insurers to a circumstance that may give rise to a claim9 more than doubled from an average of about 100 per year between 201110 and 2014, to nearly 250 in 2015. The sharp increase was due in part to a slew of filings in the wake of the high-profile data breaches at Anthem and Premera/Blue Cross ― but even excluding those notices, 2015 was Segal Select’s most active filing year on record. Regulatory probes and voluntary plan corrections account for a large share of the activity. Between 2011 and 2014, notices related to DOL investigations averaged about 32 per year, accounting for roughly a third of all notices those years, before rising to 40 in 2015. Meanwhile, filings related to the rapidly expanding IRS Voluntary Settlement and Compliance Program doubled from an average of 15 per year between 2011 and 2014, to 30 in 2015. Claims Have Become More Severe Major carriers say the growing number and scope of recent regulatory investigations have made any resulting lawsuits more complex and costly. For carriers that provide pre-claim investigation coverage and/or interview coverage, the associated legal costs can also be very significant. In the most severe cases, defense costs alone may exhaust a policy limit, leaving no money for coverage of potential court-ordered damages. Even if a multi-year regulatory investigation ends during the current policy period, the carrier will probably cover the claim under the policy that was in force when the probe began. This would put even more stress on a limit that may have been partially depleted by earlier claims or even was inadequate to begin with. Coverage Costs Decline According to Segal Select’s proprietary database of more than 1,200 plans,11 the average rate per million dollars of coverage (the “average premium rate”) has fallen in nine of the past 13 years. As seen in the graph below, the last major annual increase in the average premium rate (16 percent in 2004) was followed by seven consecutive years of declines ranging from 1.8 percent to 13.8 percent. In 2015, the average premium rate fell roughly 4 percent. Annual Percentage Change in the Average Rate Per Million Dollars of Fiduciary Liability Insurance Coverage Purchased for All Clients Source: Segal Select database, 2016   What has driven the average premium rate lower? Segal Select’s analysis points to two main factors: An aggregate decline in premiums on primary policies, and, A steady rise in the amount of lower-cost supplemental (excess) coverage being purchased. To retain clients in a competitive market, carriers have been keeping premiums on primary policies stable, or sometimes even discounting them, from year to year. At the same time, carriers have also been offering higher limits and additional excess coverage at comparatively low premiums. As claims activity has risen, plans seeking to guard against the heightened risk they face have increasingly supplemented their primary policies with these additional layers of lower-cost excess coverage. The average premium rate for overall coverage has declined in the aggregate as a result. Two examples illustrate this decline in overall cost: For one particular Segal Select client, at the start of its 2003 policy period, the plan was paying a roughly $8,000 premium on a policy with a $2 million limit. In 2013, the premium was about $6,500 on the same policy, but with a broader scope and a $3 million limit. The premium for a larger-asset client peaked in 2003 with a per-million rate of approximately $14,000. In 2015, this client was paying nearly the same premium; however, because the client had increased the liability limits over time, the rate per million was $5,500 — a 60 percent reduction. The Role of Benchmarking in Selecting a Policy Limit In today’s environment of heightened liability risk and historically low insurance costs, Segal Select suggests that trustees consider evaluating the adequacy of their current policy at the next renewal date. Using a fiduciary liability database to benchmark the limits applicable to similar-size plans can provide an objective starting point for discussions and give trustees an idea of the range of limits to consider. An example of the type of information presented in a benchmark analysis can be seen below, which shows the limits applicable to plans with between $10 million and $50 million12 in assets in 2015. A majority of plans within this grouping purchased between $3 million and $5 million in limits, and the average was about $4.4 million. However, the range of limits purchased by all plans within the grouping was much wider — from $1 million to $10 million. Limits of Liability Purchased by Plans with Between $10 Million and $50 Million in Assets in 2015 Source: Segal Select database, 2016 Additional Considerations for Trustees While benchmarking can provide a range of options to consider, it cannot define for trustees what limit is most appropriate for their specific plan. To determine that, trustees should consider the following questions in consultation with plan legal counsel, their plan administrator and their fiduciary insurance broker: Has the scope of the plan’s fiduciary liability policy broadened over time? Are the premiums quoted, both for the plan’s current limit and for higher-limit options, competitive? How long has the current limit been in place? Has the plan grown in asset size since the last time the limit was evaluated? Has the frequency or severity of claims increased for the plan and its industry segment? Is more than one plan insured under the same policy? A plan’s current and projected financial condition raises other considerations, including the following: If it is a pension plan, is it overfunded or underfunded? Has the plan’s Pension Protection Act of 2006 zone status changed? Is it in “critical and declining” status and, if so, are benefits suspensions, partitions or other remedial options13 being considered? For a welfare plan, do contributions and investment returns cover actual or expected payouts? Are reserves adequate and stable? Have significant cuts in plan benefits been made or are they expected in the near future? Take a Fresh Look at Your Policy’s Limit of Liability For many fiduciary liability insurance policies, the limit of liability remains an aggregate dollar amount that must cover all claims during the policy period, regardless of how many claims are filed during that period or how severe — and costly — they prove to be. The expanding scope of fiduciary liability coverage, as well as recent heightened claims activity and defense costs, threaten to overwhelm policy limits. With the average premium rate trending down in recent years, trustees may want to consider how their plan could benefit from a review of the limits being purchased by other plans and whether their current limit is adequate. A benchmark analysis can offer important insight and perspective as part of a thorough evaluation of what’s right for the plan.

This page is for informational purposes only and does not constitute legal, tax or investment advice. You are encouraged to discuss the issues raised here with your legal, tax and other advisors before determining how the issues apply to your specific situations.

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