Opportunity Knocks

Insurance industry press has focused on directors and officers’ insurance coverage in light of the current poor economy and soft market for insurance coverage. But important developments in the lesser-known area of fiduciary liability insurance are also taking place. There are risks and opportunities for pension plan fiduciaries and brokers that can no longer be ignored.

WHAT IS FIDUCIARY LIABILITY INSURANCE?

Trustees of employee benefit plans have a legal duty to act in the best interests of the plan members and the sponsor. Most fiduciary liability policies provide protection for losses that insureds (the fiduciaries of the pension plan) are legally obligated to pay on claims for damages resulting from wrongful acts.

The main areas of exposure to loss involve allegations against fiduciaries for loss arising from any or all of the following:

• administrative errors;

• improper advice or counsel;

• misrepresentation;

• conflict of interest;

• imprudent investment;

• failure to arrange adequate funding for the plan;

• denial or change of benefits;

• incorrect benefit calculation;

• wrongful termination of the plan; and

• civil rights denial and/or discrimination.

There are two basic approaches to the provision of fiduciary liability insurance coverage: standalone policies and policies for D&O and other liability exposures that offer fiduciary liability insurance as a sub-limit or component thereof.

As in all areas of insurance coverage placed through the network of licensed brokers, the broker’s key role cannot be understated. In working with his or her client (the corporate executives and management), the broker first identifies exposures and then conveys the importance of appropriate coverage to the insured. In doing so, brokers build their own books of business and solidify relationships with their clients.

Fiduciary liability insurance will be an increasingly sought-after coverage. Although there may be many factors affecting the level of interest insurance buyers express, there are at least four reasons for the increasing popularity of fiduciary liability insurance:

More people are retiring

Canada is experiencing a demographic change of large proportions. Thousands of working-age people are nearing retirement. As of now, approximately 225,000 Canadians retire every year; this is expected to climb to 370,000 per year by 2010 and 425,000 annually by 2020. With more people approaching retirement, there is a natural increase in the number of people thinking about pensions.

Structural changes in the economy affect the value of pension funds

Drawing on U. S. data (since U. S. research is broader than Canadian research and the core issues are the same), pension plans were typically well-funded prior to the stock market plunge in 2000-02. In fact, at end of 1999, the average plan was over-funded by 20-30%. But the figures masked the true, underlying economics of the plans: many sponsors had not contributed to their defined-benefit plans for more than a decade. And so, given that stocks accounted for 60-70% of portfolio assets during 2000-02, the average corporate plan’s funded status fell to 80% from 130% by the end of 2002.

As recently as the end of 2004, the average plan remained only about 85% funded. All of this indicates the pension-funding crunch was not just a temporary event.

In addition, major events like the meltdown of technology-sector stocks have triggered steep declines in the value of pension funds that were invested in this and other affected sectors. High-profile corporate crimes such as the financial meltdowns at Enron and WorldCom have also led to concerns among many workers, who have subsequently renewed their focus on the health of their pension plans.

At the same time stocks fell and corporate CEOs received jail time, unemployment, stagnant wages, privatization, deregulation and the globalization of finance and markets all played a role in causing workers to feel less secure about their financial well-being.

Plan fiduciaries pressured to be accountable

In general, a greater level of outsider scrutiny is leading those in charge of overseeing pensions and corporations to demonstrate greater accountability. As a result, these fiduciaries and others are naturally seeking greater personal protection for their actions or inactions.

Additional pressure on fiduciaries is mounting because of the worth — and hence the importance — of the pension assets managed by the financial industry in general. To appreciate this, we need only realize that pension assets comprise the largest single source of capital in the world. Canadian pension funds have assets estimated at more than $720 billion, second only to the Schedule A Banks in Canada. This represents a significant portion of the global pension market estimated at more than US$7 trillion. Pensions as a pool of capital have increased 400% over the past two decades. Pension funds own more than one-third (35%) of all Canadian publicly traded equity.

The unionization factor

The best way to belong to a workplace pension plan is to be a union member: 83% of unionized employees are covered by either a pension plan or a group RRSP, compared to just 33% of nonunion workers. However, as seen in the most recently available Statistics Canada information (2004), only 31% of all Canadian workers belonged to unions, and this number is trending downwards. Workplace pensions are certainly not the panacea of retirement bliss they once might have been.

All of the above factors suggest a future trend in which pension plan participants and other pension plan stakeholders take an increasingly careful look at their own pension plans and the governance exercised over them. Economic downturns, coupled with plan participants increasingly concerned about pension adequacy, point to a potentially more litigious stance against plan fiduciaries. Plan fiduciaries, therefore, can no longer afford to opt out of this vital insurance protection. Furthermore, insurance brokers, able to write new lines of business in the current soft market, would be well-advised to explore fiduciary coverage as a way to increase their book of business and further solidify their relationship with the insured.

Why isn’t fiduciary liability insurance a well-known coverage? Notwithstanding all of the factors above, risk managers and other insurance-buying corporate executives are under pressure to find ways to reduce costs. This is especially the case in light of the economic downturn currently experienced, in addition to shareholders exerting pressure on companies to maintain profitability. When exploring cost savings, fiduciary liability insurance is frequently seen as a program from which to opt out. Alternatively, it may not even be on the radar screens of many risk managers and/or insurance brokers.

As many brokers will agree, one of the best ways to sell insurance is to show the potential buyer the negative consequences of failing to purchase the product. The most recent Canadian example involves well-known Nortel and a group of its employees. On June 24, 2008, the law firm of Nelligan O’Brien Payne commenced a national class action suit on behalf of Nortel employees from across Canada regarding recent changes made to their pension plan. The class action suit, which contains allegations not proven in court, seeks damages for Nortel Networks’ alleged failure to provide their employees with reasonable notice of the changes to their pension plan. As of July 30, 2008, Nortel had not yet filed a statement of defense. The Nortel case illustrates a key event that might expose plan fiduciaries to potential litigation and liability — the re-organization or redesign of a pension plan.

LOOKING TO THE FUTURE

Fiduciary liability insurance represents an opportunity for insurance brokers to diversify or expand their book of business and solidify their relationships with corporate clients. The coverage provides insured fiduciaries with peace of mind, knowing they are protected from liability while properly conducting obligations. Although it remains a relatively lesser-known coverage, it is increasingly one that fiduciaries and brokers can no longer afford to ignore.

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A greater level of outsider scrutiny is leading those in charge of overseeing pensions and corporations to demonstrate greater accountability. As a result, these fiduciaries are seeking greater personal protection for their actions or inactions.