Is fiduciary liability insurance the same as a fidelity bond?

Fidelity bond versus fiduciary insurance

The terms fidelity bond and fiduciary insurance are often used interchangeably, but they’re not the same thing.

• Fidelity bonds are required by ERISA (unless an exemption applies) and help restore plan assets when an act of fraud or dishonesty is committed against the plan by someone covered by the bond.

• Fiduciary insurance is optional and helps protect plan sponsors and plan fiduciaries against claims of breach of fiduciary duty.

Let’s take a closer look at both to help you understand the role they each play in managing your retirement plan.

Overview of fidelity bond coverage

Under ERISA, your plan must have a fidelity bond for any plan fiduciary and other person who handles plan assets. Individuals are considered to handle plan assets if they have:

• Access to contributions and money in the plan
• The ability to transfer plan assets
• The power to approve or process distributions
• Check signing authority
• Supervisory or decision-making authority over activities that require bonding 

What’s the purpose of a fidelity bond?  

A fidelity bond protects your plan assets, not the fiduciaries or other people who handle your plan assets. For this reason, your 401(k) plan should be your bond’s named insured party.

The bond insures against losses caused by:

• Theft
• Embezzlement
• Forgery
• Misappropriation of funds
• Other fraudulent acts

If a fiduciary or other person who handles plan assets committed one of these acts, the bond proceeds would be used to help make the plan whole.

How much is the required amount?  

Each person who handles plan assets must be bonded for the greater of $1,000 or 10% of the funds they handle. For example, an employee who handles $5,000 in plan assets would be bonded for $1,000. An employee who handles $100,000 would be bonded for $10,000. The maximum is $500,000 per person, unless your plan has employer stock, in which case, the maximum is $1 million.  

Where do you get a fidelity bond?

Not every insurance company can issue fidelity bonds. You have to choose a surety or reinsurer from the U.S. Department of the Treasury’s listing of approved sureties. Additionally, the policy can’t have any deductibles.

What’s the risk if you don’t have a bond?

While fidelity bonds are required, the U.S. Department of Labor hasn’t issued any specific penalties for noncompliance. That said, the potential consequences can range from a simple order to get a bond, to the removal of plan fiduciaries, depending on the circumstances. How likely are you to get caught if your plan doesn’t have a bond? The probability seems high. Each year, you have to report your fidelity bond coverage on your Form 5500, and “no” responses are typically a red flag for regulators.

Not having a bond also affects your plan fiduciaries. Without one, they can be held personally responsible for restoring plan assets if the funds are misused.

The basics of fiduciary insurance

If a fidelity bond only protects plan assets, what can you do to help protect your company and the people who manage and oversee your plan? That’s where fiduciary insurance comes in.

What’s the purpose of fiduciary insurance?

Fiduciary insurance can help your company and plan fiduciaries defend against claims of fiduciary breaches. The ongoing excessive fee lawsuits are a prime example of why you should consider this optional coverage.

In the event of these claims or errors, you could generally use your policy to help cover:

• Attorney fees
• Investigation costs 
• Negotiated settlements
• Court-awarded damages
• The costs to make participants whole

How much does fiduciary insurance cost?

You can purchase fiduciary insurance from any provider who offers it. Unlike fidelity bonds, there isn’t a list of approved vendors to choose from. You’ll want to shop around to find the best policy at the right price for your company. Premiums can range from a few hundred dollars per year, to a few thousand. It depends on a variety factors, including the size and complexity of your plan and the associated risk of underwriting it.

Many insurance providers have beefed up their underwriting process given the volume of participant lawsuits. Their process may now delve into plan governance, fee disclosures, and procedures for monitoring investments and service providers to help assess the potential risk. The higher the risk, the higher the premiums and the deductibles. This increased scrutiny means you may want to make sure the management of your plan is in good order before applying for coverage to help secure better pricing.

What’s the risk if you don’t have fiduciary insurance?

Given the added cost, you may wonder if fiduciary insurance is really necessary. To answer that question, consider the following. Plan fiduciaries can be held personally liable for breaches of fiduciary duty. Without fiduciary insurance, you could be putting your fiduciaries’ savings, homes, and other property at risk as they could be forced to turn over these assets to help cover damages or settle a claim. Even if you have errors and omission (E&O) insurance, you should still consider fiduciary insurance. E&O insurance policies generally don’t protect plan fiduciaries’ personal property.  

It’s about safeguarding plan assets, your plan fiduciaries, and you  

Despite your due diligence and documented procedures, errors can happen, participants may sue, and plan assets can be misused. You should prepare for these possibilities for the same reasons you purchase other types of insurance. Fidelity bonds and fiduciary insurance can work together to help protect your plan and the people who manage it when the unexpected happens.