In this three-part series, Woodruff Sawyer management liability expert Jon Janes shines a light on three often-overlooked lines of management liability coverages: Employment Practices Liability, Fiduciary Liability, and Crime Insurance. Although referred to as “auxiliary lines” or “ancillary lines,” this trio of insurance policies are essential to most organizations. They also are being impacted by the pandemic, changes in the workforce, and fluctuating market conditions, just like many other lines of insurance. In this “Management Liability Auxiliary Lines” series, Jon examines how pricing, retention, capacity, and terms are being impacted—and what it means for you. First up: Employment Practices Liability Insurance.
The recent explosion of ERISA-related claims following 2019 forced insurers to make material changes to their fiduciary liability books to whether the storm. While 2021 saw a decline in ERISA-related litigation following 2020’s all-time high, insurers are still seeing an elevated number of claims which can be costly to defend and settle. On top of this, insurers are having to navigate through additional challenges, including the Biden administration’s initiatives involving cybersecurity and impact investing.
As we move into the second half of 2022, we are closely following four trends dominating renewals in the Fiduciary Liability insurance market. These trends include price, retention, terms and conditions, and capacity. As a reminder, Fiduciary Liability insurance protects companies and their employee benefit plans’ fiduciaries from alleged violations of ERISA, mismanagement, and poor administration of employee benefit plans.
Price. Premium increases will continue. The magnitude of the increase will be driven by current pricing, plan size and plan type, and plan governance especially with respect to service provider fees.
Retention. Retentions will continue to rise even if they were “right-sized” at the prior renewal. The extent of the increase will depend on the plan asset size, plan governance, and claim history. Gone are the days of the $0 retention. Retentions in the millions to tens of millions are becoming common for claims related to prohibited transactions/excessive fees and mass/class actions. Even the non-class action retentions for larger plans are generally six figures rather than five figures.
Terms & Conditions. Terms and conditions remain intact except for the class or excessive fee related retentions. Some buyers are electing to exclude excessive fee claims to manage costs, but insurers are not broadly imposing excessive fee exclusions. Instead, they are managing the exposure through retention, capacity, and pricing.
Capacity. Insurers are closely monitoring capacity, and in many instances, they have reduced capacity—especially where they had more than $10 million deployed. Although a small number of insurers continue to lead most large programs, other traditional D&O insurers may provide some capacity on a case-by-case basis (particularly if there are related primary D&O opportunities).
While the dramatic increase in ERISA-related litigation is deservedly getting a lot of attention from insurance underwriters, they are also keeping a close eye on other hot topics including cybercrime and ESG.
Increase in ERISA litigation: Last year was another active year for ERISA litigation. The number of new cases filed in 2021 dropped from the high watermark of 2020, but by most estimates 2021 ERISA filings still exceeded 2019 filings. The decline may simply be that the plaintiffs’ law firms are working on the 2020 filings, most of which are still being actively litigated.
Whatever the cause, we expect to continue to see an elevated number of filings. The top 10 ERISA settlements totaled $837.3 million last year, a massive increase over 2020′s total of $380.1 million, according to Seyfarth’s 18th Annual Workplace Class Action Litigation Report. The large settlements are attracting new plaintiffs’ firms, and smaller plans are being targeted. Plaintiffs are also successfully surviving dismissal motions and challenges to class certification. The increase in frequency, success of plaintiffs’ firms, and the large settlements are primary drivers behind upheaval in the fiduciary liability insurance market. See Protecting Against the ERISA Litigation Surge for more detail.
Cybersecurity duties: In April 2021, the Department of Labor (DOL) issued cybersecurity guidance for employee retirement plans. The guidance includes tips and best practices for hiring service providers, managing a cybersecurity program, and accessing plan information online by participants.
The DOL’s directions also make clear that “Responsible plan fiduciaries have an obligation to ensure proper mitigation of cybersecurity risks.” Plaintiffs’ firms could rely on the DOL’s guidance in arguing that there is a duty to safeguard plan assets against unauthorized withdrawals and that plan fiduciaries also have a duty to take sufficient steps to properly select and monitor a service provider’s cybersecurity policies.
Impact investing: Impact investing or ESG (Environmental, Social, and Governance) investing by people concerned about climate change or social justice issues is on the rise. Plan participants have joined in the push to for companies, plan fiduciaries, and investment committees to take ESG factors into account when selecting investment options for 401(k) plans.
The DOL took notice, and in October 2021, it released proposed regulations that permit plan fiduciaries to consider ESG factors when making investment decisions without violating their duties of loyalty or prudence to plan participants. However, the DOL’s longstanding position that fiduciaries should not sacrifice investment returns or assume greater investment risks as a means of promoting social policy remains unchanged.
Insurers are concerned that, as plan participants push for ESG-friendly investment opportunities, fiduciaries’ investment decisions will continue to be judged after the fact with the benefit of hindsight. Also, if an ESG-focused investment option underperforms, the fiduciary could be at risk.
The Changing Fiduciary Liability Market Landscape
I recently spoke with Nick Landis, Head of Fiduciary Product, Financial Lines AIG, to get his take on the current fiduciary liability market.
What is the impact of the Hughes vs Northwestern fee case on the fiduciary insurance market?
In Hughes vs. Northwestern, the Supreme Court confirmed that plan fiduciaries could not rely on the availability of a variety of options or plan participants’ choices in investment options to avoid liability for offering imprudent funds or having high fees. The decision emphasized the application of existing precedent in Tibble v. Edison International, which held “a plaintiff may allege that a fiduciary breached the duty of prudence by failing to properly monitor investments and remove imprudent ones.”
The decision does not impact the market’s current trend of conservatively approaching or underwriting fiduciary. As ERISA and excessive fee litigation exploded in 2020 and 2021, fiduciary underwriters began to insulate their portfolio from high severity exposures by managing (reducing) limits exposed, significantly increasing retentions, or attaching higher on risks, and utilizing specific class or fee retentions. Underwriters will continue to require detailed submission data, including information documenting current and historical plan oversight and fee arrangements.
I don’t, however, anticipate the market will shy away from the exposure. Retentions will be the focal point. While the use of fee exclusions has primarily been limited to client specific requests to lower the cost, and I do not expect these exclusions will be broadly used following the decision.
What remains to be seen is the decision’s impact on plan sponsors and plan participants. The unsettled law among the federal circuit courts and low pleading standard (most excessive fee claims survive the motion to dismiss) suggest that the high rate of severity litigation will continue. If the courts will not provide concrete guidance to plan sponsors, sponsors may lean towards reducing their risk profile by electing only vanilla plans with few investment options or weigh the benefits of paying the fees on behalf of participants, which could, unfortunately, be offset by lowering matching contributions.
Apart from fee litigation, what issues are you closely monitoring in 2022?
One potential issue we are watching closely is cybersecurity. In April 2021, the Department of Labor issued guidance on cybersecurity and data privacy, including best practices for hiring service providers and managing cybersecurity risks. The DOL also noted their intent to perform plan audits around these practices.
The concern is not necessarily the impact from the theft of plan assets by cyber criminals, but rather the impact of the data breach. Will data breaches result in claims alleging a lack of fiduciary oversight and preparation related to mismanaging security protocols and vendor choices? What will be impact of a systemic loss resulting from the breach of a widely used vendor?
It remains to be seen what the impact of the DOL’s guidance will be on potential litigation. While there is seemingly consensus around ERISA’s requirement to mitigation risks for plan participants, including cybersecurity risks, we do not yet know if or how fiduciaries and plan sponsors will be held to a higher standard for managing these risks.
Other issues we are also watching include:
- Actuarial Equivalence Claims: We are seeing claims, but the severity exposure is primarily limited with claims certification being beaten. It’ll be interesting to see the long-term impact of these suits after the pandemic given COVID’s negative impact on life expectancy.
- Stock Drop Claims: Employer stock drop risks continue to be a challenge to underwrite to. Specific employer security cases can warrant high exposures. Although the trend has been limited post the Dudenhoeffer decision. The risk profile will continue to be heightened in the private employer market.
- Benefit Denial / Administrative Error Claim: We are not seeing a frequency uptick, but higher costs do seem to be creeping up due to better awareness by plan participants and increasing attorneys’ fees.
- ESG-friendly investing: What will the ramifications to plan fiduciaries be for the financial and non-financial decisions made to meet a company’s or plan’s ESG goals? Was a meticulous investigation made into each of these investments?
Why should directors and officers care about fiduciary losses?
Fiduciary claims can be expensive. This is especially true of fee claims, which are no longer just an issue for large employers as mid-size and smaller companies are also being targeted. A mid-size or smaller company may not have the financial wherewithal to shoulder the cost of defending or settling an excessive fee claim without it having a serious impact on its financial performance. Fiduciary insurance can mitigate this exposure. D&O insurance policies typically have an ERISA exclusion, so without Fiduciary Liability Insurance, directors and officers may also be exposed to increasingly more expensive fiduciary claims.
Complicating matters is when there is no clear-cut line between who is acting in a plan fiduciary capacity and which individuals oversee the plan, the investment committee or the sponsor executives? Without a clear designation of duties, fiduciary liability can cover not only the plan fiduciaries but also the directors and officers if they’re acting in a dual capacity of the plan sponsor.