My company sponsors a 401(k) plan. With everything that has been in the news about retirement plan fiduciaries and some of the lawsuits against them, we are trying to decide whether or not we should get fiduciary liability insurance for ourselves. Then I looked at our Form 5500 and it shows that we already have plan-related insurance.
Is the coverage reported on the Form 5500 fiduciary liability insurance? If not, what is it and what is the difference?
The TL;DR is that the coverage reported on the Form 5500 is the plan’s fidelity bond, not fiduciary liability insurance. Both relate to your 401(k) plan, but that is where the similarities end.
A fidelity bond (also referred to as a surety bond) protects the plan itself against losses due to fraud or dishonesty. Any person who handles plan funds must be bonded, but it is the plan that actually receives the benefits to make the participants whole in the event that plan assets are misappropriated. All qualified retirement plans (other than certain owner-only plans, governmental plans, and church plans) are required to maintain fidelity bonds and to report the coverage amounts on their Forms 5500 each year.
The required coverage amount is generally 10% of the total plan assets as of the first day of the plan year, subject to a minimum bond amount of $1,000 and a maximum of $500,000. Since the instances of fraudulent misappropriation of plan assets are few and far between, fidelity bond coverage is typically very inexpensive.
Fiduciary liability insurance, on the other hand, covers the actual plan fiduciaries and protects them in the event of a claim that they breached their fiduciary duties. Policies will vary from one insurer to the next, but examples of the types of benefits afforded include legal fees as well as covering any penalties or judgments.
As a general rule, there doesn’t have to be an actual loss in order for fiduciary liability insurance to kick in. If one of the benefits is coverage of legal fees, even an accusation of fiduciary mismanagement can trigger benefits. As a result, fiduciary liability insurance is usually much more expensive than fidelity bond coverage. Another important difference is that while a fidelity bond is designed to protect against fraud, fiduciary liability insurance specifically carves out fraudulent acts and does not provide coverage for them.
Fidelity bond coverage is mandatory, but fiduciary liability insurance is completely optional. Unfortunately, there is no clear-cut “formula” to determine which fiduciaries should or shouldn’t pursue this special coverage. It is largely a matter of each person’s risk tolerance, the cost of the insurance, and any special facts or circumstances related to the plan that might increase or decrease the risk of a claim.