THE Fid Guru BLOG

Insights From Encore Fiduciary on Fiduciary Liability & Other Risk Exposures of Employee Benefit Plans

THE Fid Guru BLOG

Insights From Encore Fiduciary on Fiduciary Liability & Other Risk Exposures of Employee Benefit Plans

The State of the Fiduciary Liability Insurance Market and Excessive Fee Cases at the Half-Way Point of 2022

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By Daniel Aronowitz

The current frequency of ERISA class actions against large retirement plans remains very high.  By our count, forty-two excessive fee and imprudent investment cases were filed against defined contribution plans in the first half of 2022, and we remain on pace for seventy-five to one-hundred cases for the full calendar year.  Very little is written on the state of the fiduciary liability insurance market based on the increased frequency and severity of ERISA lawsuits, but what is written touts that fiduciary premiums are skyrocketing and that coverage is harder to obtain.  This is largely a misperception of the reality that fiduciary liability insurance carriers have provided a steady and reliable source of risk protection against the increased fiduciary risk facing plan sponsors without substantial increases in premium.  To the contrary, the biggest changes in the fiduciary insurance market have been reduced limits by major carriers and increased retentions for class action and excessive fee litigation, but fiduciary insurance remains well priced given the heightened risk environment.

As we discuss below, the fiduciary insurance market remains robust, with a broad scope of coverage available for most plans, except ESOPS and multiple employer plans, and some healthcare and university-sponsored plans.  And contrary to market perceptions, fiduciary insurance premiums for large plan sponsors remain very reasonable relative to the continued heightened risk environment.

 

The Current State of Excessive Fee Litigation

As noted above, the frequency of excessive fee and imprudence investment cases remains very high, with forty-two excessive fee cases filed in the first half of 2022.  At the current frequency, we are on pace for seventy-five to one-hundred cases for the full calendar year.  This compares to at least ninety-seven cases filed in 2022, and approximately fifty-four cases filed in 2021.  The lower number of cases filed last year mostly reflects that Capozzi Adler filed less cases in 2021 (eleven) compared to 2020 (forty).  In our review of the first twenty-five cases through the first four months of the year, we noted that a majority of excessive fee cases are filed by the Capozzi Adler and Walcheske & Luzi law firms.  The trend also continues that one out of every three cases is against a plan with actively managed target-date funds.  And nearly every case alleges excessive recordkeeping fees based on a comparison to five to seven plans out of the entire universe of defined contribution plans without any meaningful or reliable benchmark.  In addition, we have noticed two new trends in the last two months:  (1) a renewed interest in suing university plans; and (2) new law firms filing copycat excessive fee cases.

First, three universities have been sued in the last two months.  After twenty universities were sued in 2016 and 2017 with the same basic claims, there was a quiet period for several years until a new law firm to the space sued the University of Miami and University of Tampa last year.  In June, the Fair Work P.C. law firm sued both Northeastern University and Boston College, and Wenzel Fenton Cabassa P.A. – the same law firm that sued University of Miami and University of Tampa last year – sued Nova Southeastern University, Inc., which like University of Tampa is a member of the Florida Independent Colleges and Universities Risk Management Association, Inc. [FICURMA].  The Boston College and Northeastern lawsuits are serious lawsuits which demonstrate that many university plans still contain the same problematic TIAA recordkeeping arrangements based on revenue sharing, multiple recordkeeping platforms, and TIAA high-fee investments that were challenged in the Schlichter-led filings against the original twenty lawsuits filed in 2016-17.

The Boston College lawsuit alleges familiar claims:  (1) that the plan recordkeeping fees were high because it was based on revenue sharing to TIAA and Fidelity as dual plan recordkeepers; and (2) excessive investment fees to both TIAA and Fidelity, including higher-cost Fidelity K share investments when lower-fee share classes were available to a large plan.  The Boston College lawsuit is noteworthy to the extent that it specifically alleges that the plan committee “ignored public red flags about TIAA and Fidelity” based on prior litigation against other universities involving the same TIAA and Fidelity investments.  For example, the Complaint alleges that the plan fiduciaries should have learned from the Third Circuit’s decision in Sweda v. University of Pennsylvania holding that a complaint plausibly alleged that fiduciaries of University of Pennsylvania breached their fiduciary duties by offering the TIAA Real Estate Account and CREF Stock Account.  The complaint also cites the District of Rhode Island’s decision denying a motion to dismiss similar claims based on underperformance and “the costly nature” of the same two TIAA investment options in Short v. Brown University.  But “[e]ven more troubling,” according to the Boston College complaint, is the joint investigation by the Securities and Exchange Commission and New York’s Attorney General with findings that TIAA used “fear selling” and “false and misleading marketing pitch[es]” to convince retirement plan investors to rollover assets “from low-fee employer-sponsored retirement plans to TIAA managed account services.”  [Euclid note:  these “low-fee” university plans that TIAA is targeting for rollovers are the same plans that plaintiffs and other firms allege have excessive fees, like the Boston College plan, but consistency, logic and credibility are not hallmarks of the plaintiff excessive fee litigation bar].   With respect to Fidelity, the complaint alleges red flags from the Tracey v. Massachusetts Inst. of Technology case in which the District of Massachusetts allowed a suit to proceed to discovery that challenged Fidelity’s investment and recordkeeping fees, and later denied a motion for summary judgment.  The complaint notes that the MIT case is “no outlier,” as Fidelity’s “costly offerings and recordkeeping services have been challenged by participants in numerous plans, including in those offered to Fidelity’s own employees.”  And “[c]ompounding these issues” is that the plan fiduciaries failed to move out of Fidelity higher-priced K shares when lower-priced K6 shares were available.

The second interesting development of note in the last several months is the filing of excessive fee lawsuits by new law firms trying to cash in on the excessive fee business model.  From our perspective, these complaints are weak copycat versions of the Capozzi and Walcheske templates.  For example, on June 27, Pavlack Law, LLC filed what appears to be a watered-down version of the Walcheske excessive fee complaint model alleging “excessive recordkeeping and administrative services (“RK&A”) fees” – the same peculiar terminology and acronym used by the Walcheske firm in its many complaints.  But the allegations in Mateya v. Cook Group Incorporated in the Southern District of Indiana are not persuasive even if the complaint’s allegations are correct.  For example, the complaint alleges that the Cook plan has a $46 per participant recordkeeping fee for the $1.19b plan with 12,300 participants from Fidelity, which is inherently reasonable under Euclid benchmarks, but the plaintiffs purport to compare it to the alleged recordkeeping fee from three plans of completely disparate sizes with T. Rowe Price as the recordkeeper:  (1) a small plan:  Under Armour with 4,485 assets and $178.2m for $20; (2) a plan five times larger:  Sanofi U.S. Group with 24,097 participants and $5.5b in assets for $23; and (3) a plan four times larger:  Thermo Fisher Scientific Inc. with 35,739 and $4.3B in assets for $5.  The complaint does not even try to inform the court where these highly dubious recordkeeping numbers came from – as we have never seen a mega plan with a $5 recordkeeping fee – but they are not even plans with the same recordkeeper, or the same size – let alone any attempt to compare recordkeeping services.  The investment claims are similarly feeble.  The entire excessive investment claim is a list of the actively managed funds in the plan and the assertion that the plan fiduciaries should have chosen “mostly passive materially identical investments.”  But the QDIA for the plan was the highly regarded American Funds target-date funds with an excellent Silver rating from Morningstar.  The plan is invested in the R6 institutional share class with fees between 30 and 40 bps, which is substantially lower than most actively managed target-date funds, including 25% less than the Fidelity Freedom target-date funds, which range from 37 to 50 bps, even in the lower fee K6 share class [and 47 to 75 bps in the K share classes].  In sum, the entire investment claim is that active funds are per se imprudent and compared to what the complaint claims are “materially identical” passive investments.

Similarly, the Wenzel Fenton Cabassa complaint against the Nova Southeastern plan is similarly weak.  The plan with nearly $400m and 7,500 participants is one of the smallest university plans to be sued in excessive fee litigation – second only to the same firm’s ill-fated attempt to sue the even smaller University of Tampa plan last year, which was withdrawn after Morgan Lewis started the defense.  The Nova Southeastern complaint alleges that the direct recordkeeping fees ranging from $56.12 to $64.91 are excessive compared to the 401k averages book citation of a $20 million plan with 200 participants with an alleged $12 recordkeeping fee; and a $5 recordkeeping fee for a larger $200m plan with 2,000 participants.  This false claim is copied from old versions of the Capozzi Adler complaint template.  But as Euclid has demonstrated many times, the citation to the 401k Averages book violates the basic duty of candor that attorneys owe to courts and should be subject to sanctions given that the lawyers filing the complaint are on notice that the claim is fraudulent.  Any citation to the 401k Averages is deliberately misleading because the small plans cited in the book, like most small plans in the country, pay for recordkeeping with indirect revenue sharing – apparently just like the Nova Southeastern plan – and thus the average recordkeeping fees are multiples higher than $5 and $12 direct recordkeeping fees that are misleadingly cited in the complaint.  The Nova Southeastern complaint is copycat version of the weakest excessive fee complaints that have been filed historically.  These lawyers need to read more recent excessive fee lawsuits, because the major plaintiff firms have stopped the shameful and embarrassing citations to the 401k Averages Book and have moved on to other tactics.  Nevertheless, the new filing against Nova Southeastern reveals that this plaintiffs’ law firm is targeting Florida university plans.

 

The Fiduciary Insurance Market:  Lower Limits and Higher Retentions, But Premiums Remain Reasonable Relative to Heightened Class Action Risk

The high frequency of ERISA class actions has turned fiduciary liability insurance into a line of insurance that more closely resembles insurance for directors and officers.  For decades, D&O insurance carriers have had to price D&O insurance to reflect that anywhere from five to ten percent of all publicly filed companies each year will be sued for alleged securities violations.  The type of cases vary from securities fraud to accounting restatements, and more recently represent event-driven litigation.  But the common theme has always been that D&O policyholders face securities strike lawsuits, and if these cases get past a motion to dismiss, they are usually settled to make the lawyers go away given the high litigation costs and litigation uncertainty.

The onslaught of excessive fee cases against large retirement plans has created the same risk dynamic for fiduciary liability insurance.  Fiduciary insurers must now evaluate the risk of strike lawsuits that are usually settled when the case is not dismissed at the pleadings stage.  The historical difference, however, is that fiduciary insurance has been typically priced at less than twenty to twenty-five percent of D&O insurance.  It certainly was not priced to cover strike lawsuits with high defense expenses and indemnity risk.

Moreover, fiduciary insurance for large-plan sponsors was included historically in many instances as a coverage part of a larger D&O package policy in which the fiduciary coverage, like employment practices liability coverage, was added as an additional coverage part, often subsidized by the higher-priced D&O policy with a twenty percent or higher discount.  Given the higher fiduciary risk facing plan sponsors of large plans, however, major brokers are now marketing fiduciary insurance separate from the D&O policy for many plan sponsors.  This shift to monoline fiduciary insurance for large plan sponsors has made it more transparent that fiduciary insurance was historically underpriced relative to the risk profile.

The primary reaction of the leading fiduciary insurance carriers has not been to raise premiums dramatically to ensure rate adequacy.  Instead, the main priorities in the last two years from major carriers have been to (1) reduce limits offered to each policyholder, and (2) to increase retentions for class actions or excessive fee and investment imprudence cases.  Premium increases have been secondary to the priority of reducing risk exposure to excessive fee lawsuits.  Three years ago, the two leading management liability carriers AIG and Chubb offered up to $25 million in fiduciary limits to large plan sponsors.  Many of these policies were issued with zero to minimal policy retentions or deductibles under $100,000 for large plans.

That has changed.  Management liability carriers in the last two years have placed a priority on limits management, and now it is rare for any carrier to offer more than $10 million in fiduciary limits capacity for any sized sponsored plan.  And many carriers are capping their fiduciary limits at $5 million for any plan sponsor with defined contributions plans with assets over $250m.  Many $25 million or $50 million fiduciary towers are now placed in $5m increments with multiple excess carriers to fill out the program.

The second major change in fiduciary insurance has been the introduction of class action or excessive fee retentions.  The normal policy retention or deductible for standard fiduciary claims still ranges between zero and $250,000, with most policies offering $25,000 to $100,000 retentions for standard claims.  But most plan sponsors that sponsor defined contribution plans with assets over $100 million will now see a class action or excessive fee retention, and even plans under $100m may see an excessive fee retention of up to $250,000 for the first time.  Plans between $100m and $500m in assets will see class or excessive fee retentions between $250,000 and $2,000,000; plans between $500m and $1b in assets will face retentions between $2.5m and $15,000,000; and most mega plans over $1b in assets will see retentions of at least $5 million [in rare instances, high-quality plans may see a lower retention, but rarely ever below $2.5m].  Finally, while retentions have increased in the last several years, they have stabilized this year.

As noted above, the headlines have given the misperception that fiduciary insurers premium have skyrocketed, but that is not the case.  Fiduciary insurance premiums have increased in the last two years for some plan sponsors, but to the extent premiums have increased, they have increased from often very low premiums relative to the risk profile.  Fiduciary premiums remain a fraction – usually less than twenty-five percent – of what is charged for D&O insurance, even though the chance of being sued with a large plan is not much different than the historical 5-10 percent chance of a securities lawsuit, and is even higher for $1b+ asset plans.  Fiduciary coverage is also usually much lower than what companies pay for employment practices liability insurance.  Most fiduciary programs have been renewing with modest premium increases between five and ten percent this year, notwithstanding that plan assets increased at least twenty to thirty precent in 2021 with the market increases last year.  Again, the major risk management tools used by fiduciary carriers has not been premiums, but limits management and excessive fee or class action retentions.

Finally, most plan sponsors have been able to secure fiduciary insurance with notable exceptions.  Plans with all types of investment fee and recordkeeping structures, including with investments and revenue sharing that have been targeted for litigation, continue to find carriers willing to quote their programs.  The only variable is that, as noted above, retentions have increased and plan sponsors now have first-dollar exposure in the event of a class action lawsuit.  For the most part, fiduciary carriers are portfolio underwriting and not distinguishing low- and high-fee plans for underwriting purposes.  The only plan sponsors of large defined contribution that we have seen with difficulty securing adequate fiduciary coverage are universities and healthcare entities now that there is perception that these types of plans are being targeted, but even university plans have had no trouble securing fiduciary coverage until recently, even though they have been targeted for excessive fee cases for at least seven years.  The notable exceptions to securing fiduciary coverage are for ESOPs and certain multiple employer plans.  Given the continued targeting of leveraged ESOPs by plaintiff law firms, the market for ESOP fiduciary coverage has evaporated as leading fiduciary carriers have stopped insuring these plans.  Fiduciary carriers now realize that leveraged ESOPs have a high probability of being sued and cannot be profitably insured at normal fiduciary premiums.  Finally, multiple employer plans, including new PEPS, represent a high risk of excessive fee exposure, and many fiduciary carriers are wary of providing fiduciary coverage to plans that insure multiple employers.  Nevertheless, these are minor exceptions to the overall fiduciary market in which fiduciary carriers continue to provide valuable risk protection at reasonable premiums to protect the sponsors of America’s employee benefit plans.

Disclaimer:  The Fid Guru Blog is intended to provide fiduciary thought leadership and advocacy for the plan sponsor community in areas of complex fiduciary litigation.   The views expressed on The Fid Guru Blog are exclusively those of the author, and all of the content has been created solely in the author’s individual capacity.  It is not affiliated with any other company, and is not intended to represent the views or positions of any policyholder of Encore Fiduciary, or any insurance company to which Encore Fiduciary is affiliated.  Quotations from this site should credit The Fid Guru Blog.  However, this site may not be quoted in any legal brief or any other document to be filed with any Court unless the author has given his written consent in advance.  This blog does not intend to provide legal advice.  You should consult your own attorney in connection with matters affecting your legal interests.

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