BUYER BEWARE: SPONSORS SHOULD READ DETAILS IN FIDUCIARY WARRANTIES TO DODGE ‘GIMMICKS'

Employer-sponsored retirement plan fiduciaries should be cautious about signing fiduciary warranties, because some provide far less value than fiduciary insurance and can potentially be a “marketing gimmick,” plan advisers and insurers told Bloomberg BNA in a series of interviews.         

Fiduciary warranties are products offered by providers to participant-directed plans that purport to lessen a fiduciary's risk exposure to lawsuits filed by participants. The warranties may state that providers' investment portfolios are sufficiently diversified to meet the requirements for a “broad range of investments” under the Employee Retirement Income Security Act, or meet ERISA's “prudent man” standards.           

However, providers often carefully word their warranties to avoid claiming fiduciary status, J. Scott Gehman, a benefits consultant with Conrad Siegel Actuaries in Harrisburg, Pa., said May 30 in an e-mail.         

In many cases, warranties “are more of a marketing gimmick,” Gehman said. “Very possibly, the company offering the warranty is not acknowledging fiduciary status, and they are offering the warranty so they can still imply some level of fiduciary protection, no matter how thin.”         

More than half of plan sponsors—52 percent—thought that a fiduciary warranty would protect them from a participant lawsuit, according a 2009-2010 survey commissioned by Unified Trust Co., a Lexington, Ky.-based financial services firm. The data is based on the firm's most recent survey on this topic.         

The problem with this line of thinking is that warranties typically won't offer protection from participant complaints, Ary Rosenbaum with the Rosenbaum Law Firm PC in Garden City, N.Y., told Bloomberg BNA in an e-mail May 27.         

“The biggest problem with fiduciary warranty is that by using the word fiduciary, plan sponsors are under the false assumption that the plan provider offering it is serving in a fiduciary function. Even if they realize that the provider isn't a fiduciary, they don't realize that most litigation doesn't involve the topics that the warranty covers,” Rosenbaum said.         

Fiduciary Role          

The role of a fiduciary is no small matter, which makes understanding the difference between warranties and insurance very important, Gehman said.         

“To be a fiduciary is a very inclusive role, meaning the true fiduciary advisor falls under virtually all that the law requires in the areas where this responsibility and liability has been assumed. In contrast, to relegate fiduciary protection to a ‘warranty' implies more of an effort to be exclusive—meaning the firm is probably not acknowledging true fiduciary status, and is going to specify only certain situations where they are liable,” Gehman said.         

Richard G. Clarke, senior vice president at J. Smith Lanier & Co. in Duluth, Ga., echoed Gehman's comments in a May 21 conversation, saying that if a party believes that a warranty has been breached, it will have to show that the other party was wrong, “and that's a more complicated process than having insurance coverage.”         

On the other hand, with insurance coverage, the insured presents the facts of the claims situation, and the claim is either covered by the contract or it isn't, he said.         

Warranty Levels          

Fiduciary warranties are typically offered at three different levels: limited, defined and broad scope, Gary Sutherland, chief executive officer and partner of Framingham, Mass.-based North American Professional Liability Insurance Agency LLC, told Bloomberg BNA on May 23.         

Limited warranties are designed to cover a range of investment opportunities and aren't very significant in exposure, Sutherland said. Under this type of warranty, the insurance carrier states it will guarantee that its portfolio of investments meets the diversification rules, Sutherland said.         

“But at the end of the day, pretty much everything meets diversification, so they're not offering much,” Sutherland said. “They're more marketing gimmick than anything else.”         

Defined scope warranties offer a little bit more than limited scope, for example, around the qualified default investment alternative selection, Sutherland said. This level of warranty is called defined scope “because it says here's what we're doing, and here's what we may warrant,” he said.         

Broad scope warranties use an insurance company that provides “real fiduciary coverage, real indemnification, for a defined set of fiduciary duties. And that's the one I work with,” Sutherland said.         

The broad scope is a “hybrid” of both an insurance policy and a warranty, because it has the warranty component in which one party says that “we warrant our fiduciary service to you, and we back it up with a fiduciary insurance policy,” Sutherland said.

Excerpted from a story that ran in Pension & Benefits Daily (5/30/2014).