Research shows that the popularity of ESG investing is also on the rise in both defined benefit and defined contribution plans administered by U.S. employers, causing some to question the validity of basing investment decisions that could significantly impact employees’ future financial security on issues that have not typically been part of financial analysis.⁵ In addition, because many passive investors are often unaware of how their savings are being used, some suggest that the ESG market is better suited to personal investing.⁷ Over the last 20 years, the Department of Labor (DOL) has been grappling with whether or not ESG investing pushes ERISA plan fiduciaries to make decisions that violate their fiduciary duties by potentially sacrificing investment returns in the pursuit of social or collateral goals. ESG investing strategies can drive plan administrators to divest from a well performing stock due to societal pressure, and then reinvest in an ESG option that may not perform as well, thereby increasing liability. This form of investing can also result in higher fees due to the additional investigation and monitoring necessary to evaluate ESG qualities.⁴

While no one is arguing that there are many worthy social causes that deserve attention and support, investing employee retirement funds in such causes may not always be wise due to lack of clear data, dependence on undeveloped future technology, or assumptions around expected breakthroughs.⁷ It’s important to remember that a company’s interest in supporting social causes or issues, doesn’t change the obligation of an ERISA plan fiduciary. Sections 403(c) and 404(a) of ERISA dictate that benefit plan fiduciaries must act “solely” in the interest of plan participants and beneficiaries, exclusively to provide benefits and pay reasonable plan administration expenses.⁴

ESG INVESTING & ERISA PLANS

In June of this year the DOL proposed a new rule, updating investment guidance for ERISA fiduciaries in response to growing interest in ESG investments. While not yet in effect, the rule clarifies the fiduciary’s duties when it comes to ESG investing for retirement plans. In the new proposed rule, the DOL stresses that ERISA plan fiduciaries may not engage in ESG investing that increases risk or lessens returns in order to achieve non-pecuniary goals.⁴ When deemed appropriate, any ESG investments must be selected based solely on specific economic factors, such as risk, liquidity, and diversification.⁴ Non-pecuniary factors should only be considered in the event that two alternate investment opportunities are economically identical. When this is the case, fiduciaries must document the occurrence, explain the rationale for determining that there were no distinguishing factors, and explain how the specific ESG investment was chosen based on financial interests.⁴

Fiduciaries responsible for the management of defined benefit or defined contribution plan investments should:

• Review plan investments to identify any current ESG investments;
• Investigate and fully understand the financial reasoning behind such ESG investments;
• Compare any ESG investments to available alternatives, in order to remove any underperforming investments;
• Accurately document the investment decision-making process; and
• Develop and implement investment policies for considering future ESG investments⁴

MITIGATING ESG INVESTING RISKS

The DOL’s proposed rule is generating discussions across the ERISA community, and rightfully so. If finalized, the rule would take effect 60 days after final publication, making fiduciaries less likely to offer ESG products to ERISA-governed plans. Even though ESG products would not be completely prohibited, fiduciaries of ERISA plans will have to employ greater due diligence when selecting ESG investments.⁴ With the rise of class-action litigation focused on plan fees and investment choices for participant-directed defined contribution plans, a clearly-structured fiduciary process (including required documentation) is key.⁶

Fiduciaries responsible for the management of defined benefit or defined contribution plan investments should:

• Review plan investments to identify any current ESG investments;
• Investigate and fully understand the financial reasoning behind such ESG investments;
• Compare any ESG investments to available alternatives, in order to remove any underperforming investments;
• Accurately document the investment decision-making process; and
• Develop and implement investment policies for considering future ESG investments⁴

While adhering to ERISA guidelines will help prevent claims, additional protection exists in the form of fiduciary liability insurance. Fiduciary liability is an often-overlooked area of insurance coverage that can help protect businesses offering retirement or employee benefit plans that may be affected by changes in the investing environment. In the world of insurance, the need for fiduciary liability is sometimes misunderstood because it’s easily confused with fidelity bond coverage meant to guard against employee theft and dishonesty or with ERISA fidelity bond coverage that applies to theft from an ERISA employee plan. Policyholders may also incorrectly assume that Employee Benefits Liability (EBL) covers employee plan claims, but EBL is limited to coverage for administrative errors, such as failure to enroll and doesn’t extend to breaches of fiduciary duty like imprudent investment.³ Some may also assume that D&O coverage automatically includes fiduciary liability.² While it’s true that fiduciary liability is often written into the same policies as D&O coverage and covers many of the same people, D&O policies function to cover a broader variety of issues such as shareholder claims alleging mismanagement that result in devalued stock prices or an organization’s inability to repay debt.

COVERING ERISA FIDUCIARIES & COMMITTEES WITH FIDUCIARY LIABILITY

Fiduciary liability is a distinct form of coverage specifically aimed at covering those charged with creating and managing benefit and retirement plans, including plan sponsors (i.e. employers), trustees, directors, officers, and internal investment committee members. 401k plans likely come to mind first, but the majority of companies outsource the administration of these plans to larger financial services organizations, which helps to standardize plan administration and employee investment options. Fiduciary liability coverage also applies to 403bs, IRAs, stock purchase plans, employee stock ownership plans, and defined benefit plans. Perhaps the biggest area of exposure for employers lies with defined benefit pension plans requiring employer contributions, such as pension plans. Fiduciaries may face claims arising from plan participants or government agencies due to inability to fund retirement plans based on dramatic investment losses. Large losses in employer stock value could also impact the retirement savings of employee plan participants leading to fiduciary liability claims.¹

BOTTOM LINE

Failure to fully understand a risk doesn’t reduce a company’s potential exposure. Any business that offers benefit plans has some level of exposure in the area of fiduciary liability. Larger organizations are more likely to employ personnel solely responsible for managing employee benefits in alignment with ERISA law, but smaller businesses without dedicated benefit managers may find themselves at greater risk.³ Fiduciary liability coverage is generally very affordable, especially for the value it offers. Small to mid-size companies could obtain $1M in coverage for around $1-3K in annual premium, rounding out risk management efforts by protecting D&Os from the personal liability of fiduciary responsibilities. Those companies with D&O coverage already in force will find that adding fiduciary liability is even more cost effective. Organizational leaders should keep in mind that choosing not to purchase fiduciary liability coverage equates to choosing self-insurance, and getting hit with litigation, even if a company made the right choices, could result in catastrophic costs.

When submitting for fiduciary liability coverage, agents should document the different kinds of benefit plans offered, including healthcare benefits, pension plans, and retirement investment options, so that underwriting can evaluate the level of risk involved in each. For example, Employee Stock Ownership Plans (ESOP) and pension plans often present a higher level of risk, prompting additional underwriting questions. Underwriting will also require information about each plan’s size, including number of participants and the assets included.

Contributors

• Jason White is the ExecPro National Practice Co-Leader, based in Los Angeles.
• Mike Robison is the ExecPro National Practice Co-Leader, based in Dallas, Texas.

ENDNOTES

1. Fiduciary Liability Insurance Basics, IRMI, October 2018. https://www.irmi.com/articles/expert-commentary/fiduciary-liability-insurance-basics
2. Coronavirus: Factors for the Insurance Industry to Consider – Part 4 Directors & Officers (D&O) Insurance, The National Law Review, March 18, 2020. https://www.natlawreview.com/article/coronavirus-factors-insurance-industry-to-consider-part-4-directors-officers-do
3. What is Fiduciary Liability Insurance, Insurance Business America, May 24, 2019. https://www.insurancebusinessmag.com/us/guides/what-is-fiduciary-liability-insurance-168205.aspx
4. To ESG or Not to ESG: ESG Investments and ERISA Plans, Winston & Strawn, LLP, June 29, 2020. https://www.winston.com/en/benefits-blast/esg-investments-and-erisa-plans-to-esg-or-not-to-esg.html
5. Your Complete Guide to Investing with a Conscience, a $30 Trillion Market Just Getting Started, CNBC, December 14, 2019. https://www.cnbc.com/2019/12/14/your-complete-guide-to-socially-responsible-investing.html
6. Has the DOL Closed the Door on ESG Investing in ERISA Plans?, JD Supra, July 13, 2020. https://www.jdsupra.com/legalnews/has-the-dol-closed-the-door-on-esg-61874/
7. ESG Investing Should Remain an Individual Choice, Forbes, July 16, 2020. https://www.forbes.com/sites/daneberhart/2020/07/16/esg-investing-should-remain-an-individual-choice/#2eec526553ed