What You Need to Know About ERISA Bonds

What Is an ERISA Bond?
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ERISA bonds were created by the Employee Retirement Income Security Act (ERISA) of 1974. ERISA is among the most significant pieces of legislation for retirement planning and administration because it created a regulatory framework for employer-sponsored retirement plans. The goal of the legislation is to protect employees participating in these employer-sponsored retirement plans, as well as any other plan beneficiaries.

One tool for protecting beneficiaries that arose from ERISA became known as the ERISA bond.

Employee Retirement Income Security Act of 1974

Congress devised three ways in which ERISA could achieve its goals of protecting beneficiaries, each of which is supported by a myriad of rules and regulations:

  1. ERISA requires employers to disclose certain information, including certain financial information, about the employer-sponsored retirement plan.
  2. ERISA creates rules of conduct that are required for those acting as a fiduciary of an employer-sponsored plan. ERISA bonds were created to help ensure this point.
  3. ERISA grants both plan participants and the beneficiaries of plan participants certain rights in the U.S. federal court system, including the right to sue if they are harmed by the misconduct or incompetence of plan sponsors.

What Is an ERISA Bond?

An ERISA bond—also called an ERISA fidelity bond—isn't the kind of bond that's traded on the market. It isn't a form of debt. Instead, it's a special insurance policy that applies to health and retirement plans that fall under ERISA's jurisdiction. With an ERISA bond, these plans are protected against losses that result from fraud or dishonesty. The bond was created to address public concern that pensions and other employee benefit plans were being abused and mismanaged.

The Department of Labor administers ERISA and ensures compliance with the law. It defines fraud or dishonesty, as it pertains to ERISA bonds, as "larceny, theft, embezzlement, forgery, misappropriation, wrongful abstraction, wrongful conversion, willful misapplication, and other acts."

How ERISA Bonds Differ From Other Types Coverage

ERISA bonds have specific terms and conditions that must be included to be compliant with the law and the Department of Labor's regulations. First, an ERISA bond cannot include any deductible in the insurance contract—or any feature that resembles a deductible—because all losses caused by fraud or dishonesty must be covered from the very first penny.

Second, an ERISA bond must explicitly name the employer-sponsored benefit plan itself as the beneficiary of the insurance policy. That helps ensure that the plan (and therefore, the plan participants and their beneficiaries) can make a direct claim on the bond.

How Much Insurance Coverage Does It Need to Include?

The ERISA bond coverage is usually determined as follows:

  • Each person handling or having access to funds of an employer-sponsored retirement plan must be covered for at least 10% of the amount they handled or had access to in the previous year.
  • In most cases, coverage cannot be less than $1,000 or more than $500,000.
  • The maximum coverage required extends to $1 million when the employer-sponsored plan includes securities issued by the employer. An example of this scenario would be if Procter & Gamble held shares of its own common stock in its retirement plan for employees.

For example, let's say you run a successful business that offers an employer-sponsored retirement plan with $7 million in total assets within the plan. The retirement plan isn't holding stocks in your own company (in other words, it doesn't contain securities issued by the employer), and two employees had access to all of the money and holdings within the plan.

In this scenario, each of the two employees with access to the funds would need to be covered under the plan's ERISA bond for $500,000. While 10% of $7 million is $700,000, this exceeds the maximum ERISA bond coverage required by law. If the plan ever added the company's own stock to the plan, then that raises the maximum coverage requirement, and each employee would need to be covered for $700,000.

You have the option to purchase larger coverage amounts under the ERISA bond, beyond the 10% requirement, to further protect plan participants and their beneficiaries. However, the Department of Labor points out that this would involve a fiduciary decision about whether or not the additional protection justifies the higher bond expenses.

Who Pays for the ERISA Bond?

Since the ERISA bond covers the employer-sponsored plan itself, it is considered acceptable to use plan funds to pay the ERISA bond premiums.

How ERISA Defines "Funds"

For the purposes of ERISA, "funds" is a purposefully broad term that includes a wide range of assets. The term goes far beyond the publicly traded stocksbondsmutual funds, and exchange-traded funds that are commonly associated with retirement plans.

The Department of Labor specifically mentions investments in "land and buildings, mortgages, and securities in closely-held corporations," as well as contributions from both the employer and employees. All contributions are covered by the term "funds," whether they come in the form of cash, check, or property. The ERISA bond needs to be in place to protect against any assets being embezzled or somehow misdirected before being invested.

Who Is Required to Be Covered?

ERISA makes it an unlawful act for any person to "receive, handle, disburse, or otherwise exercise custody or control of plan funds or property" without being properly bonded.

The Department of Labor offers six criteria for determining when a person is "handling" funds during the prior year. The criteria are here posed as questions, and if the answer to any of these questions is "yes," then that person is "handling" funds:

  1. Did the person have physical contact with cash, checks, or similar property belonging to the employer-sponsored retirement plan?
  2. Did the person have the authority or power to transfer funds from the employer-sponsored plan to themselves or a third-party?
  3. Did the person have the authority or power to negotiate plan property? The Department of Labor provides examples such as taking out a mortgage on a piece of real estate, holding the title to land or buildings, or physically possessing stock certificates.
  4. Did the person have some other disbursement authority or authority to direct disbursement?
  5. Did the person have the authority to sign checks or other negotiable instruments drawn against the funds in the employer-sponsored plan?
  6. Did the person have "[s]upervisory or decision-making responsibility over activities that require bonding"?

Who Issues ERISA Bonds?

The ERISA bond market is highly regulated. ERISA bonds must be issued by an underwriter, such as a surety company or reinsurer, that is identified in the Department of the Treasury’s Listing of Approved Sureties, Department Circular 570. The Department of Labor notes that there are certain conditions under which an ERISA bond can be acquired from a specialty insurance market known as the Underwriters at Lloyds of London.

There's also one other catch: ERISA bonds must be issued by an independent insurance company and acquired through an independent insurance broker. If you have a significant financial interest in either, you can't buy your ERISA bond through that business. For example, if you own a manufacturing business, and you also have a big stake in a local insurance agency, you couldn't buy the ERISA bond for your manufacturing business through that insurance agency.

ERISA Exemptions

While ERISA applies to many employer-sponsored benefit plans, there are exceptions. ERISA bonds are not required for:

  • Organizations that are included in the Title 1 section of ERISA, including church employee plans and plans offered by government entities
  • Some regulated financial institutions, including "certain banks, insurance companies, and registered brokers and dealers"
  • Employer-sponsored retirement plans that are "completely unfunded," in other words, those in which the plan benefits are paid directly out of the company's general assets

ERISA Bonds vs. Fiduciary Liability Insurance

ERISA bonds are meant to protect employer-sponsored retirement plans from fraud and dishonesty on behalf of those handling funds. That makes an ERISA bond fundamentally different from fiduciary liability insurance. The latter is a special type of insurance contract that can cover either or both the fiduciary and/or the plan against breaches of fiduciary responsibility.