ERISA bonds were created by the Employee Retirement Income Security Act (ERISA) of 1974. This act is one of the most important laws to address retirement planning because it created a rules and a regulatory framework to support and govern employer-sponsored retirement plans and their administration. The goal of ERISA is to protect employees who enroll in such plans, and keep checks on any other parties who take part. Importantly, the act helps beneficiaries as well .
One tool that protects beneficiaries that arose from ERISA became known as the ERISA bond. Here you'll learn about this bond, why it is unlike other bonds, and how it works under the act.
- An ERISA bond is a special insurance policy that applies to health and retirement plans that fall under ERISA's jurisdiction.
- It is against the law for the ERISA bond to include a deductible, because all losses caused by fraud or dishonesty must be covered from the first penny.
- An ERISA bond must name the employer-sponsored benefit plan itself as the beneficiary of the insurance policy.
Employee Retirement Income Security Act of 1974
Congress devised three ways in which ERISA could attain its goals to protect beneficiaries, each of which is supported by a number of rules:
- ERISA mandates that employers must disclose certain financial information about the employer-sponsored retirement plan.
- ERISA creates rules of conduct that those acting as a fiduciary of a plan must abide by. ERISA bonds were created to help ensure this point.
- ERISA grants both plan participants and their beneficiaries certain rights in the U.S. Federal court system. These include a cause of action, or the right to sue, if they are harmed by the misconduct or incompetence of plan sponsors.
What Is an ERISA Bond?
You might also hear an ERISA bond called a fidelity bond. To be clear, it is not the kind of bond that's traded on the market. It's not a form of debt at all. Instead, it's a special insurance policy that applies to health and retirement plans that fall under ERISA's jurisdiction. The bond was created to address public concern about fraud in the system. Before the act came about, many feared that pensions and other employee benefit plans were being abused and poorly managed. An ERISA bond protects these plans against losses that may result from fraud or dishonesty by the people in charge.
ERISA falls under the purview of the Department of Labor. The DOL offers guidance, sets standards, and ensures that all parties comply with the rules They are also in charge of doling out penalties when needed. This is mostly in regard to fraud. If someone in your workplace, or a plan administrator violates ERISA, the DOL will conduct an investigation, impose sanctions, and maybe even get involved in a trial. The bond is in place to restore any money that is lost in the upset to the rightful parties.
Under the act, fraud and dishonesty are defined broadly, and can take many forms: "larceny, theft, embezzlement, forgery, misappropriation, wrongful abstraction, wrongful conversion, willful misapplication, and other acts."
How ERISA Bonds Differ From Other Types of Coverage
ERISA bonds must include specific terms in order to comply with the law and with the Department of Labor's rules.
First, an ERISA bond cannot include any deductible in the insurance contract, or any feature that charges the holder upfront, because all losses caused by fraud or dishonesty must be covered from the very first penny.
Second, an ERISA bond must name the employer-sponsored benefit plan itself as the beneficiary of the insurance policy. This means that if any party stands to gain from the plan, it's the people who pay into it in the first place. The measure helps prevent against foul play by taking away any chance that people who manage the plan can stuff their own pockets. It also helps ensure that the plan (and the plan participants and their beneficiaries) can make a direct claim on the bond.
How Much Coverage Does a Bond Need to Include?
ERISA has strict rules around how much bonds need to cover. Amounts are as follows:
- Each person who handles or has access to the funds in an employer-sponsored retirement plan must be covered for at least 10% of the amount they handled or had access to in the year prior.
- In most cases, bonds cannot cover for less than $1,000 or more than $500,000.
- Bonds can cover up to $1 million when the employer-sponsored plan includes securities issued by the employer.
An instance of the latter would be if Procter & Gamble held shares of its own common stock as an asset in its retirement plan for employees.
A Special Case
To explain, let's say you run a business, and as a perk you offer your employees the option to pay into a retirement plan that has $7 million in total assets. The plan does not hold any stocks in your own company (in other words, it doesn't contain "securities issued by the employer"), and two employees have access to all of the money and holdings within the plan. These two have been in charge of the fund for a few years now.
In this case, 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 amount that the ERISA bond must cover by law. This is a problem. If the plan ever added the company's own stock to the plan, then that raises the limit to $1 million, and each employee could be covered for $700,000. But as things stand, there is still a gap.
In some cases, the act grants 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 added safety is worth the higher bond expense.
ERISA bonds may share some aspects with fiduciary liability insurance in that they deal with fraud, but they are nothing alike. The latter is a special type of contract that can cover either or both the fiduciary and/or the plan against breaches of fiduciary responsibility.
Who Pays for the ERISA Bond?
Since the ERISA bond covers the employer-sponsored plan itself, plan funds can be used to pay the bond premiums.
How ERISA Defines "Funds"
Under the act, "funds" is a broad term that includes a wide range of assets. The term goes far beyond the publicly traded stocks, bonds, mutual funds, and exchange traded funds that make up most retirement plans.
In listing ways a plan might invest, the DOL makes a point to mention "land and buildings, mortgages, and securities in closely-held corporations," as well as contributions from both the employer and employees. All of these types of assets 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 they are invested.
Who Must 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 factors that define when a person is "handling" funds during the prior year. They are posed as questions, and if the answer to any of these questions is "yes," then that person is "handling" funds:
- Did the person have contact with cash, checks, or similar property that belongs to the plan?
- Did the person have the authority or power to transfer funds from the plan, either to themselves or to a third-party?
- Did the person have the authority or power to negotiate around property that belongs to the plan? (The DOL offers examples such as taking out a mortgage on a piece of real estate, holding the title to land or buildings, or being in possession of stock certificates.
- Did the person have some other disbursement power or the authority to direct others to disburse funds?
- Can the person sign checks or other negotiable instruments drawn against the funds in the plan?
- Is the person in charge of any activities or of making any decisions that require bonding?
Who Issues ERISA Bonds?
The ERISA bond market is highly regulated. For one, bonds must be issued by an underwriter, such as a surety company or reinsurer. This is pretty standard, but for ERISA bonds, it can't be just any licensed body—they must be chosen by The Department of the Treasury. The Treasury keeps a "Listing of Approved Sureties" to select from.
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 any hint of financial interest in either, you can't buy your ERISA bond through that business. For instance, if you own a retail store, and you also have a big stake in a local insurance agency, you couldn't buy the ERISA bond for your retail store through that insurance agency.
In rare cases, an ERISA bond can be acquired from a specialty insurance market known as the Underwriters at Lloyds of London, but only if the DOL allows it.
While ERISA applies to many employer-sponsored benefit plans, there are exceptions to the rule. ERISA bonds are not required for:
- Organizations that are included in the Title 1 section of ERISA, which includes church employee plans and plans offered by government entities
- Some financial institutions that are regulated in other ways, such as "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 straight from out of the company's own assets