Pension Plan Risk: Conversion of Defined Contribution Plan to Defined Benefit Plan

The trigger for this post was the G&M Article by Janet McFarland, here, July 18, 2011, titled  “The hidden costs of switching to a cheaper pension plan”. Janet raises some good points that might not be considered by companies considering closing access to their Defined Benefit Plan and offering only a Defined Contribution Plan to new hires. First, even if you convert today, you could still be managing that DB in 90 years, which means managing two plans. Second, without the employee retention benefits of a DB plan employees might be more willing to move to a competitor. Third, economic downturn will mean lower pension savings for older workers, so they will delay retirement in a period you are looking to trim staff by attrition. Fourth, education costs rise because employees retain the risk of poor investment strategy and the onus is the employer to provide multiple investment options, to explain those options, and to choose the investment management firm. And Fifth, investment management fees may increase, even if the majority of the management fee is being transferred to the employee. Other risks of a pension plan conversion are disrupted production as employees dispute pension changes.  Pension conversion and has contributed to lengthy strikes. There is also an increased risk for lawsuits based on allegations of improper training, poor selection of investment management and investment options. This risk is double-edged because providing too much information and choice can confuse the plan members. This risk is known as Fiduciary Liability, because the trustees, board members, employees, administrators, investment committee members, employee representatives, employer representatives and advisors are all consider fiduciaries of the various pension and benefit plans, and they all are subject to lawsuits. The risk of such lawsuits increases during periods of economic downturn, merger, acquisition or divestiture of companies and winding down of plans (including how deficits are funding or surpluses disbursed.)

Fiduciary liability, and lawsuits against plan fiduciaries may include the following allegations:

1. Failure to advise members of plan amendments with reasonable warning,
2. Inaccurate or misleading statements, and even if the errors was honest, the allegation will be failure to take appropriate corrective action,
3. Conflict of interest in investments or investment management choices,
4. Failure to adequately disclose fees and other related costs,

Fiduciary liability insurance policies are available in two forms, single-employer/sponsor plans and multi-employer plans (labour management plans). The most common fiduciary liability insurance policies respond to cover the individual persons fiduciaries for their defence costs, but also the plan sponsor for loss incurred indemnifying the individual persons, as well the plan itself for asset loss based on the fiduciary’s negligence. Some fiduciary liability policies only cover the personal loss of individual insured persons, and do not respond to the loss of the sponsor or the plan, but these are far less common.

When determining limits of liability for a fiduciary liability insurance policy the Insureds should consider the following:

1. The limit of liability is an aggregate limit for each and every claim and each and every insured (all insured persons, sponsors, plans, and past, present or future fiduciary (which is not a defined term)), including damages, judgments settlements, costs, defence costs, attorneys’ fees and experts’ fees, investigation costs,
2. Defence and investigation costs can be very expensive due to the high costs of actuaries, accounts and lawyers specialized in this unique field, and the extraordinary amount of data and paper they have to examine,
3. The long duration of investigation, defence and settlement, where the aggregate limit of the policy may be stretched over many years and not “replenished” at the expiry of the policy,
4. The high likelihood of class action proceedings,
5. The “long-tail” nature of risk based on potential for years or even tens of years between an alleged “wrongful act” and the resulting claim,
6. The significant value of assets involved in the company’s benefit program

Insurance coverage terms and conditions are complex, and there is no regulation of policy wordings in Canada, so your insurance broker should be truly independent, experienced with policy negotiation and claims, and have access to many insurance companies with experience in fiduciary liability coverage and claims. Your independent broker should be able to explain to your satisfaction and comfort the following:

1. Limit management,
2. Risk of limit erosion or exhaustion, and limit sharing,
3. Continuity of coverage in all of its facets,
4. Severability of application and exclusions,
5. Claim trigger, and the positives and negatives of “broad” definition of claim,
6. Advancement of limits,
7. Non-Indemnified vs Indemnified Loss,
8. Discovery and Extended Reporting Provisions,
9. Insurer structure, strengths and weaknesses,

Other risk management issues that should be considered by all fiduciaries of pension and benefits plans include:

1. Insurance maintained by third party service providers including fund managers,
2. Crime/Fidelity insurance for the plans,
3. Crisis management plans for the sponsor(s) and the plans,
4. Access to independent legal, financial, economic, actuarial and insurance advice.

Greg Shields is a D&O, Professional Liability, Fiduciary Liability and Crime insurance specialist and a Partner at the University and Dundas (Toronto) branch of Mitchell Sandham Insurance Services. He can be reached at gshields@mitchellsandham.com,  416 862-5626, or Skype at risk.first. And more details of risk and loss control can be found on the Mitchell Sandham blog at https://mitchellsandham.wordpress.com/

CAUTION: This article does not constitute a legal opinion or insurance advice and must not be construed as such. It is important to always consult a registered and truly independent insurance broker and a lawyer who is a member of the Bar or Law Society of the relevant jurisdiction with regard to this material before making any insurance or legal decisions. All material is copyrighted by Mitchell Sandham Inc. and may not be reproduced in any form for commercial purposes without the express written consent of Mitchell Sandham Inc. Anyone seeking to link this document from any external website must receive the consent of Mitchell Sandham Inc. by sending an e-mail to gshields@mitchellsandham.com.