Retirement Plans and the Courtroom

Most U.S. businesses of any size offer their employees one or more retirement plan in addition to the government's social security program. These range from simple 401(k) plans - with or without a company "match" - to full-fledged defined contribution or pension plans, some of which, like Employee Stock Ownership Plans (ESOPs), can be very complex and carry substantial funding burdens

In providing these plans, employers necessarily communicate with their employees about them, and therein lies a problem. Retirement plans do not always perform as expected. Communications are not always "perfect." Employees frequently misunderstand even the clearest and most accurate of plan descriptions, not to mention what is communicated less formally, even by word of mouth from supervisory personnel to others. Unfortunately, perhaps proving that "no good deed goes unpunished," such circumstances may result in litigation.

Experience shows that such litigation can be both demoralizing to "the troops" and expensive and time-consuming for the employer. To make a bad situation worse, company directors and officers typically are named individually in their capacities as "fiduciaries" under the Employee Retirement Income Security Act of 1974 (ERISA.) Directors and Officers (D&O) liability insurance policies usually - but not always - exclude suits brought under ERISA. The mandatory "ERISA bond" required of qualified plans is only a payment bond, not an insurance policy. Employee Benefits Liability (EBL), often an "add-on" to general liability insurance, only covers administrative oversights (such as failure to add dependents to a medical insurance plan), and does not extend to ERISA fiduciary exposures. Employment Practices Liability (EPL) policies typically do not apply in ERISA litigation either. General liability and umbrella liability policies also do not generally apply, for different reasons.

Because of all this, more and more businesses are purchasing specialized liability insurance protection for themselves and their leadership. Such policies, known as Fiduciary Responsibility Insurance (FRI), specifically cover both the corporation and its key employees and are designed to apply to ERISA and related lawsuits.

Don Way
CEO

Directors & Officers

In 2005, Tillinghast, part of Towers Perrin, conducted its 28th study of directors and officers (D&O) liability claims and insurance purchasing trends. The survey results indicate that the market for D&O insurance has continued to soften, while claim frequency and severity have continued to increase, an obviously unstable condition. Tillinghast's D&O premium index decreased 9% in 2005, after a 10% decrease in 2004. Capacity continued to increase and restrictions continued to ease.

Claim frequency in 2005 of for-profit respondents to the survey was 0.34, compared to a frequency of 0.33 for 2004; roughly one in three respondents had at least one D&O claim. The non-profit participants reported higher frequencies, 1.53 and 1.34, respectively. In addition, the large increase in shareholder/investor claims drove a substantial increase in the average claim size in the for-profit group.

The survey is admittedly a self-selecting non-probability sample, but it does cover a great many businesses. In 1974, Tillinghast developed a standardized premium index starting at 100. Subsequent surveys tracked the index. Historical values range from 1974's 100 to a low of 71 in 1982 and a high of 1,237 in 2003. The 2004 index was 1,113; the 2005 index was 1,101.

Average policy limits last year were $14.3 million, an increase from 2004's $13.6 million (for-profit U.S. companies.)

Coverage enhancements increased and exclusions continued to ease, building on a trend observed in the 2004 survey, reversing the prior trend that had existed from 1998 through 2003.

Claimant distribution continued to be heavily dependent upon ownership structure. For-profit companies suffered 52% of their claims from shareholders and 23% from third parties. In contrast, non-profits faced 92% of their claims from employees, compared to only 25% for for-profit companies. Key exposure characteristics included:

• Size (total assets, revenue, and market capitalization)
• Class of business
• Ownership structure
• Number of employees
• Number of years in business
• Occurrence of an after-tax loss in recent times
• Merger, acquisition, or divestiture activity
• Initial Public Offering (IPO) in recent times

Tort Costs

U.S. tort costs reached a record $260 billion in 2004, or approximately $886 per person, according to a recent report from Tillinghast, part of Towers Perrin. Costs grew at a slightly faster pace in 2004 (5.9%) than in 2003 (5.5%), but still well below the high growth rates seen in 2001 and 2002, which averaged 14% each year. The 5.9% growth rate was less than the overall U.S. economic growth, as measured by Gross Domestic Product (GDP), of 6.6%.

Since 1950, however, growth in tort costs has exceeded GDP by an average of 2% to 3%. U.S. tort cost growth since 1950 far exceeds U.S. population growth. After adjusting for inflation, tort costs per capita have risen more than 900% between 1950 and 2004.

Tillinghast's report shows that commercial tort costs have outpaced personal tort costs since 1990, 5.9% versus 3.7%.

Given current trend patterns, Tillinghast expects U.S. tort costs to increase approximately 6.5% for each of the next three years.

If you have any questions regarding topics mentioned in this newsletter, please contact our office.