Until this century, retirement was for the rich, everyone else worked until they could no longer do so. The advent of Social Security in the 1930s began the process of providing some minimal security on which people could depend as they grew older. In our minds 65 was firmly established as the retirement age.

In the 1930s and 1940s companies began to provide retirement benefits by setting up defined benefit pension plans. There was very little regulation and companies pretty much did as they pleased. Nonetheless, the concept of an employer-provided pension for life became fairly widespread. In recent years, we have seen the decline of the defined benefit plan and its replacement by a defined contribution plan. The expectation that many had of a pension for life is largely disappearing.

What is ERISA?

ERISA is a federal law passed in 1974 and effective 1 January, 1975 which protects the rights of pension and welfare plan participants. Prior to the passage of ERISA, plan participants often found themselves at the end of their work lives with no pension. Sometimes this was because the company had very restrictive vesting requirements which made it hard for employees to become vested, sometimes because the plan was inadequately funded or because plan assets were diverted to support the general needs of the company. Several prominent companies went bankrupt in the 1960s and early 1970s, leaving many thousands of employees without the pensions they had worked for. This situation finally caught the attention of Congress and resulted in the passage of ERISA.

The major objectives in passing ERISA were:

  • To set standards of conduct for those who sponsor, administer or make decisions for pension and welfare plans

  • To ensure that workers and beneficiaries receive adequate information about their employee benefit plans

  • To safeguard pension benefits for workers whose pension plans have been terminated

  • To ensure that adequate funds are being set aside to pay promised pension benefits

  • To unify the rules for employee benefit plans by setting up a three part oversight responsibility shared by the Department of Labor (DOL), the Pension Benefit Guaranty Corporation (PBGC) and the Internal Revenue Service (IRS). Defined benefit plans are overseen by all three agencies. Defined contribution and welfare plans are overseen by the DOL and the IRS.

    Plans covered by ERISA

    Defined benefit/defined contribution plans

    The traditional type of pension plan had been a “defined benefit” plan. This meant the company promised to pay a certain monthly pension for the life of the retiree. The benefit was certain and the investment risk rested solely with the employer. If the plan investment return was poor the employer would have to contribute more money to the plan to ensure that it remained properly funded. In a “defined contribution” plan the employer agrees to make a specific contribution to the plan (which is frequently matched by an employee contribution in a 401(k) plan). The employee normally chooses from among several investment vehicles and the investment risk rests with the employee. Whatever monies are in the plan when the employee retires constitute the employee's retirement fund. While the 401(k) plan is now the most common type of defined contribution plan, there are others such as profit sharing plans or employee stock ownership plans where the employer makes the investment decisions but the investment risk remains with the employee.

    Welfare plans

    These include life, health, dental, apprenticeship training, scholarship, etc.

    Plans not covered by ERISA

    These include governmental plans, church plans, plans maintained outside the United States primarily for non-US citizens, plans established to provide additional benefits for highly compensated employees and plans established solely to comply with workers' compensation, unemployment compensation or state disability insurance laws.


    The DOL, through the Secretary of Labor, oversees the enforcement of ERISA. In addition to receiving 5500s for all plans, the Secretary is empowered to make appropriate regulations necessary for the operation of ERISA, and has the right to conduct investigations. These investigations can be general or specific. A general audit of the plan may relate to a review to determine if the plan generally complies with the statute, without any particular area of concentration. A specific investigation will have a focus as to possible violations. The focus may be the result of a complaint to the DOL, it may arise from some media statement or event, or from information contained in a filing. If the DOL finds a violation, the normal procedure is the transmittal of a compliance letter. In such a letter, the Department will state the results of its investigations, the nature of the violations and the relief it is seeking. The fiduciaries are usually given the opportunity to correct the violations voluntarily, before a suit is brought. If corrective actions are not taken, the Secretary will bring suit in federal court.

    In addition to this course of action, ERISA requires that every private litigant alleging breaches of fiduciary duty must file a copy of the complaint with the DOL. Thus, the DOL can potentially be a plaintiff in any action alleging breach of fiduciary duty under ERISA. Even a settlement in a private action does not bar the Secretary from proceeding with an action, as it has been held that the Secretary has responsibilities of enforcement which are different and distinct from those of private litigants. In addition, the Secretary has the ability to seek other forms of relief. Where a prohibited transaction is involved, the Secretary can recover a 5% civil penalty under Section 502(i) of ERISA. Under 502(l), the Secretary is required to impose a 20% penalty on any amounts recovered for breach of fiduciary duty, whether by settlement or judgment.

    The PBGC guarantees the benefits of participants in defined benefit plans. This government run program acts as an “insurance company”, collecting premiums based on the plan exposures with respect to its funded status. The PBGC is responsible for the termination of defined benefit pension plans so as to ensure that benefits will be paid to participants and beneficiaries. There are three types of plan terminations. The first is a standard termination where the employer voluntarily wishes to end the plan and there are enough assets to pay all the benefits. In this situation, the PBGC will give its approval to the termination. The second type is where the employer voluntarily files a notice of termination with the PBGC but does not have sufficient assets to fund all benefits. This is a “distressed termination” and ERISA requires that the employer give 60 days notice to the PBGC of the intent to terminate, indicating whether it is in liquidation or reorganization under the bankruptcy code. The PBGC will make a determination as to whether plan termination is the best option or whether the company can afford to continue sponsoring the plan. The third is where the PBCG itself determines that a plan must be involuntarily terminated. This is usually based on the plan not having met the minimum funding standards, not being able to pay benefits when due, or where certain other reportable transactions have occurred. Where either a distressed termination or involuntary termination occurs the PBGC can apply to a federal district court for the appointment of a trustee or can appoint itself as a trustee. In either event, the trustee will have the same powers as any other fiduciary to sue others for breach of fiduciary duty.

    Once a defined benefit plan is in the process of termination, jurisdiction passes from the DOL to the PBGC for enforcement of ERISA. When a termination occurs in an under-funded plan the PBGC is required to pay the amount of benefits which the plan cannot afford, up to a maximum benefit per participant. These guaranteed benefits are funded by the premiums paid by every defined benefit plan.

    The IRS, because of the tax favored treatment of ERISA plans, is empowered to audit for ERISA compliance. Where it finds violations, it may negotiate settlements, litigate and assess penalties. These penalties can be substantial and are non-deductible as a business expense.

    Who is a fiduciary? A person or a corporation who exercises control or authority over the management or disposition of plan assets. There are outside professional fiduciaries, such as mutual funds, TPAs, consultants, etc. There are also fiduciaries who are employees of the plan sponsor and who administer the plan and/or oversee the administration by professional fiduciaries.

    The responsibility of fiduciaries is to administer the plan in the sole interest of the plan participants. If there is a conflict between the interest of the participants and the corporation, the corporation as a fiduciary must act solely in the best interests of the participants. The fiduciary must act for the “exclusive purpose” of providing benefits to participants and to defray reasonable expenses of administering the plan. Thus, a plan cannot theoretically engage in any activity which is not related to these two functions. The fiduciary must act “with the care, skill, prudence and diligence” which a prudent person would under the same circumstances. The fiduciary is required to diversify the investments of a plan so as to minimize the possibility of large losses. However, the statute does give the fiduciary the right to refrain from diversification if it is clearly prudent under the circumstances to do so. This rule does not prohibit the existence of employee stock ownership plans. Further, there are express provisions that allow the holding of employer securities by a plan. However, this does not give the fiduciary absolute protection against a claim for breach of fiduciary duty. If it becomes imprudent to continue to purchase or hold employer securities, such as where the fiduciary knows or learns of the financial instability of the sponsor corporation, the fiduciary must act to protect the participants. Thus, if the corporation is the fiduciary and wants to save the corporation from bankruptcy by using plan assets to purchase stock, it may not do so unless it is clearly prudent.

    Actions for breaches of fiduciary duty under ERISA must be brought within six years of the breach or within three years from the date the plaintiff had actual knowledge of the breach. ERISA holds a fiduciary personally liable for his/her actions and, in most cases, the corporation cannot indemnify that individual. Section 410 of ERISA permits the corporation or the plan to purchase insurance to protect the liability of these fiduciaries.

    What is fiduciary liability?

    Fiduciary liability is a third party liability coverage providing protection to trustees, fiduciaries, plans and plan sponsors, for the liabilities imposed by ERISA and the common or statutory law of the US.

    It is important to note the following:

  • Every director and officer of the organization is a fiduciary and as such can be held liable for ERISA claims. This can be an especially difficult position when the directors and officers are called upon to make a business decision that may be advantageous to the corporation, but detrimental to plan participants - for example, a merger with another company or the sale of an underperforming division to another company. Even though the directors and officers are required to make these types of decisions, if a claim occurs, under ERISA, the sponsor employer may not be able to indemnify them depending on the type of claim brought.

  • The sponsor organization and its fiduciaries are held liable for all investment, administrative and management decisions even if the organization employs a third party administrator or the plan in question is a 401(k).

  • The sponsor and fiduciaries can be sued by: 1) Plan participants, their heirs and beneficiaries, and 2) Governmental organizations such as the IRS, the DOL, the PBGC, and in the case of a stock ownership plan, the SEC.

    The following scenarios highlight the types of claims which can be brought against the fiduciaries of benefit plans:

    1. Two participants in a retiree group medical plan were offered the choice of continuing their existing coverage at a new premium rate or of discontinuing participation in exchange for a lump sum payment. Both participants chose the lump sum payment. The participants later alleged that the company failed to inform them of the tax liability on the payments they received and sued the company. The case went to trial and was dismissed. The judge found that the sponsor had no duty to disclose tax information to the participants when making a lump sum payment. The plaintiffs filed an appeal with the circuit court. The circuit court upheld the trial judge's opinion. The adjudication of this claim took three years and defense costs totaled $100,000.

    2. Two employees lost their jobs during a restructuring. The employees filed a wrongful termination suit and a retaliatory termination suit. The allegations include age discrimination and retaliation for filing a claim with the Occupational Safety and Health Administration (OSHA). The employees also alleged that they had not received all benefits due them as part of the termination. The sponsor was able to prove that the termination was due to poor job performance and they were also able to show that the OSHA claim was groundless. However, even though the employees had received full severance packages, it was determined that there had been a wrongful denial of retirement benefits. This case took one year to reach a conclusion and defense costs totaled $40,000.

    3. The decision to merge, terminate or sell a plan can result in claims. A claim can occur in several ways. When one plan is merged into another plan, it is necessary that the participants in both plans receive equitable treatment. Both groups of participants must receive fair benefits and neither group can be penalized because of the merger. This is also true of a sold plan, where the benefits provided cannot be reduced because of the sale. With a plan termination there are other concerns such as whether the termination was voluntary or involuntary. A voluntary termination, is self-explanatory, the sponsor, for business reasons, decides to terminate the plan. This usually occurs when a defined benefit plan is terminated and replaced by a defined contribution plan, such as a 401(k). The claims exposure in this type of termination is that the “payout” the participants receive from the terminated plan can be much lower than if the plan had not been terminated. Many lawsuits have arisen from this type of termination. As previously discussed, we have seen what the cause and effect of an involuntary termination can be.

    4. IRS Closing Agreement Program (CAP): The IRS can audit all plans, looking for infractions that would cause a plan to be in violation of IRS regulations. When the IRS discovers a defect in the plans' technical compliance with the Code's qualification requirements, the auditor will insist that the defects be corrected retroactively. The trustees/fiduciaries or plan sponsor, as reasonable fiduciaries, will be asked to make a non-deductible payment to the IRS - the CAP penalty. This amount is based on the total amount of taxes the plan would have paid for the year(s) in question, when technically the plan had lost its tax-exempt status. Depending on the size of the plan, that amount could be substantial and the corporation or the trustee/fiduciary (not the plan) must pay it. Because this is a “penalty” it is a non-deductible expense for the corporation.

    5. Managed care: Plan sponsors have a vicarious liability arising from their selection of a managed care provider. The sponsor, risk manager and insurance buyer face a multitude of potential exposures in dealing with managed care issues. Claims in this area can range from bodily injury, sickness and disease to emotional distress, mental anguish or even death.

    For years, employers were protected from these types of claims by various provisions of ERISA. Recently, however, federal courts have limited the protection for certain claims, including those that involve the selection and performance of managed care service providers.

    Other types of claims could be:

    6. Failure to monitor the performance of the 401(k) provider.

    7. Failure to offer an adequate amount of investment options in the 401(k).

    8. Denial or change of benefits.

    9. Administrative error or omission.

    10. Improper advice or counsel.

    Since 1975 there have been frequent changes in ERISA, indeed it seemed that Congress had made the law so complicated that it appeared to actively discourage companies from creating pension plans, particularly defined benefit pension plans. Defined benefit plans reached their peak in 1985 when they covered approximately 30 million participants. They have been in decline ever since. Constant tinkering with ERISA over the years has made defined benefit plans so expensive that a significant number have been terminated and very few have been created. Employee benefit plans in general and defined benefit plans in particular have been a target for those in Congress who wished to increase federal revenue without raising taxes. Congress has defined the pension incentive provisions of the tax code as “tax expenditures” and this philosophy has led to a significant reduction in incentives. Changes in the code have forced defined benefit plans to ignore anticipated future benefit increases and funding is now allocated on the basis of current liabilities. These and other factors, such as the large increase in PBGC premiums, have made defined benefit plans more and more unattractive from a corporate point of view.

    Most pension plans being created today are defined contribution and most of those are 401(k) plans. Studies have suggested that many employees invest very conservatively, with far too little in equities which have traditionally shown the highest return. An additional problem is that government regulations have restricted the amounts which employees can invest to 15% of gross salary or $10,500 per year, whichever is greater.

    Questions are now being raised about the adequacy of the private retirement system. With an aging population the trend should be toward greater benefits and better funding. Short term expediency, however, has led to restrictions in both funding and benefits. The number of Americans aged 65 or older has increased from 8.1% of the population in 1950 to 12.5% in 1990 and is projected to reach 16.4% in 2020.

    Though the median income of those 65 and over has doubled in constant dollars since 1962, it still amounts to only $16,000 per year. Two out of five get 80% of their income from Social Security. With the change from defined benefit to defined contribution plans during the past several years, retirees will outlive the monies in their retirement fund. They will eventually be totally dependent on Social Security unless there is a significant rethinking of pension policy.

    With the increased attention being paid to the problems in the Social Security system, Congress has finally begun to understand that the private pension system must be strengthened. Reform efforts have been unsuccessful up to now but legislation proposed this year may have a better chance of passage. Congress may finally have realized that a robust private pension system is necessary to avoid an even heavier dependence on Social Security.

  • Audrey S. Coughlan is vice president and Mary Longmuir is assistant vice president of Professional Indemnity Agency, Inc. (PIA). Based at Mount Kisco, NY, PIA is a managing general underwriter dedicated to serving the interests of its producers and their clients with specialty insurance products. The financial services division writes fiduciary liability, middle market D&O liability and non-profit organization liability.