Most qualified retirement plans need a fidelity bond.  This has been the rule for more than 40 years. Even so, it is not the kind of thing the typical plan sponsor spends a lot of time focusing on. A what bond? Fidelity who? We run across a number of plans which either (i) don’t have the required bond or (ii) have a bond but the employer doesn’t realize it or know how they got it.

The fidelity bond rules can be found in the Employee Retirement Income Security Act of 1974, commonly known as ERISA.  Hence, fidelity bonds are sometimes called ERISA bonds.  The Department of Labor addressed many questions about fidelity bonds in Field Assistance Bulletin No. 2008-04. We will hit some of the highlights here. 

Who Must Be Bonded? 

We should go ahead and point out that the bonding requirements do not apply to certain employee benefit plans: 

1. Plans that are completely unfunded, meaning benefits are paid only from the general assets of a union or employer.
2. Plans not subject to Title I of ERISA. This generally means plans that do not cover any employees other than owners and their spouses. 

If either of these describes your plan, you are free to get up and leave.  Your plan does not need a fidelity bond. 

For those still reading, the purpose of a fidelity bond is to protect a plan against losses resulting from acts of fraud or dishonesty – theft, embezzlement, etc. – on the part of persons required to be bonded.  Who is required to be bonded?  Every fiduciary and every plan official who handles funds or other property of the plan, that’s who.  “Plan officials” will usually include the plan administrator and those officers and employees of the plan or plan sponsor who handle plan funds by virtue of their duties relating to the receipt, safekeeping, and disbursement of funds.  But that’s not all.  Plan officials may include other persons, such as service providers, whose duties and functions involve access to plan funds or decision-making authority that can give rise to a risk of loss through fraud or dishonesty. 

If that’s not enough info for you, the regulations go on to describe what “handling” funds means.  If you touch the money, you’re handling it – maybe.  If you touch the money but you’re supervised closely enough, you may not be considered to be “handling” the money.  There is an element of decision-making authority and power required.

Employees of banks, insurance companies, brokers, and dealers do not need to be bonded assuming their company meets certain criteria. 

A fidelity bond should not be confused with fiduciary liability insurance.  Fiduciary liability insurance generally insures the plan against losses caused by breaches of fiduciary responsibilities, not acts of fraud or dishonesty.  You may hear someone refer to a fidelity bond as a “fiduciary bond,” which could cause confusion. 

A fidelity bond does not need to name every single person covered under the bond.  There can be a blanket schedule encompassing the insured’s officers and employees without a specific list or schedule of those being covered.  A plan may be insured on its own bond or it can be added as part of an ERISA rider to an existing employer bond or insurance policy, such as a commercial crime policy. 

How Much Bond Is Needed? 

Typically, the bond needs to be at least 10% of the value of the plan assets.  Regardless of the asset value, the bond must be at least $1,000 and need not be greater than $500,000. 

If a company has multiple retirement plans, one bond can cover all the plans.  A company that has one plan with $600,000 in assets and another plan with $400,000 could have a single fidelity bond of $100,000 (10% of the combined plan assets of $1 million).  A company with two plans with $10 million and $12 million, respectively, would need a bond of $1 million – $500,000 for each plan.  Neither plan needs bond coverage exceeding $500,000 even though $500,000 is less than 10% of both $10 million and $12 million. 

A small plan (generally under 100 participants) may want a bond bigger than $500,000 if more than five percent of its assets are non-qualifying plan assets.  Qualifying plan assets include pretty much everything that most plans would invest in – employer securities, participant loans, mutual fund shares, insurance contracts, and assets held at banks, insurance companies, and broker-dealers, as well as assets in individual accounts for which the participant receives a statement from a regulated financial institution.  Anything else is a non-qualifying plan asset.  Examples include artwork, real estate, and stocks held in certificate form outside a financial institution.  It is rare for a plan to have any non-qualifying assets at all, much less enough to comprise more than five percent of the plan’s total. 

We said a small plan with more than five percent non-qualifying assets might want, not need, a bigger bond.  Such a plan has two choices.  It can obtain a bond with a value at least equal to the value of the non-qualifying assets, or it can be audited by an independent qualified public accountant each year.  The audit requirement normally applies only to “large” plans (more than 100 participants).  Given the choice between a bigger fidelity bond and an accountant’s audit, most small plan sponsors will choose to get the bigger bond.  They just need to remember to actually buy said bond and renew it properly.  Otherwise, they are subject to the audit.

As an example, if a small plan’s assets are $1.4 million and $600,000 of that is real estate, the bond would need to be at least $600,000 to avoid the accountant’s audit, even though $600,000 is greater than the usual maximum of $500,000.  We have found that bonds exceeding $500,000 are more expensive per unit of coverage than bonds $500,000 and less because of the additional underwriting needed for non-qualifying assets, which insurers view as higher-risk. 

We should mention here that while “non-qualifying plan assets” is a nasty-sounding term, it doesn’t mean these assets are not allowed or that the plan is in trouble for investing in them.  It simply means that the assets aren’t classified as “qualifying plan assets,” and holding them could subject a small plan either to the accountant’s audit or the increased bonding requirement. 

Effective in 2008, the maximum required bond is $1,000,000 for plans that hold employer securities. 

The bond amount needs to be set only once per year.  It does not need to be increased during the year if there is a run-up in asset value.  The bond amount for a year must be fixed as soon as possible after the information is available to do so. The amount of bond must be based on the highest amount of funds handled in the preceding plan year. 

A bond may be written for a period of longer than one year provided the bond amount remains high enough throughout the term of the policy.  If plan assets are currently $100,000 but there is an expectation that assets will rise to $500,000 within three years, the plan sponsor may wish to buy a three-year bond of $50,000 or $60,000.  While that amount of coverage is excessive when assets are at $100,000, it will be just barely enough when assets rise to $500,000.  It is acceptable to have an “inflation guard” provision to ensure the bond amount remains high enough.  At least one company sells a bond that constantly adjusts so that the bond always equals 10% of the asset value for a fixed number of years.  No steps are required on the plan sponsor’s part to increase the bond’s value.  It happens automatically. 

Failing to Obtain a Bond 

From time to time, we will hear small business owners say they do not intend to purchase a fidelity bond.  Their reasoning is that the vast majority of the assets are allocated to the owner’s account, so the owner himself would be the only one seriously hurt by any fraud or dishonesty.  In any event, the owner is the only person handling funds, so there wouldn’t be any fraud or dishonesty in the first place, right?  Therefore, they are going to roll the dice, go without a bond, and hope they don’t get caught.  (And if they do get caught, hope the penalties are nonexistent or not severe.) 

Here’s what we say to folks like this.  First, there is no exception in the bond rules for plans where the likelihood of fraud or dishonesty is small or whose assets are skewed overwhelmingly toward the owner.  Unless you meet one of the exceptions identified above, your plan needs a bond.  Second, the annual Form 5500 series has a question about whether the plan is covered by a bond and how much the bond is.  Because of this, it is naive to think that one can go without a bond and not have it come to the attention of the regulators.  It’s right there on the Form 5500 for anyone to go online and see.  Finally, you may not be aware of any penalties for not having a bond, or you may have heard you get nothing more than a slap on the wrist.  That doesn’t mean the DOL won’t up and decide one day to whack the non-compliers with something heavier.  Our advice is, just get the bond.  It doesn’t cost that much.  Moreover, while unlikely, you may find the coverage saves your bacon one day.  (Some instances a fidelity bond might have come in handy are here, here, and here.  And, of course, here.)

We will close with an anecdote that we find amusing.  Apparently, there have been cases in which plans that went without fidelity bonds have been ordered to buy retroactive bond coverage.  In one case, a plan that went 20 years without a bond had to go back and buy bond coverage retroactively for those 20 years.  That’s not really how insurance is supposed to work.  The concept of insurance is that you pay a small premium today to insure against a low-probability but potentially expensive risk in the future.  With retroactive coverage, you already know whether or not fraud or dishonesty occurred in the prior years to be covered.  So retroactive coverage doesn’t make a whole lot of sense.  However, a plan sponsor should gladly accept that punishment since this ERISA violation could theoretically have led to worse sanctions.  And bonding companies are probably more than happy to accept premiums for years in which the probability of a claim is zero.