Fidelity bond coverage is essential to protect your employee stock ownership plan (ESOP) from loss due to fraud or dishonesty. You’re required to report fidelity bond coverage on IRS Form 5500 each year, so it’s important to know the Employee Retirement Income Security Act of 1974 (ERISA) bonding requirements to make sure you comply. To do this, you must first understand what a fidelity bond is and how it helps protect you and your ESOP.
What Is a Fidelity Bond?
A fidelity bond is a type of insurance required under Section 412 of ERISA to protect the ESOP from losses resulting from fraud or dishonesty. According to 29 CFR 2580.412, fraud or dishonesty includes all “risks of loss that might arise through dishonest or fraudulent acts” in handling plan funds or other property. This can include a range of actions, such as theft, embezzlement and misappropriation.
ERISA requires every person who “handles funds or other property” to be covered under the fidelity bond. There are certain exceptions, but this typically includes the plan administrator and other officers and employees who have duties related to the receipt, safekeeping and disbursement of funds, i.e., those who have contact with cash/checks, have power to transfer funds, have authority to sign checks, etc. The ERISA bonding requirement isn’t covered by fiduciary liability insurance, which typically insures the ESOP against losses caused by violations of fiduciary responsibilities.
An ESOP’s fidelity bond coverage is based on the funds held by the plan at the beginning of each year. The ERISA requirement is 10 percent of these funds, with a minimum requirement of $1,000. No bond is required to exceed $500,000 (or $1 million for plans that hold employer securities such as an ESOP). Most bonds can be set up with an “inflation guard” provision, which automatically increases the coverage to the required amount under ERISA, up to the $1 million limit.
For example, assume an ESOP holds $3 million in funds as of December 31, 2018. The required fidelity bond coverage for 2019 would be at least $300,000. If that same ESOP held $30 million in funds as of December 31, 2018, the required coverage for 2019 would be $1 million.
The ESOP must be specifically named in the bond (or otherwise identified on the bond) to ensure proper coverage. In addition, the bond should have no “deductible” feature that applies to ERISA plan claims, as §412 requires that the bond insure the plan from the first dollar of loss. Bonds also must be placed with a surety or reinsurer that’s named on the Department of the Treasury’s Listing of Approved Sureties. Multiple plans may be insured on the same bond as long as the bond insures the required minimum coverage for each plan.
The ESOP plan sponsor and others who handle funds must ensure proper bond coverage is in place to guarantee ERISA compliance. Since the bond coverage is required to be reported on Form 5500 each year, it’s essential to understand your responsibility and make sure you’re fully protected. For more information, reach out to your BKD trusted advisor or use the Contact Us form below.