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- Getting the Most Out of Your Public Pension Plan Insurance Coverage
All public pension plans need a well-crafted fiduciary liability insurance policy. This should include ample coverage, including protection against the risk of impending litigation. The recent ruling by the U.S. Court of Appeals for the Ninth Circuit in favor of the San Joaquin County Employees’ Retirement Association (“SJCERA”) in its case against Travelers Casualty and Surety Company of America (“Travelers”) highlights the importance of understanding what to include in your insurance policy. The court found that Travelers had been in breach of contract and granted declaratory relief arising out of Travelers' denial of coverage under the duty-to-defend clause in SJCERA’s fiduciary liability insurance policy. In this episode of Public Pensions & Investments Briefings, Ashley Dunning and Jim Vorhis review this significant decision and explore what lessons may be drawn from that litigation as public retirement systems consider how to get the most out of their fiduciary liability and other insurance policies going forward.
Transcript: Getting the Most Out of Your Public Pension Plan Insurance Coverage
0:00:00.0 Ashely Dunning (AD): Fiduciary liability and other insurance policies have become a norm for many public retirement systems throughout the United States. By understanding the key issues in the recent San Joaquin County employees retirement association versus Travelers case, trustees, executive staff, investment officers and in-house counsel of public pension systems will better understand what to include in their policies and what level of protection they can expect from them.
0:00:40.9 Speaker 2: Welcome to Public Pensions and Investments Briefings. Nossaman's podcast exploring the legal issues impacting public pension systems and their boards.
0:01:02.6 AD: My name is Ashley Dunning, I'm a partner at Nossaman and co-chair of the Public Pensions and Investments Group. Our practice is devoted to representing public pension plans across the country in a wide variety of matters, these include plan administration, benefits, actuarial matters, fiduciary duties, investments and litigation, and of course, insurance coverage, which is the topic of our podcast today. My guest today is Jim Vorhis, also a partner at Nossaman. Jim co-chairs our Insurance Recovery and Counseling group. He counsels numerous public pension boards in obtaining insurance and represents those boards in the claims process with respect to insurers and in litigation. Welcome, Jim.
0:01:48.7 Jim Vorhis: Thank you, Ashley. I really appreciate the opportunity of speaking with you today.
0:01:53.0 AD: Today, we are going to start our discussion by focusing on a piece of litigation, the SJCERA versus Travelers case that you handled for SJCERA, and could we start out please by you identifying the provisions of the policy that Travelers relied upon when denying SJCERA coverage initially?
0:02:17.2 JV: Absolutely. Ashley, let me give you just a little bit of context about the lawsuit itself, and then I'll get to the coverage provisions. And so, this lawsuit, which was between SJCERA and Travelers related to a coverage disagreement after SJCERA had been sued by a group of retired members in 2017. Travelers relied upon one exclusion, which was a prior and pending litigation exclusion, and it said that the 2017 litigation was barred because it arose out of litigation that post-dated the Ventura ruling in 1997. So basically, Travelers was taking a piece of litigation in 2017 and said, Well, you know, back in 1998, there was a piece of litigation that arose out of this Ventura decision, which everyone in the public pension world knows, and because it wouldn't have existed, but for that litigation, it should be barred by this prior and pending litigation exclusion.
0:03:16.4 JV: And the second exclusion was an inadequate funding exclusion, and that was an exclusion that was put in the policy to preclude coverage for claims when the entire retirement system was underfunded. And I think the idea behind that from Travelers or any other fiduciary insurer is, they don't want to ensure losses when a public pension system is going through a funding crisis, because those types of claims are significant, lengthy, expensive, and will burn through just about any policy limit that you have.
0:03:44.4 AD: Are those two exclusions that you've just described common in fiduciary insurance that's proposed to public retirement systems?
0:03:53.1 JV: They are common. One you'll find in every policy, one is in most policies, so let me take each one in turn. The prior pending litigation exclusion is, as I noted, it is an exclusion that insurance companies will put in policies to preclude coverage for existing risk, and it makes sense. So, if there had been a lawsuit filed five years ago about a specific topic, and then an insurance policy is issued in that same topic, ends up being the subject of a lawsuit, the insurance company basically doesn't want to pay for that risk again, and the idea is, the insurance company doesn't want to pay for a burning building basically, once it's already happened. Prior and pending litigation exclusions are common, they're in just about every type of policy, fiduciary policy or otherwise.
0:04:41.2 JV: The Second exclusion, which is this inadequate funding exclusion, while it's common in the fiduciary context, because obviously the funding level of a public pension system is really important, you won't actually find that in every policy, so I think it's also not worded the same in every policy, and so, I think it will be very important for any public pension system that is obtaining a fiduciary insurance policy to look and see if there's this type of exclusion, because not every policy will have it.
0:05:08.3 AD: It's interesting, you mentioned on the prior and pending litigation exclusion, reminds me of a circumstance that we looked at years and years ago, where a proposed exclusion was to any litigation that arose out of the Ventura litigation, which was really quite broad and really swallowed the benefit or potentially would have swallowed the benefit of that policy, because so many disputes arise out of the definition of compensation article and how it's applied in various different circumstances, which arguably all relates back to the Ventura decision of the California Supreme Court, so that type of exclusion seems to me at least not something that we would ever want to include in a policy for a public retirement system in California, at least.
0:06:02.2 JV: Yeah, exactly, and that was part of the problem that we had in this case with Travelers. When Travelers was trying to look back to this post-Ventura litigation, SJCERA was not the only civil system that was involved in litigation after Ventura. But SJCERA was sued as part of a class action and ultimately reached a settlement agreement that put into play the operations for the payment of retirement benefits for all retired members, current members, future members at that time. It basically covered every member of the system, so the idea that Travelers might look back to that litigation as the prior litigation that would bar future coverage, it was kind of absurd, because it's just like you're saying, it would swallow the coverage. And so, I think that's one thing that we're talking about sort of general advice for anyone listening to this podcast is, read the policy.
0:06:57.7 JV: I recall, you and I were looking at a recent renewal where there was an exclusion put into play about litigation related to the Alameda decision that just came out. And while there might be ways to put language in place that could have some type of exclusion in that scenario, you have to be really careful about what it is that you're agreeing to. I think that there are types of policies out there where the renewal process is pretty straightforward, and a lot of times you just take what your broker says and you sometimes don't need to read the policy, you should always read the policy, but there are definitely, there are types of forms out there that are so standard that it's probably less important. Fiduciary policies are not that type of policy, you really need to dig in, look at the endorsements and see what they say, because you can end up in some certain scenarios where they're trying to add an exclusion that precludes coverage for all benefits-related litigation.
0:07:47.0 AD: So say you had a prior impending litigation exclusion, do you have to be as concerned if you've had the same carrier all along, or does it only matter if you've changed carriers, so the original carrier... The new carrier is claiming they shouldn't be on the hook for something that arose under the prior carrier?
0:08:05.0 JV: That is an excellent question, and we saw a specific situation come up in this Travelers litigation I'll talk about in a second. Generally speaking, I would say you can be less concerned about that type of situation where you have a carrier on the risk for a long time. So let's pretend Travelers had been insuring SJCERA back to 1995. It was insuring SJCERA during the course of when Ventura was decided, it was there when the litigation was filed against SJCERA. After the Ventura decision, it stayed on the risk, because it was the carrier at that time, it should be well aware of all of the developments that were going on with its client and what were relevant to it. If you have a new carrier though that's changing over, I think it becomes really important because then you have to start thinking about what was disclosed in an application or how might a new carrier look at a situation when it wasn't evaluating the risk before it ever came on and issued policies to your client?
0:09:05.9 JV: The situation that I'm thinking about in Travelers is this, when we were looking at the discovery in this case, we found that Travelers for about the first five years had insured SJCERA from 2005, maybe seven years to 2012-2013 included a specific endorsement that said it wouldn't cover losses related to funding problems with a specific type of benefit that was included in that settlement agreement but it didn't include a similar exclusion for the type of benefit that was an issue in the 2017 litigation. I think that's important, because what it showed to me was Travelers understood, it could look at how SJCERA operated, it understood the benefits it paid, it saw one particular type of benefit and said, Well, this might be a problem when it comes to the funding of that benefit if it doesn't get paid to the recipients, so we're just going to exclude that entirely, but we're not going to do it for this type of benefit, that tells me the Travelers affirmatively decided it wasn't going to exclude that type of loss.
0:10:09.9 JV: So, getting back to your original question, Ashley, if you are with the same carrier for a long time, I think the one thing you get is this kind of... It's not institutional knowledge, but it's this course of dealing. I think it's fair to say that a carrier that's been working with you for a long time is going to be aware of what you've gone through, what types of litigation and claims have arisen and you're more likely to end up with a favorable scenario. It turns out in this case though, that didn't help SJCERA. Travelers still denied coverage when the second claim came up.
0:10:37.5 AD: So just turning back to that litigation, Jim, what did the Ninth Circuit ultimately conclude as to each of those exclusions?
0:10:45.6 JV: The Ninth Circuit ultimately ruled in favor of SJCERA, which we would both agree was the right result. It pretty quickly dismissed the inadequate funding exclusion argument that Travelers raised. So what Travelers was trying to argue was because a benefit wasn't paid, this benefit was a non-vested supplemental benefit, it wasn't paid to a particular group of retirees, that constituted inadequate funding. The Ninth Circuit looked at the definition of what had to be inadequately funded in the policy, and it was the entire retirement system. And in fact the plaintiffs in this 2017 litigation allege that SJCERA as a whole was funded adequately enough to be able to pay these benefits, that's what they were trying to have happen through that litigation. And so, Travelers was kind of taking the opposite approach of saying this was inadequate, this was a lawsuit arising from inadequately funded system, it was the exact opposite argument that the plaintiffs raised.
0:11:45.7 JV: The second thing that the Ninth Circuit noted was when it came to the prior impending litigation exclusion, it identified that Travelers was really relying on the wrong language and the exclusion, and so the exclusion precluded coverage for loss that was based upon or arose out of facts, underlying or alleged in prior litigation. What does that mean? That means you have a second piece of litigation, it will be barred if it is the same as the facts that were underlying the first piece of litigation, not something that happened after that litigation happened. So in our case. Everything that travelers was pointed to were these benefits from the 2001 settlement agreement of the 1998 litigation. I know it's a mouthful, but basically, the Ninth Circuit said, Look, this is what the 2017 litigation is about. Let's go back and look at what the 1998 litigation was about after Ventura, it was about, how do you pay retirement benefits, was it applied retroactively?
0:12:45.5 JV: And what travelers was focused on were events that happened after the litigation, and the Ninth Circuit said, You can't do that, there's the underlying or alleged in that necessarily means what you have to look at in the context of this exclusion is what happened before the first lawsuit was filed. And so they were able to dismiss Travelers arguments in that regard and reversed it and obviously decided that there was a duty to defend, which was fantastic.
0:13:10.3 AD: It was a great result. Congratulations. Have there been other provisions of the Travelers policy that have become pertinent in this litigation or in its aftermath that would be useful for other public pension systems to know about as they think about their own policies?
0:13:30.5 JV: Yes, absolutely, and this is probably a broader discussion beyond just this Travelers litigation, although it's come into play there, what is most important to take out of this and what is sort of a universal... It's a universal take-away for people is the importance of retention and the importance of negotiating attorney rates before you execute the policy, and here's the reason why, retention or a deductible is the amount that you have to pay before the insurance will kick in, so you may have a retention of $25,000 or you may have a retention of $50,000 or $100,000, that's how much you will have to pay out of pocket before the insurance company will pay anything. So the lower the retention figure, obviously the better for the client when it comes to the reimbursement of attorney's fees. However, part of the things that then determines how quickly you get through that retention is what is the reimbursement rate from the insurance company. So one of the things that you and I have been very successful at when negotiating with insurance companies is pre-approval for particular insurance rates or firms.
0:14:37.5 JV: So pre-approval endorsements to say, You can use this attorney and here are the rates that we are going to reimburse the partners, associates, paralegals, whatever categorization of attorney that you want to put there. Now, the importance of that, of course, is the higher those reimbursement rates are, the quicker you get through the retention, the quicker the insurance will kick in. If you don't have that type of situation where you have a pre-approval for particular attorney rates, what's going to happen inevitably is that an insurance company is going to say, You know what, this is not a complicated case. We're going to kick this to a panel counsel, and that panel counsel who we work with all the time, charges us partner rates of $230 an hour and associates at $180 an hour, or $150 an hour, it's going to be something out of 1985, and that's really not appropriate in this context, there are certainly types of law and cases out there where that is fine, if you have a personal injury case, there are thousands of attorneys that do personal injury cases, but this is a real niche space, there are only a few people that do it and do it well.
0:15:45.0 JV: And so I think this is one of those places where you have the leverage to be able to work with your fiduciary carrier to say, Look, you want to work with this attorney, here's what their rates are, and you're going to find I think on balance that fiduciary carriers are willing to do that. So long story short, I think a take away is try to negotiate those rates, you want to get through the retention as quick as possible if you end up winning the claim.
0:16:09.9 AD: Yeah, what I was hearing you say is, well, you may not necessarily know exactly who you want to retain on a given matter, you want to be able to retain the right to choose the appropriate counsel, so if you retain that right, then the most important thing is the reimbursement rate, so if it's at $500 or $550 or $600 an hour, even if the counsel's rates are something slightly different from that, you're going to get that minimum amount for an hour of that partner's time. Is that fair, Jim?
0:16:41.5 JV: That is exactly right. If you have a $50,000 retention, you would rather have your attorneys reimburse the $500 an hour, than $250 an hour, so a lot of times when you're in that situation, you can negotiate with your carrier to use the attorney you want, but they're only going to do it if you're at the panel rates, which may be half of what your attorney charges, and this is something that you can, with a little bit of planning, get out in front of and solve a problem before it ever exists.
0:17:11.3 AD: So on that point, what should Retirement Systems consider when they assess a proposed retention amount or reimbursement rate, or even the policy limits within their fiduciary insurance policy?
0:17:26.5 JV: It's a good question. I think the important thing to say on this point, is it's a very individualized decision, I work with a lot of clients and they view insurance very differently, there are some people that look at it like, this is catastrophic insurance, we want to be covered if the worst case scenario happens, so we're going to get a fiduciary insurance policy and we're going to have $20 million in limits, and we don't care if the retention is high, which will bring the premium down, but the idea is basically, look, if the big one comes in, we want a lot of coverage, that is a reasonable way to handle your risk analysis, and if the big one ever comes, you feel you have a lot more comfort about, Hey, look, we're covered. There are other clients though that would prefer to buy that retention down and pay a bit more in premium, so that these sort of more common claims end up getting into the reimbursement of the defense fees, so if you have a retention figure of $250,000, it's going to take a pretty big case to get up to that point.
0:18:25.4 JV: Some of that would get handled on a demurrer, it would never even get close to $250,000. If you have a $25,000 retention, it may be more expensive on the premium, but the reality is you're going to have more situations where the carrier is actually paying you back for your attorney's fees. So there are a lot of different ways to look at this, but those are the types of things that the public pension system should be looking at, what do you really want? Is it here for protecting from the catastrophic loss or is this, I want it to actually come into play more frequently when the claims are filed? Either way is fine to go, it's just that's the type of thought process you should be going through with this.
0:19:05.1 AD: So just thinking about the context where you have a $20 million policy limit, these policies aren't paying for things like investment losses or benefits that haven't been paid, and they're not going to actually pay the benefit or pay the loss of investment earnings. Correct?
0:19:26.7 JV: Correct. And I think that is one really critical thing to look at, there are a number of policies, and the fiduciary policies are similar to directors and officers policies or employment practices liability policies, they pay defense fees. Maybe you'll have a carrier that will contribute to a settlement just to get something done, but there's no obligation to indemnify for benefits, so I've had this question come up a lot. Okay, our pension system grew, now we went from $5 billion to $7 billion, does that mean that we should increase the limits? And my response is always, is the litigation going to be more expensive? 'Cause that's ultimately what matters. I'm not sure that the litigation is going to... If you have some big piece of litigation, it's going to change your attorney’s fees one bit, but that's what you need to be looking at. Because you're not paying benefits, what you need to think about is the risk and the exposure when it comes to attorney’s fees.
0:20:19.7 AD: Yeah, and possibly also the number of lawsuits you expect to receive because the policy limit, would that be a policy limit per piece of litigation or per the life to the policy or for the year? How do they work typically?
0:20:36.0 JV: They're usually annual policies, and they'll have an aggregate. So if it's a $10 million policy, we'll pay out $10 million. I'm accustomed to seeing an individual per claim and aggregate limit the same, basically meaning you got a $10 million policy, if you have a claim comes in, you pay $10 million and attorney’s fees will cover it all. Not all policies are structured that way, some of them will have differences, so that you might have $5 million per claim but a $10 million aggregate. In this case, it's all kind of lumped in. I think one thing though that is interesting about these policies, I know we've talked about this a lot over the past couple of months actually, is they also have a lot of other sort of bells and whistles that come with it, there are a lot of sub-limits in coverage. And so one of the things we've seen is Voluntary Compliance Program Coverage. Another thing you're talking about, benefits are not covered, but there's always, with some of these carriers, a small benefit overpayment coverage.
0:21:31.5 JV: It's only maybe $100,000, but if you can't recover this benefit overpayment, at least you can recover something back, and so I think it's really important as you're looking at your policy to ask the question, "Well, what else can I get here?" Because a lot of people don't actually go through that process, they get their proposal from the broker and they just take it for, "Well, that's all that's there." And sometimes there's more there, just ask the question, the worst they can say is no, that's it.
0:21:57.1 AD: Yeah, that's a great observation because I wonder when a plan has a benefit overpayment situation that doesn't necessarily lead to litigation, how many would think that the policy that the system has might actually cover that situation, that's a really, really interesting observation. So what other factors in a fiduciary insurance policy should a public retirement system focus on, in addition to the ones you've talked about?
0:22:27.5 JV: So I think two things, one I touched on a little bit, I called it the bells and whistles, but a lot of these policies structurally will have some things other than your traditional fiduciary coverage, and so I think it's important, look for the scope. What is the scope of the coverage? What are the scope of the exclusions. On the coverage side, because you have these different sub-limits and you've got coverage for voluntary compliance program situations, maybe you have a benefit overpayment coverage, you also have situations we've seen where they're packaging a little bit of cyber coverage here or there, there might be a package policy with an employment practices liability coverage. I think that understanding what is there from a coverage perspective is really important, and understanding that insurers have been willing to go outside of the norm to try to add on a little bit and incentivize using their policies.
0:23:17.8 JV: I think the second thing I would say is, look at the endorsements. The public pension systems should be looking at what is and is not covered, and you and I have seen some situations pop up in the last couple of years, you brought up that Ventura exclusion, we saw an exclusion on Alameda, we recently saw a carrier that tried to parse out, so there was different coverage parameters, whether there was a class action or a smaller benefit-related piece of litigation. Those are unique, I mean carriers... Because these are not common policies, fiduciary policies are very specific, you see some unusual things that will pop up, and it really is important for you to read the endorsements.
0:23:58.8 AD: Yeah, one of the things that I thought about in connection with the class action language that you noted, Jim, is the more of those provisions that are included in the policy, such as you get one thing if it's a class action and a different thing if it's not, and then there's a question, okay, when does it become a class action, is it when the pleading's filed that says it's filed on behalf of an individual and everyone else who is similarly situated, or is it when the class is certified or some other point? That's just creating a fight within a fight.
0:24:37.1 AD: Why would one do that, when you could simplify your policy and just agree at the outset, okay, here's the policy that applies, regardless of what type of litigation is filed? Yeah, another thing you mentioned, the nuances of the language used in the policy, and it reminds me of another situation we dealt with, which was a system that was contemplating whether to go to the IRS on a voluntary compliance program or to seek a closing agreement, based on the tax issue involved. And one question was, well, does the policy, the insurance coverage policy distinguish between the two? Fortunately, the language was broad enough, so that it really didn't matter, the system could choose to go whatever approach was the most appropriate, but having to parse through that sort of coverage analysis, I thought was interesting, and sort of a cautionary note not to have your language to be too specific.
0:25:39.1 JV: Yeah, it's a good reason to look at. I know we've had a number of situations where that comes up, and it reminded me of we saw that other policy that had DCP coverage, but it didn't cover situations with the state, it was only the IRS, and that doesn't make any sense, why you would have some coverage in place for an IRS filing but not for a state. So it is important to really review that language closely.
0:26:03.2 AD: So turning now, in the last four minutes or so we have of our podcast, to some other types of insurance that public retirement systems may be purchasing, what types of policies have you seen that provide the greatest value to public retirement systems?
0:26:20.3 JV: Well, I have reviewed all sorts of policies for public pension systems. I've looked at entire policy portfolios, you have to have CGL coverage, commercial general liability coverage, and you have to have property for any property you own, and all that, and that's fine, but those are all like pretty standard coverage forms. I think the thing that I have done more advisory work on than anything other than the fiduciary coverage is cyber. All you have to do is go on any news network, and you're going to hear about ransomware this, and hackers that, and it's true.
0:26:55.3 JV: Five years ago, the world was in a very different place, 10 years ago it was in a very different place, but when we were looking at this landscape five years ago, the cyber market was increasing, but it was still fairly small, the policy forms were very like unique, everyone had different types of coverage in different language, and that's all kind of started to normalize a little bit. I think the most important thing is when you're looking at cyber coverage is to look at what is actually there. There are some types of coverage that are probably going to be in any cyber form you're going to find. You're going to have coverage for lawsuits from data breaches, you're going to have all of your expenses covered, likely if there's a disaster scenario, you're probably going to have breach notification or public relations coverage. Those things are pretty standard.
0:27:38.4 JV: The types of things that are not standard would be business interruption coverage, and most specifically from a law we'll be seeing recently, ransomware. And that's really important to know is if you're purchasing a cyber policy, if you're expecting coverage, when you have a ransomware situation, whether it's for the ransom itself, whether it's for the tech needs that happen to try to rectify the problem, you have to know that doesn't come with every policy. And the one other thing that I did want to bring up here is one of the most common types of cyber crime these days is social engineering fraud, where people are basically duping other folks and organizations. So it'd be someone that was trying to pretend that they were, for example, our managing partner. And what happens is they spoof his email address, they send it to someone in accounting, and they say, "Hey, you need to wire $1 million to this account 'cause this client is really mad." And etcetera, etcetera.
0:28:28.5 JV: It's really easy to combat that type of situation if you just have the right internal controls, but it happens, and it happens a fair amount. And one of the things that's developed through case law over... And language changes in these two types of policies, the cyber policy and the crime policy is that coverage for that type of loss can fall in one or the other of the policies, but it's not always standard about how the language is worded because in those types of situations, you have a voluntary transaction from someone in the Accounting Department. It wasn't like they were coerced, it wasn't that they were hacked, I mean, they just looked at something, and they thought it was real, and they sent it. So one of the things I have been telling more and more people, you just need to be really clear, where does that type of problem fall, does it fall on your cyber policy, does it fall on your crime policy? Both carriers will offer it in some form, but you just need to make sure it's there. You don't want to have that gap.
0:29:24.4 AD: It sounds like a great topic for yet another podcast or maybe a presentation on some other forum, Jim, 'cause cyber security certainly is a hot topic of the moment. Thank you again, Jim, for being with me today to talk about this important issue of fiduciary insurance policies for public retirement systems. I very much appreciate your time.
0:29:47.4 JV: Thank you, Ashley.
0:29:48.9 AD: Thank you to our listeners for joining us for this episode of Public Pensions & Investments Briefings. For additional information on this topic, or other public pension issues, please visit our website at nossaman.com, and don't forget to subscribe to Public Pensions & Investments Briefings wherever you listen to podcasts, so you don't miss an episode. Until next time.
0:30:13.8 S2: Public Pensions & Investments Briefings is presented by Nossaman LLP, and cannot be copied, or rebroadcast without consent. Content reflects the personal views and opinions of the participants. The information provided in this podcast is for informational purposes only. It is not intended as legal advice and does not create an attorney-client relationship. Listeners should not act solely upon the information without seeking professional legal counsel.