Fiduciary Liability Insurance Coverage Considerations in Tobacco Surcharge Litigation

Plaintiffs typically seek restitution of surcharges, equitable relief, plan reformation, disgorgement, interest and attorneys’ fees. Because these remedies are framed as arising from alleged fiduciary breaches rather than mere plan benefit disputes, insurers and policyholders may face threshold disputes over whether such amounts constitute covered “Loss” or uninsurable restitution.

Accordingly, tobacco surcharge litigation is not merely a benefits compliance issue; it can create insurance coverage issues. Employers and plan fiduciaries should evaluate whether their fiduciary liability policies respond to these claims, carefully review primary and excess policy language (including definitions of “Loss,” benefits-due exclusions, restitution limitations and allocation provisions) with qualified counsel, and provide prompt notice of claims and potential claims to preserve coverage rights.

Wellness Programs
For more than a decade, employers have implemented wellness programs designed to promote health or prevent disease. Tobacco cessation programs are one significant component of these wellness programs and typically involve rewards through utilizing a “carrot or stick” approach in the form of discounts, rebates or surcharges—in some cases as high as an additional 50% of the cost of employee-only coverage for employees who utilize tobacco (or similar products) given the higher health care costs associated with tobacco use.

HIPAA’s nondiscrimination provisions, as incorporated into ERISA, prohibit premium discrimination based on health factors except in connection with compliant wellness programs. Under the governing regulations, health-contingent wellness programs—including tobacco-use surcharge programs—must comply with these HIPAA and ERISA requirements. To comply with ERISA and HIPAA, the tobacco-cessation wellness program is required to:

• be reasonably designed to promote health and prevent disease, with a reward amount that meets the regulatory requirements;
• provide a uniformly available reasonable alternative standard or waive the requirement to any individual for whom, during that period, it is unreasonably difficult due to a medical condition to satisfy that otherwise applicable standard—for example with regard to tobacco cessation, employees could be allowed participate in a tobacco cessation program or obtain a doctor’s note that they are under medical care, but employees cannot be required to cease tobacco use;
• provide that the reward is made available to similarly situated individuals;
• offer the opportunity to qualify for the reward at least once per year; and
• provide disclosures in all plan materials that describe the program requirements, including the reasonable alternative standard, confidentiality and deadlines for complying. These disclosures should be consistent with the plan document and the summary plan description.

Regulatory Framework and Litigation Theories
ERISA imposes duties of prudence and loyalty on plan fiduciaries. It authorizes participants to bring civil actions for fiduciary breaches and equitable relief. Recent complaints allege that employers and plan fiduciaries imposed monthly surcharges without providing a compliant reasonable alternative standard or adequate notice, and therefore breached their fiduciary duties when providing for a tobacco surcharge under their wellness program. Plaintiffs commonly seek restitution of paid surcharges, equitable relief, plan reformation, disgorgement, interest and attorneys’ fees to address these allegedly noncompliant wellness programs.

Coverage Under ERISA Fiduciary Liability Policies
ERISA Fiduciary liability policies typically provide coverage pursuant to an insuring agreement, usually stating:

The Insurer shall pay on behalf of the Insureds all Loss arising from any Claim first made during the Policy Period for a Wrongful Act in the performance of Insured Plan Fiduciary Duties.

“Wrongful Act” is commonly defined to include “any actual or alleged breach of fiduciary duty, neglect, error, misstatement, misleading statement, omission, or other act by an Insured in the discharge of duties with respect to an Employee Benefit Plan.”

Allegations that fiduciaries imprudently implemented or administered a noncompliant tobacco surcharge program generally fall within this coverage grant at least for purposes of defense costs. However, several policy provisions may materially affect indemnity exposure.

Definition of Loss and Restitution Issues
Policies typically define “Loss” to include damages, judgments, settlements and Defense Costs, while excluding taxes, fines, penalties and matters deemed uninsurable under applicable law. They often also exclude “the return of fees, commissions, or remuneration to which the Insured was not legally entitled.”

Insurers may contend that reimbursement of tobacco surcharges constitutes uninsurable restitution or disgorgement. Policyholders may respond that the relief sought represents compensatory damages arising from alleged fiduciary breach rather than the return of ill-gotten gains. The characterization of the relief sought in these actions may significantly influence coverage outcomes.

Benefits-Due Exclusions
Many fiduciary liability policies contain a benefits-due exclusion, typically providing:

The Insurer shall not be liable for Loss on account of any Claim for benefits due or to become due under the terms of an Employee Benefit Plan, except to the extent such Claim alleges a breach of fiduciary duty independent of a claim for plan benefits.

Because tobacco surcharge plaintiffs frequently frame their claims as statutory discrimination or fiduciary breach claims rather than demands for plan benefits, application of this exclusion may turn on how a court characterizes the surcharge under the plan’s governing documents and applicable regulations.

Insured vs. Insured Exclusion and Allocation
Standard insured-versus-insured exclusions often preserve coverage for participant suits, providing that the exclusion does not apply to claims brought by plan participants acting independently. Given that tobacco surcharge cases are participant-driven class actions, this carve-back typically preserves coverage, subject to policy wording.

Allocation provisions may become relevant where complaints assert parallel statutory theories alongside ERISA fiduciary claims. Policies commonly require the parties to use their best efforts to agree upon a fair and proper allocation between covered and uncovered Loss. Early attention to allocation strategy may reduce later disputes.

Conclusions
Tobacco surcharge litigation is evolving into a meaningful fiduciary liability insurance exposure—not simply a wellness program design and administration issue. Because plaintiffs are strategically pleading these cases to trigger fiduciary breach theories, coverage under primary and excess fiduciary liability programs may become a central battleground alongside the merits of the underlying litigation.

Employers and plan fiduciaries should take a coordinated approach that integrates regulatory compliance with insurance strategy. This includes reassessing wellness program design and administration, carefully analyzing fiduciary liability policy language—particularly “Loss” definitions, restitution limitations, benefits-due exclusions, insured-versus-insured carve-backs, and allocation provisions—and providing timely notice of claims and circumstances.

Proactive attention to insurance structure and coverage positioning at the earliest stage can materially affect both defense cost funding and ultimate indemnity outcomes as this litigation trend continues to develop.