This article originally appeared in the March 23, 2012, issue of The Lawyers Weekly published by LexisNexis Canada Inc.
The economic downturn of the past few years has forced many businesses to face a harsh reality: Some of their employees are dishonest. This unfortunate fact has focused fresh attention on fidelity insurance as a way to effectively manage the risk of inhouse fraud.
Fidelity insurance provides coverage for losses resulting from fraud, theft or other crimes perpetrated by employees, whether they are acting alone or in collusion with others.
Since the economic downturn in 2008, many of us who practice in the area of fidelity insurance have noticed an increase in claims activity. Whether this means there is more fraud today than during more prosperous economic times is open for debate. There are two schools of thought here: In difficult times, employees are more likely to engage in dishonest conduct at the expense of their employer to make ends meet; the second is that during tougher economic times employers are more likely to scrutinize their books and employees more carefully, thereby uncovering dishonest conduct that may have been present for years.
Mark Abbott, for one, subscribes to the latter: people steal from their employer all the time, but their crimes are more likely to get exposed by questioning managers or co-workers who become more vigilant during tough economic times.
As assistant vice-president of fidelity claims for Chubb Insurance Co. of Canada, the largest writer of fidelity insurance in Canada according to the most recently published industry statistics, Abbott describes a phenomenon he terms the "top producer syndrome." It involves a seemingly highachieving individual in a relationship-managing capacity who begins taking advantage of some of the liberties of his or her role for additional improper personal financial gain. "Like Icarus, these star performers can rise up only to fly too close to the sun, melting their own wings and resulting in a dramatic fall," Abbott says. "In the process, they can cost their employers a great deal of money, not to mention embarrassment."
Numerous high profile Ponzi schemes and rogue traders cases have filled the financial news in the past few years that speak to the need for the protection offered by fidelity insurance. While cases such as Bernie Madoff 's have been much publicized, smaller frauds are being uncovered every day by small- and medium-sized employers.
Fidelity insurance is a complex area requiring careful scrutiny of the policy or bond at issue. These insurance products can be tailored to the insured's business and business practices. Certain specialty products on the market include a financial institution bond and comprehensive crime insurance, which includes coverage beyond merely employee theft and dishonesty, extending to burglary and losses as a result of counterfeit, forgery and computer crime.
Fidelity insurance, contrary to the views of some, is not "fraud insurance" or liability coverage. It is first-party insurance for "direct financial loss" sustained as result of an employee's "dishonest or fraudulent acts." That direct financial loss can't be for employee benefits such as wages, salaries, commissions and the like.
Coverage isn't triggered until several additional conditions in the insuring agreement are met. For example, the employer must be able to demonstrate a two-fold intention: that the rogue employee had both an intention to cause the direct financial loss, as well as to either personally profit or cause a profit to be realized by another party at the expense of the employer.
Attention also must be paid as to when the loss was discovered — it must be within the policy period or a specified period after the end of the period.
Typical exclusions in fidelity coverage include consequential loss (for example, it does not recover potential income that could have been earned if not for the wrongful or fraudulent act of the employee).
In addition, most policies exclude dishonesty by the insured organization itself, resting on the principle that one cannot insure against one's own dishonesty.
Unraveling the fraudulent schemes, from the simple to the very complex, can often be a painstaking exercise requiring a huge document review, forensic analysis and sophisticated valuation before there can be any attempt at recovery of the losses. Sometimes, these investigative costs are covered, but not always. However, fidelity insurers typically require the insured organization to take steps toward recovery of its losses from the wrongdoers as a condition of payment under a fidelity bond.
As corporations engage in belt-tightening and become more restrictive oversight of employee conduct, perhaps the recent increase in employee misconduct and fraud will be reduced. Alternatively, perhaps these rogue employees will simply get more sophisticated in planning and executing their fraudulent schemes.
Either way, mitigating the risk of employee fraud and dishonesty has become a necessary business expense for many employers who either seek to insure against such losses or take a chance at selfinsuring against what might be massive risks. One thing is certain, fidelity insurance is an important tool to manage and mitigate that risk as much as possible.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
