Employee fraud has been a hot topic this year, for insurers seeking our insight and training. In this article, Paul Widger from Clyde & Co's Forensic Accounting Practice discusses the matters insurers need to be alert to, in order to restrict leakage.
Fidelity Guarantee insurance ("Fidelity") indemnifies employers for losses sustained as a result of employee fraud. A standard policy is triggered by "direct loss of money or goods as a result of any fraud or dishonest act by any employee" and therefore responds to a broad range of employee wrongdoing, from expense fraud to misstatement of accounts.
Prevention is better than cure...
Lax internal controls and lukewarm recovery policies create an environment where fraud can thrive. A zero tolerance culture and robust reporting and investigative procedures can go a long way towards dissuading would-be fraudsters. By exploring the insured's fraud prevention policy during the underwriting phase, insurers can identify and address vulnerabilities through risk improvement conditions and, where appropriate, endorsements, thereby reducing the number of frauds their insureds experience.
Managing Fidelity claims
Claims handlers may wish to consider the following:
- Claims Conditions. Many policies require notification "as soon as practicable" after the insured should reasonably have suspected fraud. Claims handlers should thoroughly investigate the underlying circumstances of a fraud with a view to identifying when a claim should have been notified, focussing on any "red flags" such as failures to complete account reconciliations, abnormal management information, internal controls being overridden, whistleblowing or concerns being raised by internal or external audit.
- Allocation. Most employee frauds persist for more than 12 months, so claims handlers should give careful consideration to whether they are dealing with one or with several frauds, and then which policy years they fall under. In this regard, it is worth bearing in mind that Courts have tended to group one employee's actions into a "single occurrence", even if over several years or by multiple methods.
- Many policies exclude losses quantified solely "by inventory computation or profit and loss computation", because these methods are simplistic and data is liable to be skewed by wastage or bookkeeping errors. Courts tend to restrict coverage to the loss that can be traced to the employee's actions, relying on sources such as confessions, eyewitnesses, CCTV, onward sales trails, records of unfulfilled deliveries, or evidence of tampering with records. A claims handler faced with incomplete evidence may, therefore, wish to offer a percentage of the insured's loss in settlement of its claim.
- Claims handlers should pay close attention to any claims for and/or quantified with reference to lost profit, checking that any alleged losses are adjusted to reflect the costs associated with realising that profit. E.g. Diverted sales should be restricted to gross profit value. Stolen stock should be restricted to cost price.
- Investigation. Frauds merit robust investigation. Policies will typically cover investigation costs external to the insured, such as forensic accountants. Insurers should advocate a proportionate investigation by a qualified professional as soon as possible after discovery.
- Collusion. Some policies exclude frauds performed by colluding individuals. In these cases, thorough investigation and systems testing should check for evidence of collusion.
- Recoveries. Depending on the form of fraud and the fraudster's resources, recoveries may take a variety of different forms from retrieval of stolen goods, to revoking an employee's pension; from taking a charge on an employee's house, to obtaining international freezing orders. Before embarking on a recovery action, claims handlers should ensure that the recovery assets can be appropriately secured such that the fraudster cannot dispose of them before judgment is obtained. This is a complex area, particularly if the recovery is running in parallel to criminal proceedings. Legal advice is essential.
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.