What Is Fidelity Insurance?
By Rehana Moosa
When an organization is defrauded by an employee, there are a few avenues that can be pursued to recover some or all of the stolen funds / property. One such avenue is to file a claim under a fidelity insurance policy.
What is fidelity insurance?
Fidelity insurance covers losses that occur when an employee (as defined under the policy) commits fraud or theft. Examples of the types of losses that can be covered under fidelity insurance include:
- Theft of cash or other property such as inventory and equipment
- Setting up a vendor that is owned by the employee (unbeknownst to the employer) and billing the employer for goods or services that were never provided
- Claiming reimbursements for expenses that were never incurred or are personal in nature
For losses to be covered under a fidelity policy:
- The losses must be caused by an employee (acting alone or in collusion with others)
- The losses must involve the unlawful taking of property
- The fraud or theft must deprive the insured of the property that was taken
How are losses calculated under fidelity insurance?
Fidelity insurance covers the value of the property that was stolen. For property such as cash, determining the value is quite simple. However, for other types of property such as inventory and equipment, fidelity policies define how the value of these items will be determined, which is typically based on the replacement cost or actual cash value.
Replacement cost is the cost to replace the item with one of the same kind and quality, without any deduction for depreciation. Actual cash value is the cost to replace the item with an item in similar condition, meaning that depreciation is taken into consideration.1
What is not covered by fidelity insurance?
Fidelity policies have various exclusions:
- Policies will not cover any losses caused by an owner of the business. In other words, an owner cannot steal from themselves. Fidelity policies include very specific definitions as to who is considered to be an “employee”. Certain types of workers such as contractors and agents may not be included, and as such, any losses caused by these individuals may not be covered.
- Policies will not cover losses caused by accounting errors. Losses must be caused by dishonest acts, meaning fraud or theft.
- Fidelity policies do not cover any losses of income, even if they can be attributed to the fraud. For example, if an employee steals cash from their employer, the organization may claim that they have lost interest income on the stolen cash. Fidelity policies only cover the value of the property that was stolen.
- If an insured pays its employees additional wages to prepare a fidelity insurance claim, the wages are typically not covered under the policy. Some policies will include professional fees coverage, which covers fees paid to forensic accountants or other experts who assist in preparing the claim.
Other Elements of Fidelity Insurance
Some organizations may discover that a fraud has been occurring for a period of time. However, due to the nature of the fraud, the company may be unable to identify the specific employee who was responsible. Fidelity policies do not require the insured to identify the individual(s) involved in the theft. The organization only needs to establish that an employee committed the dishonest act.
In cases involving the theft of inventory, some insureds will rely on what is known as an “inventory computation” to establish that a fraud has taken place. An inventory computation is a calculation that estimates the amount of inventory that should be on hand at a given point in time:
To estimate the amount of stolen inventory, businesses will take the result of the above inventory computation and compare it to the actual inventory physically on hand. Any shortfall is then attributed to the fraud.
Under a fidelity policy, the inventory computation on its own is not sufficient to prove that a fraud took place. This is because differences between the inventory computation and the inventory physically on hand can be caused by other factors, such as damaged or obsolete items, or accounting errors. Additional proof is required, in addition to the inventory computation, to substantiate that the inventory shortfall was caused by theft.
Lastly, fidelity insurance does not require that the employee receive a direct financial benefit from the fraud. The employee may facilitate the fraud, which allows someone outside the organization to receive the financial benefit.
For example, an employee may award work to a supplier owned by a family member, who bills the employer for work that was never performed. In this case, the financial benefit is received by the family member. However, since the fraud required the participation of the employee, the losses would be covered under a fidelity policy.
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Communications are intended for informational purposes only and do not constitute legal advice or an opinion on any issue. For permission to republish this content, please contact Rehana Moosa Forensic Accounting Professional Corporation.
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