What it means
Most businesses trust their staff with cash, stock, payments and bank access. Even with good controls, the risk of an insider stealing remains, and the losses can be large because insiders know where the weaknesses are.
Fidelity insurance transfers some of that financial risk to an insurer. Policies cover direct losses of money, securities and other property caused by dishonest or fraudulent acts by named employees or by all employees, depending on the wording.
Some include forgery, computer fraud and funds transfer fraud. Policies normally exclude losses that arise from honest mistakes, from the owner's own actions, or from an inventory shortage with no proof of employee dishonesty.
The cost depends on the number of employees, the size of the cash and assets they handle, the strength of the business's controls and the limit chosen. Insurers often ask about segregation of duties, bank reconciliation and approval limits, and may refuse to pay if the business ignored reasonable controls.
Many employers and organisations that handle other people's money, including accountants, payroll providers and property managers, are required by contracts or regulators to hold such cover. Fidelity bonds are also used by pension plans and by companies that hold clients' funds.
Insurance is a backstop, not a replacement for controls. The best protection is a combination of strong internal controls, background checks, rotation of duties and regular audits, with fidelity cover to absorb a loss that still gets through.
Notice requirements are strict, so a loss must be reported promptly. Making a claim usually requires evidence.
The insurer will want to see accounting records, bank statements, interviews and often a police report, and it will examine whether the policy was in force when the dishonest acts took place. Because many policies only pay for losses discovered within a set period, prompt detection and reporting protect the claim.
In practice
Real-world examples
Example 1
A payroll company holds client funds and takes out fidelity insurance as required by its contracts. When a staff member creates fictitious employees and pockets $75,000, the insurer reimburses the loss after investigation. The insurer then pursues the dishonest employee to recover the money where possible.
Example 2
A small charity buys a policy after a volunteer treasurer is appointed. The cover protects donations from theft by the people entrusted with handling them. The trustees also adopt a rule that two people must sign every cheque above a modest limit. A small organisation may find the premium modest relative to the protection.
Example 3
A retailer discovers that a store manager has been manipulating refunds to take cash. Because the policy covers employee theft, the firm claims the documented losses after providing audit evidence. The insurer's investigation helps the retailer tighten its refund approvals.
Think of it
Fidelity insurance is like having a financial airbag for your internal team. You hope you never need it, but if a trusted employee crashes your finances through dishonest acts, it absorbs the impact so the business survives.
Formula
Calculation
Insurance payout = Lower of (Covered loss, Policy limit) - Deductible
Greenway Property Services, a fictional firm, holds a policy with a $250,000 limit and a $10,000 deductible. An accounts clerk is found to have diverted $180,000 over two years. The payout is $180,000 - $10,000 = $170,000, because the loss is below the limit. If the loss had been $300,000, the payout would be $250,000 - $10,000 = $240,000, leaving the firm to absorb the remaining $60,000.Case study
Seen in the real world
Hartwell Estates is an illustrative, fictional property manager that collects rent on behalf of landlords. Its bookkeeper had sole control of both receipts and bank reconciliation, and over eighteen months she transferred $95,000 of tenants' money to her own account.
The loss came to light when an external auditor noticed unexplained differences. Hartwell had a fidelity policy with a $200,000 limit and a $5,000 deductible, so the insurer paid $90,000 after the investigation, and Hartwell absorbed the rest.
In the illustrative lessons learned, the firm separated the duties of receiving money and reconciling accounts, introduced monthly review by a director and raised its policy limit. The insurer lowered the premium the following year in recognition of the improved controls. Hartwell's finance director also set up an annual review of the policy limit against the size of the client funds it holds.
Watch out
Common mistakes
- Believing fidelity cover replaces internal controls, when insurers can deny claims if basic controls were ignored.
- Assuming the policy covers any inventory shortage, when proof of employee dishonesty is normally required.
- Delaying notification of a suspected loss, which can breach the policy's notice conditions.
Questions
People also ask
What does fidelity insurance cover?
It covers direct financial losses caused by employee dishonesty such as theft, fraud and forgery, subject to the policy terms.
Is fidelity insurance the same as cyber insurance?
No, fidelity cover focuses on dishonest acts by employees, while cyber insurance responds to data breaches and network attacks, although some crime policies now include a limited cyber extension.
Who is the beneficiary of a fidelity bond?
The employer or the organisation that holds the policy is protected, not the dishonest employee.