Filed Under:Claims, Catastrophe & Restoration

How to insure against employee dishonesty

Despite a strengthening global economy, incidents of employee theft continue to rise.
Despite a strengthening global economy, incidents of employee theft continue to rise.

Employee dishonesty crimes spiked at the height of the Great Recession in 2008. But despite a strengthening of the global economy, incidents of employee theft continue to rise.

The U.S. Chamber of Commerce estimates that employers lose $20 billion to $40 billion each year to employee theft. More shocking still, employee theft contributes to nearly 30% of all business failures.

And the alarming statistics don't end there.

According to a report issued in 2012 by the Association of Certified Fraud Examiners, U.S. businesses lose 6% of their annual revenue to employee fraud.

The median loss to employers is $140,000, with the median loss suffered by small businesses nearly $100,000 higher than the median loss suffered by larger companies. Fewer than 10% of employee theft incidents are discovered, and only a small percentage of those uncovered are ever reported.

Loss recovery statistics are equally grim: The median recovery to an employer (from an employee) is 20% of the original loss. More stunning, 40% of employers recover nothing at all.

Employers must take action to protect against internal losses. One measure is a specialized insurance policy referred to as Employee Dishonesty Coverage, designed to indemnify an employer in cases of fraud and embezzlement by an employee and to provide third-party coverage for related losses.

Though Employee Dishonesty Coverage seems straightforward — an employee steals from the company and the policy indemnifies — employers should take note of two important facets of its protections: the prerequisites for coverage and a nuanced exclusion for “prior knowledge.”

Prerequisites for coverage

Policies will vary, but typically an employer can expect three prerequisites for coverage under an Employee Dishonesty policy:

  • The action must be intentional, fraudulent and dishonest. Accidental or negligent loss to the company is not sufficient.

  • The employee must intend to obtain a financial benefit for himself or another person.

  • The financial benefit must be other than salaries, commissions, fees, bonuses, promotions, awards, profit sharing or pensions or other employee benefits earned in the normal course of business.

Nuances to the “prior knowledge” exclusion

Assuming an employee's actions satisfy the prerequisites for triggering coverage, employers should pay close attention to a policy's prior knowledge exclusion. The prior knowledge exclusion has three nuances that frequently result in a denial of coverage:

  • Nuance 1: Coverage for subsequent dishonest acts. An employer's decision to excuse or forgive an employee's first act of dishonesty constitutes prior knowledge. If the same employee commits a subsequent act of theft or dishonesty, the subsequent act will not be covered.

  • Nuance 2: Employees identified to possess prior knowledge. Generally, the prior knowledge exclusion prohibits recovery if anyone employed by the company has knowledge of the fraudulent activity. Technically, an employee who is intentionally, fraudulently and dishonestly stealing money from an employer has prior knowledge of the dishonest act he or she is committing. Policyholders must be diligent in reviewing a policy's exclusionary language and negotiating less restrictive language that protects their interests. It is possible for the employer to negotiate an alternative with the insurer to limit the prior knowledge exclusion to the CEO, CFO and/or general counsel — meaning the exclusion will only apply if any of these specific people have prior knowledge, as compared to anyone employed in the organization.

  • Nuance 3: The definition of “knowledge.” Though on its face, the prior knowledge exclusion only purports to exclude known behavior, a Kansas Court expanded this definition to include insurer investigations into potential fraud. The thinking definitional expansion is that the insurer had a reasonable expectation that dishonest acts occurred and, therefore, the prior knowledge existed.

Given the specificity of the prerequisites of Employee Dishonesty Coverage and the highly nuanced prior knowledge exclusion, employers must do their homework. Engaging an experienced broker and coverage counsel to review or audit an Employee Dishonesty Coverage policy can provide added protection.

Related: 8 tips to mitigate employee theft risks

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