Fidelity Bonds: COVID Hits Demand, not Claims

Author: Suretypedia Team

5-29-2020

Fidelity bonds provide businesses with coverage against employee theft. With roughly 41 million Americans out of work and many businesses forced to be closed to comply with Stay-at-Home orders, demand for fidelity bonds has been drastically reduced, potentially reducing premium for surety carriers and commissions for their agents. Worse still, with many employees working remotely and potentially at reduced pay, it is possible the propensity for dishonest acts to occur may increase.
 
In the context of this environment, Suretypedia analyzes the coverage fidelity bonds provide and COVID-19’s potential impact on this historically low-risk class of business by answering the following questions:

1. What Coverage is Provided by Fidelity Bonds in a Normal Environment?
2. How are Industries that Purchase Fidelity Bonds Impacted by Social Distancing?
3. How Should Surety Underwriters Respond to Fidelity Bonds during COVID-19?
4. Will Court Closures Increase the Value of Conviction Clauses? 

Will the fidelity market experience the one-two punch of lower premium volume and increased claims activity in what has traditionally been a low-risk, and growing, category? While concerned about fidelity bond customer demand in the near term, Suretypedia does not expect a material increase in claims in the current environment.

What Coverage is Provided by Fidelity Bonds in a Normal Environment?

A fidelity bond provides protection for a business from employee fraud, theft, embezzlement, larceny, and forgery. While all fidelity products provide protection against forms of theft, the various types of fidelity coverage differ in important ways. Employee Dishonesty bonds generally provide protection for the employer from theft by their employees (also known as 1st Party Coverage) AND coverage for the employer’s customers should they suffer a loss as a result of employee theft (also known as 3rd Party Coverage). Business Services and Janitorial bonds generally only provide 3rd Party Coverage. For actions to be deemed as “Dishonest” the employee must be proven to have acted to 1) cause a loss to their employer and 2) to obtain an unlawful financial benefit for themselves or others. While these two specific requirements don’t generally appear in the bond form language, Sureties often include Conviction Clauses to help mitigate losses on this class of business. Conviction Clauses put the responsibility on the business owner to seek criminal conviction of the employee(s) who caused the loss in order to seek reimbursement from the Surety. Unlike most Surety products Fidelity bonds are more similar insurance policies, in that the forms are drafted by the carrier rather than the Obligee. The language in these forms is generally more favorable to the carrier in contrast to typical Surety Bonds where forms are in favor of the Obligee. Fidelity bonds can also be expanded to include Commercial Crime Policies which allow for more comprehensive coverage. The baseline coverage still provides protection from employee theft; however, it can be tailored to add coverage for Computer Funds & Transfer Fraud, Social Engineering, Inside/Outside the Premise, Forgery & Alterations, etc.. Fidelity products continue to evolve and expand as new loss exposures reveal themselves and undercut employers and their customers.

Unlike standard Employee Dishonesty or Business Services bonds, Commercial Crime products tend to be more heavily underwritten. Where Dishonesty Bonds primarily require an employee count, verification the business hasn’t experienced prior losses due to dishonest acts, and confirmation of a bond amount, Commercial Crime underwriters will require a plethora of information to understand the controls that are in place to mitigate losses. For First Party (Employee Theft) coverage, the most common controls required are as follows:

• Countersignatures on checks or an acceptable alternative
• Segregation of duties between employees who: reconcile monthly bank statements, sign checks and handle bank deposits
• Use of an authorized vendor list

For Third Party (Employee Theft on Client Premises Only) Coverage the Surety will want to understand the following:

• Does the Principal have control over their client’s assets?
• Number of employees that will be working on the client’s premise and if any are 1099’s
• Will the employees be supervised by the client? 
• Does the Principal perform background checks and review prior employment history? 

Commercial Crime products are much more comprehensive than standard employee dishonesty bonds and we could devote an entire article on this subject (keep an eye out for a future installment). For the purposes of this article, we wanted to provide an overview of these bonds and, as we will explain shortly, how Social Distancing is impacting this segment of the Surety market.

How are Industries that Purchase Fidelity Bonds Impacted by Social Distancing?

Business shutdowns have caused layoffs of over 30 million workers,  and we expect social distancing policies will continue to tremendously slow down the recovery for at least the next 12 months. Therefore, we expect subdued demand for fidelity bonds for the foreseeable future. 

The chart below looks at different types of businesses that may need a fidelity bond and examines the potential impact social distancing has on the risk to the Surety.

With employees of various industries out of work, the risk associated with fidelity bonds has been reduced. Unfortunately, while good for loss ratios in the near term, we expect premium to decline substantially.

Should Fidelity Bond Underwriting be Augmented in Response to COVID-19?

Underwritten properly, fidelity bonds have historically been considered a low-risk class of business and based on the nature of bond’s obligation, we do not believe Surety Underwriters should increase scrutiny of this class of business due to the economic or societal impacts of social distancing policies. In fact, the risk associated with fidelity bonds for the surety industry seems to have decreased due to a lack of present employees. Furthermore, many of the industries relying on providing services on their customer’s premise (janitorial services, in-home childcare, house/dog sitters) are unable to work, thus diminishing risk to the Surety.

In the case of commercial crime coverage, Sureties should remain vigilant. Although commercial crime coverage is more comprehensive than a typical dishonesty bond, Fidelity underwriters scrutinize and require more controls to be in place to prevent losses on these bonds. The impact of social distancing policies on the industries who typically need these bonds should result in reduced demand for these products and with the inability to have employees in the office the overall risk to the carrier should decrease as well. With that being said,  opportunities to develop coverage pertaining to remote workers may arise. To capture, Sureties would need to gear their underwriting questions (and required controls) toward access and privileges provided to remote workers in contrast to those available in office. In doing so, businesses may be able to obtain more extensive coverage and fidelity markets will be able to underwrite their actual exposure with more clarity.    

Will Court Closures Increase the Value of Conviction Clauses? 

While Conviction Clauses in fidelity bonds require the reported employee to be convicted of theft in a court of law in order for the Surety to be liable under the bond, the closure of courts has substantially curtailed hearings for criminal trials.We believe this delay will provide a reprieve in claims payment for the Surety, but ultimately will not reduce the risk to the Surety in the long term. Some clerk offices have remained open so claim filings may continue to be processed, but it is unclear how the courts will react to the backlog of delayed and incoming criminal and civil trials.  

Please email [email protected] with issues your organization is facing. We would love to add your contribution to the overall Surety discussion.