Insurance – A Critical Defence Against Employee Fraud

Rob Fowlie, CA-IFA, CFI

Employee fraud is “big business” that will cost the U.S. economy approximately US$600 billion in 2002, according to one US Study. Victimized businesses usually suffer significant losses – over half of frauds committed cause losses of at least US$100,000 and nearly one in six result in losses of over US$1 million. Similar data doesn’t exist for Canada, but employee fraud is unlikely to be any less of a threat to Canadian business.

Fraud drains businesses of cash and other valuable assets needed to ensure solvency and long-term viability, and may even cause a company to fail completely. However, the damage is not only financial. Fraud can also disrupt daily business activities, impair long-standing relationships with customers, suppliers and lenders and possibly damage the business reputations.

Insuring against fraud

Most organizations have controls that limit opportunities for theft – though no controls are entirely foolproof. Companies that are victimized also attempt to recover losses, though usually with limited success since the misappropriated funds are normally used to enhance the fraudster’s lifestyle, leaving few recoverable assets. Therefore, many business owners, financial officers and risk managers consider fidelity insurance critical to protecting their organizations from fraud losses.

Often referred to as “employee dishonesty insurance,” fidelity insurance reimburses a business for losses related to employee fraud or theft. As with all insurance products, the amount of the reimbursable loss is subject to the conditions, limitations and deductibles specified in the insurance contract.

Understand your coverage

Fidelity insurance policies differ, therefore it is important to understand the standards and conditions.

Definition of the Insured – To be covered, businesses must be identified specifically in the policy. Therefore, if subsidiaries or newly acquired entities are to be insured, each must be defined as an insured party.

Parties Insured – Fidelity insurance typically covers employees, though a rider may provide for separate coverage to insure partners, agents and independent contractors. Many businesses also require independent contractors to obtain (and pay premiums for) a fidelity bond, under which an insurance company reimburses the contractor’s clients for fraud losses caused by the contractor.
Direct Loss Coverage – This coverage reimburses the insured only for direct losses due to employee fraud or theft to a maximum amount specified in the contract. Reimbursement isn’t provided for ancillary losses or income that could have been earned on the stolen assets, such as interest income lost on cash frauds or profits lost on inventory frauds. Typically, losses due to accounting errors are not reimbursed.

Manifest Intent – Insured companies must normally prove who was responsible for the loss, and that it was intended to cause a loss to the insured (and a benefit for those committing the fraud or for others). Proving intent is important – losses resulting from error or negligence are not covered. This proof is usually provided through a forensic accountant’s report.

Coverage Limits and Deductibles – Policies specify the maximum amount the insurer will reimburse a loss due to fraud. Limits are usually on a “per loss basis” and related acts of fraud or theft by one or more employees working together are considered one loss for the purposes of the coverage maximum. Policies also carry a deductible exempting the insurer from paying an initial amount in the event of a loss.

Subrogation – After the insured is reimbursed for fraud losses, insurers normally assume the right to try to recover the losses from the employees responsible for them and from third parties who may have benefited (e.g., friends and family), or those who may have prevented the loss (e.g., auditors).

Making a Claim

Most policies require the insured to notify the insurer of a loss or potential loss, either in writing or by phone. Insurers expect to be notified as soon as the insured becomes aware of facts causing them to assume a loss has occurred. The insurer may also require the insured to notify the police and file an incident report.

Early notification enables insurers to take steps to enhance or protect their rights to pursue fraud losses from the employee(s), such as applying for a Mareva Injunction or Certificate of Pending Litigation to freeze or preserve the value of employee’s assets. In other cases, the insurer may, after the fact, enter into direct negotiations with the employee and their legal counsel.

The next step is for the insured to conduct an investigation, which may involve senior company employees, forensic accountants, lawyers and others but usually not the police given their limited time and resources for white collar crime. The investigative team gathers evidence to establish the loss’s factual basis, which includes identifying those responsible for the loss, methods used to defraud the business, type of assets misappropriated, amount of loss and time period of the loss. In some cases, the team may attempt to trace, locate and recover assets.

The investigation will result in a report, schedules, witness statements and a brief of evidence detailing the loss. The report, together with a Proof of Loss form, is submitted to the insurer as the insured’s request for reimbursement of the fraud losses.

At this point, the insurer will begin its own investigation, including a review of the contract and the applications for insurance (involving enquiries about records, internal controls and employees to verify the information in the application) the Proof of Loss and forensic accountant’s report. If the claim is deemed appropriate, the insurance company will reimburse the insured and begin actions to recover the losses from employees.


Despite the prevalence of employee fraud, many companies do not carry fidelity insurance and most that do are underinsured. A US study found that almost 40% of organizations victimized by fraud were uninsured. Of those insured, only 35% had coverage that enabled them to recover more than 75% of the amount lost. Business owners, financial officers and risk managers would therefore be wise to review their insurance policies to ensure that their companies are properly protected.

Robert W. Fowlie is a Vice President of Deloitte & Touche’s Forensic & Investigative Services Inc. in Toronto. He is a Chartered Accountant and has been recognized as a specialist in Investigative and Forensic Accounting by the Canadian Institute of Chartered Accountants. He is also a CFI and a member of the Board of Directors for the Association of Certified Forensic Investigators of Canada.