What are Fidelity Bonds?
The term “fidelity bonds” refers to the type of insurance policies that protect the policyholders (companies)from losses incurred due to fraudulent activities by their employees. Typically, these policies insure businesses for losses that are caused due to dishonest acts within the organization. In the US, various entities governed by the Employee Retirement Income Security Act of 1974 (ERISA) are mandated to be adequately covered by fidelity bonds in prescribed amounts.
Explanation of Fidelity Bonds
The term bond in the name fidelity bonds is a misnomer as these are a form of insurance policy. In the UK, this type of insurance policy is known as fidelity guarantee insurance coverage, while in Australia, it is known as employee dishonesty insurance coverage. Businesses or employers use these policies to insure themselves against losses that can arise out of the actions of dishonest employees (or, at times, clients) who deliberately cause harm to the business. Fidelity bonds are not traded anywhere and do not accrue interest like other bonds.
How does Fidelity Bond Work?
Now, let us look at how a fidelity bond works:
- Firstly, businesses create a list of heads under which they may incur losses due to fraudulent activities.
- Next, a list of employees working in an organization is prepared.
- Next, the premium amount to be paid is determined based on the nature of work and the number of employees,
- In the case of fraudulent activity, inform the insurance company as soon as possible of the claim.
- Next, the insurance company will investigate the matter to estimate the quantum of loss.
- If the insurance company approves the claim amount, it will be handed out to the policyholder.
Types of Fidelity Bonds
Two significant types of fidelity bonds – 1st party bonds and 3rd part bonds.
- 1stparty bonds: These fidelity bonds protect employees on the employer’s payroll. These commonly used policies cover businesses from financial losses caused due to deliberate deceitful actions of employees or customers. Such activities not only inflict financial losses but also harm the reputation of the companies. Examples of such acts include theft, fraud, forgery, and other malicious actions.
- 3rdparty bonds: These fidelity bonds protect employees who contract with the companies. Independent contractors and consultants are mainly covered in this category. As such, most companies who work with contracted employers ask the contractors to get the 3rdparty fidelity bond. Financial institutions, such as banks and other lending institutions, usually request the contracted parties to have3rdparty insurance.
Who Should Purchase Fidelity Bonds?
As per federal regulations, all businesses with retirement plans must have an ERISA fidelity bond for employees responsible for managing benefit funds. These ERISA fidelity bonds must cover 10% of the funds these employees manage. However, the companies should also check their industry-specific regulatory requirements while purchasing these policies. Further, these policies are also helpful for companies that frequently send their employees to client sites.
How Much do Fidelity Bonds Cost?
The cost of a fidelity bond is primarily driven by the policy limits, the volume of sensitive information managed by the company, and the number of employees accessing the sensitive information. According to one of the insurance companies (Insureon), small businesses, on average, pay $1,055 per year for a fidelity bond. Based on the customer profile of Insureon, 37% of small businesses spend more than $1,200 per year for a fidelity bond, 42% pay in the range of $600 to $1,200 per year, and the remaining 21% pay less than $600 per year.
Requirements for Fidelity Bonds
The following are the requirements of a fidelity bond:
- All businesses with retirement plans must have ERISA fidelity bonds and cover at least 10% of the funds managed by the employees.
- These bonds cover only those employees who directly handle cheques, cash, other properties, or any sensitive information.
- Only companies with proper employees can purchase fidelity bonds; fidelity bonds do not cover self-employed personnel.
- The minimum amount of fidelity bonds to purchase is more than $1,000 or 10% of plan assets. On the other hand, the maximum limit of fidelity bond purchase is $500,000, which can go up to $1,000,000 if the plan also holds employer securities.
Uses
The fidelity bond covers the employees’ fraudulent activities and the customers impacted by the fraud. The following are some of the practical uses of fidelity bond:
- Forgery: Duplicating someone’s signature for transferring money from a company or client account
- Asset theft: Deliberate appropriation of valuable assets of the company
- Identity theft: Gaining access to personal or financial information of someone else for making some illegal transactions or purchases
- Embezzlement: Diversion of funds or assets belonging to the employer
- Claims by clients: Claims made by clients when the employees of an organization steal money or valuable assets from them
Why is a Fidelity Bond Required?
The fidelity bond is required for the following purposes:
- To cover losses incurred due to frauds committed by employees
- To minimize the impact of losses arising out of fraud by third parties
- To safeguard the company’s assets against fraud
Conclusion
So, it can be seen that fidelity bonds are the type of insurance policy that covers the loss of forgery, theft, misuse of assets, etc. These are usually used by companies with a large employee base and having access to valuable assets or sensitive information.
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