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 the 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 actions of dishonest employees (or at times clients) who deliberately cause harm to the business. Fidelity bonds are not traded anywhere and they do not accrue interest like other bonds.
How does Fidelity Bond Work?
Now, let us look at how fidelity bond works:
- Firstly, businesses create a list of heads under which they may incur losses due to any kind of fraudulent activities.
- Next, a list of employees working in an organization is prepared.
- Next, based on the nature of work and the number of employees the premium amount to be paid is determined.
- In the case of fraudulent activity, inform the insurance company as soon as possible for the claim.
- Next, the insurance company will investigate the matter to estimate the quantum of loss.
- If the insurance company approves the claim amount, then it will be handed out to the policyholder.
Types of Fidelity Bonds
There are two major types of fidelity bonds – 1st party bonds and 3rd part bonds.
- 1stparty bonds: These type of fidelity bonds provide protection for employees that are on the payroll of the employers. These commonly used policies protect the businesses from financial losses caused due to deliberate deceitful actions of employees or customers. Such actions not only inflict financial losses but also harm the reputation of the businesses. Some of the examples of such acts include theft, fraud, forgery, and other malicious acts.
- 3rdparty bonds: These type of fidelity bonds provide protection for employees that work on a contract basis 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 bonds. 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 are required to have ERISA fidelity bonds for employees who are responsible for managing benefit funds. These ERISA fidelity bonds must cover a minimum 10% of the funds managed by these employees. However, the companies should also check their own industry specific regulatory requirements while purchasing these policies. Further, these policies are also found to be useful for companies that frequently send their employees to client sites.
How Much Fidelity Bonds Cost?
The cost of fidelity bonds are primarily driven by the policy limits, the volume of sensitive information managed by the company, and number of employees having access to 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 pay in excess of $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 fidelity bonds:
- All businesses with retirement plans are required to have ERISA fidelity bonds and they must 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; self-employed personnel is not covered by fidelity bonds.
- The minimum amount of fidelity bonds to be purchased is higher of $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 in case the plan also holds the employer securities.
Uses of Fidelity Bonds
The fidelity bonds not only cover the fraudulent activities of the employees but also covers the customers who are impacted by the frauds. The following are some of the major uses of fidelity bonds:
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- 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 bonds are required for the following purposes:
- To cover losses incurred due to frauds committed by employees
- To minimize the impact of losses arising out of frauds by third parties
- To safeguard the company’s assets against frauds
Conclusion
So, it can be seen that fidelity bonds are the type of insurance policies that cover 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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