Updated July 17, 2023
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.
In the US, the Employee Retirement Income Security Act of 1974 (ERISA) requires various entities to have adequate fidelity bond coverage in prescribed amounts, insuring businesses against losses caused by dishonest acts within the organization.
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, companies refer to this insurance policy as fidelity guarantee insurance coverage, whereas 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.
- Prepares a list of employees who are working.
- Determine the premium amount to be paid 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.
- The insurance company will hand over the approved claim amount to the policyholder.
Types of Fidelity Bonds
Two significant types of fidelity bonds – 1st party bonds and 3rd part bonds.
- 1st party 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.
- 3rd party 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 policy limits primarily drive the cost of a fidelity bond, 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 the employees manage.
- These bonds cover only those employees who directly handle cheques, cash, other properties, or 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.
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 bonds:
- 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 the 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 fraud committed by employees
- To minimize the impact of losses arising out of fraud by third parties
- To safeguard the company’s assets against fraud
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. Companies with a large employee base usually use these and have access to valuable assets or sensitive information.
This is a guide to Fidelity Bonds. Here we also discuss the introduction and how it works with types and uses. You may also have a look at the following articles to learn more –