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How Fidelity Bonds are Underwritten

Part II

Yesterday, we drafted part I of our post on how a surety bond is underwritten.

As you could easily tell, a lot of emphasis is placed on the character of the applicant.  The goal is, of course, how to ably predict how an employee will act in the future, based only on the employee’s past and their position within the company.

Underwriters, therefore, try and ask themselves questions like:

• What will be the opportunities to take the employer’s money?


• What are the temptations that occur as a direct result of the job?


• What are the temptations that occur as an indirect result of the job?


• What amount of money will he handle?


• To what extent will he have control over the flow of funds?


• What opportunities will there be to conceal funds?  And what is the expertise of the employee in the organization as compared with that ability to conceal funds?


• What are the employee’s personal expenditures?


• What is the total debt of the employee?


• Can the employee borrow money and what is the expectation of returning that money?


• What auditing capabilities does the company have regarding the position of the employee?


• What is the culture of the company?

Most of the underwriters that I know pay particular attention to the company’s culture and auditing capabilities.  That is because a periodical audit of the employee’s files is really a necessary safeguard to reduce the temptation of bad behavior.  Also, such a practice is generally recognized as a part of best business practices and are done without demeaning the integrity of the employee.

Trying to figure out the character of the employee is the utmost concern.  This is done by a thorough investigation of the employee and their history (as discussed in Part I).  Most underwriters interview former employers and colleagues and do a thorough background check.

Once approved, the agent sends a letter of transmittal, which provides all  the information gathered, the investigation into the employee and explaining any other risk areas not explored.

The fidelity bond is writte in one of two ways: as an individual bond or as a schedule bond.

An individual fidelity bond covers the employee only.

A schedule bond, however, covers several persons under the same basic bond (usually six or more).  The general provisions are very much similar to an individual bond with the main difference being a schedule of persons covered under the bond.  This schedule gives the names, positions, liability being underwritten and the premium for each person listed on the schedule.  Then, these schedules can be updated as employees change.

Additions, deductions and other modifications after the bond is issued are made by “change notices” signed by the employer.  Most employers prefer schedule bonds as they are easier to keep track of, including all changes, etc.  Better yet, the renewal dates all fall on the same day and, therefore, the paperwork is substantially reduced.

Both individual and schedule bonds are generally written for one year, with a sixty (60) day window to renew prior to the end of the term.

There are certain risks that are excluded from coverage, which include such things as jewelry employees, outside employees of breweries, etc.

I hope that this has been somewhat helpful for you in understanding how these bonds are underwritten.

Gary Swiftbonds, Our short bio

How Fidelity Bonds are Underwritten

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How Fidelity Bonds are Underwritten

Part I

Yesterday, we posted a short article on the difference between a surety bond and a fidelity bond.  One question that is consistently asked is this: how is a bond underwritten?  Today, we’ll focus on how a fidelity bond is underwritten.

As you may recall, a fidelity bond provides protection against the potential for dishonesty or theft of a person serving in a fiduciary capacity.  Thus, these bonds are typically written for an official or employee of a financial institution, government official, court representative, etc.  These fidelity bonds provide protection, that is they guarantee indemnity, if the bonded person violate the trust by acting in bad faith, misappropriating funds or property under which they are serving in that fiduciary capacity.

Who is covered

Fidelity bonds also cover insurance agents, officers of building and loan associations, U.S. Government officials, and various employees that serve in other fiduciary capacities for our state and municipal government.

Years ago, it was recommended that all mercantile, financial, hotel, real estate companies, telephone companies and manufacturing companies require their employees to provide a corporate fidelity bond.  These bonds would encompass all of the officers, such as presidents, vice-presidents, and other employees that had access, such as secretaries, treasurers, cashiers, book-keepers, clerks, salesmen and collectors.

Fortunately, technology has replaced the need for so many corporate fidelity bonds.  In our current nearly cashless society, there is very little cash to abscond with.  Further, there are numerous robust tracking systems for the employees so that absconding with funds is a much, much smaller concern than it was years ago.

technology

Unfortunately, many small companies do not employ these robust tracking systems.  Thus, there is a lot more fraud in those companies.  The companies that I have dealt with over the years that have experienced fraud were simply not prepared for its devastating effects on growth, operations, and capital.  Many of them did not have the capacity to withstand such a drain on resources, which materially affected the growth and earnings of the company.  Strangely, many times it was a relative of the main principal who was defrauding the company.

Ok, back to fidelity bonds.

You should know that fidelity bonds may be canceled by the surety on thirty days written notice to the employer.

Another thing to know is that the surety company is not liable under a fidelity bond for any act of fraud or dishonesty that was committed by the employee after the employer had knowledge of an act that would start the claim process.  Employers are required to notify the surety promptly of any acts that could lead to a claim and the omission of any such act would relieve the surety company of any liability.

An applicant for a bond must be of the type of person that a surety would underwrite.  This is shown through the applicant’s work history, including both their current employer and their past employers.  The bond is underwritten on the facts presented at the time of bond approval and not any potential future happenings.

So, when an applicant can show a record of personal character that contains the person’s honesty through their actions and position, then the bond is generally written quickly.  However, when an applicant does not have that history, such as when a person has never held a position of trust, then the underwriter will go into more personal history and detail.

See part II for more details.

How Fidelity Bonds are Underwritten

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Two Types of Bonds – Fidelity and Surety Bonds

I got a great question today from a very good client: what is the difference between a fidelity bond and a surety bond?  So, here’s my best shot at explaining the difference.  Hopefully, you can determine which boat you are in at the end of this.

Boat

Fidelity and surety bonds make up the largest two classes of corporate bonds.  In general, a fidelity bond guarantees the person while a surety bond guarantees the performance.  Thus, a fidelity bond is specific to the individual while the surety bond is specific to the job (and this type of bond can be broken up into a variety of flavors, from payment to performance, etc.).

All bonds that cover positions of trust are fidelity bonds while contract bonds are considered surety bonds.  In the old days, these were both referred to a corporate surety bonds.

There are exceptions, of course, to the general classification above.  These exceptions can be very numerous and sometimes it seems as if the exceptions will overwhelm the basic rule.  Still, it’s nice to know that the general holds true.

Required by the Law

There are also a variety of bonds that are required by law.  All forms of contract bonds that pertain to the Federal government, state, and municipal governments are required by law.  A subset of these are the Little Miller Acts that require bonds on federal jobs.

Bonds that are required by law before one can serve as a administrator, guardian, trustee, executor, assignee or otherwise in connection with a legal transaction (such as is required in any probate situation), before someone is qualified to serve in a public office and before engaging in certain specialized lines of business, such as cigar, tobacco, and liquor sales, also require a fidelity bond.

As a general rule of thumb, a fidelity bond that covers bank employees, persons in fraternal orders, etc. and those that provide security for private companies are not required by law.  These bonds are issued to provide the private organization some assurance that the person serving will not take advantage – or provides a benefit if they are swindled.  These protections are seen by the private companies as beneficial not only to themselves, but to any investors or other stakeholders in the organizations that do not have the same familiarity with the person being asked to serve in a fiduciary capacity.

Why do I have to give a bond if it’s not required by the law?

Well, the first and obviously best answer is that if you want to perform the job being asked, and the bond is required, then you have to do it.

But a better, and deeper, understanding is helpful.  The stability provided by a bond, through its loss-paying power, prompt payment of losses and character of service benefits are clearly helpful to the parties that want to enter into the transaction.  Their lack of perfect information only fuels the fire of the perceived problems that can arise in personal surety, such as absconding with funds, bankruptcy, death, disability, etc.

Thus, these two types of bonds – fidelity bonds and surety bonds – certainly help with the ability to keep commerce flowing.

Two Types of Bonds - Fidelity and Surety Bonds

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