Risk Management
The skinny on crime insurance
Court cases highlight need for adequate limits and an accurate explanation of crime insurance definitions
By Donald S. Malecki, CPCU
Employee dishonesty is one of the loss exposures that is increasingly difficult to control—for both for-profit and not-for-profit organizations. This is especially true for the small to mid-sized organizations that often take a “Pollyanna” approach and discount the potential for employee dishonesty losses.
It is not that all employees are dishonest. Some are. Others are tempted to become dishonest in the work environment when they are exposed to large sums of money and given a large helping of employer trust, coupled with little oversight.
Whenever an employee is trusted to handle money or securities, the employer has to assume that no matter how trustworthy an employee may appear to be, the employer is vulnerable to a loss that ends up being far more than an entity can withstand. Since many entities cannot fully control the possibility of an occurrence, the next best alternative is to purchase insurance.
The question is how much insurance should be purchased? This is the identical question that businesses ask in reference to liability limits. Or, asking how high one’s limits should be is like asking how high is the sky. The standard answer should be: Purchase all the limits you can afford.
The business owner, of course, has the final say on what those limits should be. Too often, however, businesses purchase insurance based on price. The problem is that at the time of loss, they are not concerned with how much the insurance cost, but rather when the insurance check for loss payment is going to be cut.
Crime policy—limitations
Many entities do not understand how the crime policy insurance limits for employee dishonesty actually work until after they are confronted with a loss that far exceeds their policy limits. Insofar as the application of limits is concerned, there are limitations.
The first limitation is that the loss is limited to each occurrence, and the second limitation is that the policy limits are not cumulative from year to year. While both of these aspects need to be explored further, only the first such limitation is discussed here. The second limitation will be discussed in a subsequent column.
Crime policies have long provided that, as far as employee dishonesty coverage is concerned, the insurer will not pay any more in any one occurrence than all loss caused by one or more employees (acting in collusion) whether the loss is the result of a single act or a series of acts. That seems clear enough, but apparently it is not to everyone.
A clarifying case is Thornburg Insulation, Inc. J.T.J.R., Inc., et al. v. J.W. Terrill, Inc., et al., 236 S.W. 3d 661 (Mo. App. E.D. 2007.) This involved two corporations owned by the same persons.
Both companies separately purchased a commercial crime policy that included employee dishonesty coverage subject to a $50,000 limit per occurrence. The policy defined “occurrence” to mean “all loss caused by or involving one or more ‘employees’ whether the result of a single act or a series of acts.”
One of the corporations, J.T.J.R., employed an office manager and bookkeeper. This employee also periodically worked for the other corporation but was not paid directly by it. That corporation, however, reimbursed the J.T.J.R. for the wages earned by this employee.
For two years, this employee embezzled money from both corporations. The amount taken from her immediate employer, J.T.J.R., was $508,350 and $745,800 from the other corporation. As a result of this loss, the insurer issued a check for each corporation in the amount of the policy limit of $50,000.
The corporate owners did not like the idea that all they were getting was a total of $100,000 when their combined loss total was in excess of $1 million. They maintained that because each fraudulent check required a series of actions including writing out the check, stealing the signature stamp, applying the signature stamp and depositing the check, the series of acts for each check was an occurrence. In other words, from the perspective of the corporate owners, each loss was considered to be a separate occurrence.
The court disagreed. It held that the definition makes clear that an occurrence consists of “all loss” caused by an employee. The court also stated that other courts dealing with this same issue have found identical policies to be unambiguous. These cases are: Wausau Bus. Ins. Co. v. U.S. Motels Management, Inc., 341 F.Supp.2d 1180 (D.Colo. 2004); Bethany Christian Church v. Preferred Risk Mutual Ins. Co., 942 F. Supp. 330 (S.D. Texas 1996;) and Diamond Transport Systems, Inc. v. Travelers Indem. Co., 817 F.Supp 710 (N.Ill. 199).
Recent change
Despite the success of some insurers to hold losses to one occurrence, the Insurance Services Office changed the definition of occurrence with its 2006 crime forms amendments, stating that the courts have found it to be ambiguous. This has held to be true in some jurisdictions, but not by all courts.
The case cited by ISO where the court held the definition of occurrence to be ambiguous is Auto Lenders Acceptance Corporation v. Gentilini Ford, Inc., 854 A.2d 378 (N.J. 2004.) The court here held that the acts caused by the same person at different times were separate acts and separate occurrences.
For purposes of comparison, the first definition below is how occurrence was defined prior to the 2006 change and the second definition is how it currently reads:
Occurrence means … all loss caused by, or involving, one or more “employees” whether the result of a single act or a series of acts.
Occurrence means:
1. An individual act;
2. The combined total of all separate acts whether or not related; or
3. A series of acts whether or not related; committed by an “employee” acting alone or in collusion with other persons, during the Policy Period shown in the Declaration, before such Policy Period or both.
Note the reference in the new definition to acts that occur during the policy period as well as before the policy period. This is intended to combat the argument that acts occurring before the term of the current policy are not to be counted as part of the series of acts.
Apart from those cases where the courts have held the former (pre-2006) language to be ambiguous, those cases where insureds have been successful in maintaining more than one occurrence also involve situations where there actually were two occurrences. One such case is Ran-Nan Inc., et al. v. General Accident Insurance Co., 252 F. 3d 738 (U.S.Ct.App. 5th cir. 2001).
The insureds were convenience store owners who also operated a Western Union and check cashing business. During the fourth and fifth year of coverage, the owners became aware that two employees caused losses through entirely independent thefts. With “occurrence” defined to mean “all loss caused by, or involving, one or more employees, whether the result of a single act or a series of acts,” the insurer maintained that this loss involved one occurrence.
The insurer also maintained that there was only one loss because (1) the loss involved a single sum of cash and (2) reference to “involving” in the definition of occurrence meant that regardless of how many employees stole from the insured, there was only one loss of cash and, therefore, one occurrence.
The court disagreed with this argument. In doing so, it stated that the more natural reading of the policy was that the “involving” clause signified a group of employees conspiring together. To accept the insurer’s interpretation, the court said, the independent nature of these two series of thefts would be irrelevant and that one loss with two unrelated causes would be one occurrence.
In ruling for the insureds, the court also held that the law did not support the insurer’s interpretation of “occurrence.” The reason was that the proper focus in defining an occurrence was on the events that caused the injuries, rather than on the number of injurious effects.
The matter of limits
With the crime policy’s definition of occurrence purportedly strengthened, employers need to seriously consider maintaining more realistic limits. Limits of $50,000. $100,000 or even $250,000 are too low, considering how astronomical the losses can be.
For example, in the case of Reliance Insurance Company v. IRPC, Inc., et al., 904 A.2d 912 (Sup. Ct. Pa. 2006), the fidelity bond limit was $750,000, but the amount of embezzlement was $5.1 million; in Shemitz Lighting, Inc. v. Hartford Fire Insurance Co., 2000 WL 1781840 (CT.Sup.Ct. 2000), employee dishonesty coverage was written for a limit of $10,000, but the loss sustained was $202,000; and in the case of Employers Mutual Casualty Co. v. DGG & Car, Inc., D/B/A Metrol Security Services, CV-07-0280-PR (Sup. Ct. AZ 2008,) the limit was $50,000 and the loss was in excess of $500,000.
Embezzlements commonly are referred to as the silent crime. They usually go unnoticed for many years and commonly involve employees who are the least expected to steal. Once these dishonest employees get away with stealing money, there often is no stopping them, until they get caught. By then, the loss is likely to be disastrous for the employers.
Given the pace at which embezzlements continue and the staggering amounts being taken, it would not be out of line for small to medium-sized entities to consider limits of $500,000 to $1 million per occurrence. This is not out of line, considering that the limits are not cumulative from one year to the next. In other words, it does not matter how many years the insurance remains in force and premiums are paid, the limits are not multiplied by the number of years the insurance has been in force.
Conclusion
It is no secret that employee dishonesty is a potentially disastrous exposure confronting organizations today. The financial dislocations can prove to be serious enough to cause bankruptcies. The fact that employers do not know when they will be hit with a loss, if at all, makes it all the more important that they take the following steps:
• The first precaution is the implementation of some basic risk management techniques to reduce the chances of loss. This could be as simple as requiring two signatures on a check, requiring employees to take vacations, the separation of receivable and payable functions, and vendor verifica-tions. What is clear is that the more trust instilled in a person, the greater the chances of misappropriations.
• The second step is to purchase appropriate insurance, because it does not appear to matter what precautionary techniques are implemented, they may reduce the chances of loss but may not entirely do so. Organizations are well aware of the employee dishonesty exposure. They, in fact, do not have to be told about the need for insurance, since embezzlements not only have existed as long as civilization but also are often well-publicized events.
Although the obligation to inquire about employee dishonesty and other crime-related coverages rests with the organizations requiring the insurance, some package policies automatically include these coverages. The problem is that organizations can become complacent since they are given the coverages at minimal limits without seriously taking into consideration what their more realistic needs are. When coverage and/or limits fall short, they are quick to blame others.
Once insurance is in place, producers should try to see that the limits are increased to more reasonable levels, even though the persons approached for approval may be the very persons who are the potential thieves. *
The author
Donald S. Malecki, CPCU, has spent 48 years in the insurance and risk management consulting business. During the course of his career, he was a supervising casualty underwriter for a large Eastern insurer, as well as a broker. He currently is a principal of Malecki Deimling Nielander & Associates L.L.C., an insurance, risk, and management consulting business headquartered in Erlanger, Kentucky.