Tackling financial fraud risk
TODAY’S ARTICLE is about Jamaica’s bank and non-bank financial sectors. It will discuss how the insurance market handles the risks of employee dishonesty or fraud for companies in these industries.
Allegations of fraud at local commercial banks and nondeposit-taking financial institutions dominate the news cycles and social media platforms. Questions have been raised about regulatory oversight, governance, the loss of hard-earned investments, insurance coverage against employee fraud, the importance of trust in the financial system, and the need for regulatory and other reforms.
As usual, the pundits have offered their opinions, which are often treated as facts. In the meantime, insurance of employee dishonesty, one of many tools used to protect the integrity of the financial system and help businesses and other organisations manage one group of risk, is treated like a black hole.
People can’t see black holes, according to the US National Aeronautics and Space Administration, better known by its acronym NASA. The force of gravity is so strong in black holes that even light cannot escape.
Today’s piece aims to shine a light on insurance against employee dishonesty or fraud. Even the former head of the Financial Services Commission – the entity that supervises the insurance, pensions, and securities industries and whose duties will soon be shunted to the Bank of Jamaica – was remarkably ignorant about the scope and size of the insurance protection that was afforded to the controversial regulated entity, SSL, when the terms of that coverage were set by the commission.
Some information eventually was shared with the public by the Minister of Finance & Public Service.
First: a few words about my credentials. I have, in the past, advised the central bank and two of Jamaica’s biggest commercial banks on the subject of insurance against employee dishonesty. I have also worked with one of the world’s leading technology companies in the development of a solution for the life and non-life segments of the local risk transfer or insurance industry to protect themselves from the effects of insurance fraud.
US Risk, a Dallas, Texas-based insurance entity, wrote in a February 11, 2020, article: “Financial institutions around the world face significant risks in their operations – both externally and from within. Employee theft and crime, including fraudulent activities, are believed to be the largest risks banks and other financial services firms face. Despite numerous safeguards, financial institutions are vulnerable to criminal activity of employees, who often have access to customer accounts as well as transaction and personal data that can be used for illicit means … the financial services sector was especially hardhit by fraud committed by those working within organisations. Employees committing theft or fraud in banking ranged from bank tellers to executives and board officers.”
Generic employee dishonesty coverage
Business enterprises and other entities across Jamaica, and elsewhere, are plagued by employee theft. One of the managers of a local manufacturer, for example, told me last week that the rate of pilferage of its finished goods had increased very sharply this year as compared to 2022.
Insurance company CEOs have disclosed that the frequency of insurance fraud is on the rise. More retail shops are checking sales receipts against items sold to limit pilferage. The electricity and water utilities have not seen any reduction in their losses due to consumer theft. Employee theft in financial institutions mirrors dishonest activities in other economic sectors.
Local insurers, for some strange reason, call insurance that provides protection against employee dishonesty or fraud ‘Fidelity Guarantee’. A typical fidelity guarantee policy says it “will indemnify the insured against such direct loss of money and or goods belonging to the insured or for which the insured is responsible at law as the insured shall sustain because of fraud or dishonesty committed during the period of insurance by any employee … in the performance of his duties and whilst employed … provided that: such fraud or dishonesty is discovered not later than six months after either the termination of the employment of the employee in respect of whom a claim is made hereunder or the expiry of this policy whichever shall first happen; and the liability of the company in respect of such fraud or dishonesty committed by any employee during the whole period of the subsistence of this policy shall not exceed the sum stated … in the schedule and not more than one claim in respect of such employee shall be payable under this policy.” Banker’s blanket bond coverage Investopedia defines a banker’s blanket bond or BBB as a “fidelity bond that protects a bank (or another type of financial institution) against losses from various criminal acts carried out by employees. A banker’s blanket bond is also known as a blanket fidelity bond. Some US states require blanket bond coverage as a condition of operating a bank.”
BBBs have been around for over a century and were specifically drafted to protect commercial banks. The scope of coverage has evolved and has been modified to include other types of financial institutions.
It operates as an insurance policy that provides coverage against direct financial loss from forgery, cyberfraud, physical loss of or alteration to property, extortion, and employee dishonesty.
“The employee must have committed these fraudulent acts for personal gain for the company to make any claim against the bond. This means the bond does not cover the activities of employees who commit unethical transactions for making a financial institution appear healthier. For example, losses that result from an employee that cooks the book or engages in other creative techniques to put the company in a better light than it is will be exempt from coverage.”
The blanket fidelity bond is classified as “first-party coverage since it covers the institution itself, not the account holders or shareholders”. However, this bond is not to be taken as a form of credit insurance.
“A banker’s blanket bond does not extend credit or assumes the credit risk of the borrowers. Credit risk management is a component of the bank’s core operations and is the sole responsibility of the financial institution. The blanket bond deals only with extraordinary events related to employee criminal activities and is a regulatory requirement in some states requiring banks to obtain fidelity bonds to operate.”
It is not clear whether the local entity that suffered what has been described as the country’s largest case of fraud is insured by the generic employee dishonesty policy or the more industry-specific BBB insurance.
One is left to speculate in the absence of more precise details whether the impairment to the securities firm reputation and balance sheet would have been less costly had its insurance protection been adequate.