Construction is a risky business. According to a 2005 report from the U.S. Bureau of Labor Statistics, less than 50 percent of construction businesses that started in 1998 existed four years later.
In addition to risk drivers such as inadequate estimating, poor site conditions, labor shortages and materials price increases, contractors are vulnerable to significant losses caused by employee theft and dishonesty.
Studies and commentary on the cost of employee theft peg annual costs in the tens of billions of dollars. The Association of Certified Fraud Examiners estimates the median loss for “asset misappropriation” is $150,000, but losses have exceeded this figure into the millions of dollars. For example, an ING Reinsurance employee recently was sentenced to eight years in prison for embezzling $8.5 million from the company. Such losses could destroy any business’ capital and liquidity and cause it to fail.
Just as a business purchases property insurance to cover the risk of fire, it should purchase fidelity insurance to cover the risk of employee theft. In addition, businesses should establish sound internal controls to serve as a first line of defense to thwart and detect employees’ dishonest schemes.
Internal Controls
A strong system of internal controls can reduce the opportunity for theft significantly. Internal controls are particularly critical for a contractor with employees scattered across various jobsites. In this case, systemic controls are necessary because centralized oversight of employees located in more than one place is not possible.
To protect the bottom line, it is imperative for a contractor to implement the following internal controls:
- Make sure clear lines of authority and responsibility exist between employees and departments. Accounting and operating functions should be separated as much as possible.
- Set up a division of duties so one person is not responsible for handling financial transactions from beginning to end.
- Carefully select personnel by utilizing background checks.
- Supervise and enforce internal controls. Management must always be alert to signs of changing employee behavior and potential breakdowns in the internal control system.
Fidelity Insurance
No internal control system is 100 percent foolproof; it represents only half of the risk management solution. If the internal controls are overcome and a significant loss occurs, a contractor needs fidelity insurance as a second line of defense. Fidelity insurance, sometimes called a fidelity bond, protects contractors against losses incurred due to the dishonest acts of an employee.
Most insurance companies provide employee dishonesty coverage under a policy with multiple coverages, including employee dishonesty and theft of money and securities by persons other than an employee. Significantly, money and securities generally are excluded from a contractor’s property policies.
Although some differences may exist among fidelity policies available in the market, they are basically similar in terms of structure and coverages offered. The Crime Protection Policy published by The Surety & Fidelity Association of America provides six different coverages.
- Employee dishonesty. Pays for loss of money, securities and other property resulting directly from the dishonest acts of an employee with manifest intent to cause the insured a loss and obtain financial benefit. This is the cornerstone of the policy and the main reason why businesses purchase the policy.
- Forgery or alteration. Pays for loss resulting directly from forgery or alteration of checks and other instruments that are made or drawn upon the insured. On a weekly basis, a contractor issues hundreds of checks to vendors, suppliers and subcontractors. This coverage protects the contractor against the risk of the checks getting into the wrong hands.
- Inside the premises. Pays for loss of money and securities inside the company premises or banking premises resulting from theft, disappearance or destruction. Many property coverages do not cover money and securities, so this coverage fills that gap.
- Outside the premises. Pays for loss of money and securities outside the premises while in the care and custody of a messenger or armored motor vehicle company.
- Computer fraud. Pays for loss of money, securities and other property resulting from the use of any computer to fraudulently cause a transfer of the property to a person or place outside the premises. In today’s age of electronic transactions, a contractor faces exposures that were not even contemplated five or 10 years ago.
- Money orders and counterfeit paper currency. Pays for loss resulting directly from having accepted in good faith in exchange for merchandise, counterfeit United States or Canadian currency or money orders that are not paid upon presentation.
Two other coverages are available by rider:
- Client’s property. Pays for loss of a client’s property resulting from the dishonest acts of an employee with manifest intent to cause the insured a loss and obtain financial benefit.
- Funds transfer fraud. Pays for loss of funds resulting directly from a fraudulent instruction directing a financial institution to transfer funds from the insured’s account.
The insured selects only the coverages it needs. Each coverage has a separate limit of insurance and a separate deductible. Because the policy is on a “discovery” basis, it pays for losses sustained by the insured at any time and discovered during the policy period.
To protect its bottom line, a construction company must implement a robust internal control system and obtain fidelity insurance. A multiple-line policy will afford protection against employee theft in addition to other operational exposures, such as theft of money and securities and forgery.