ISO Commercial Crime Coverages Underwriting Considerations

ISO COMMERCIAL CRIME COVERAGES UNDERWRITING CONSIDERATIONS

(July 2019)

INTRODUCTION

Underwriting commercial crime begins with evaluating the coverage form or policy being considered, understanding exactly what dishonest actions it covers, and determining the type of property to be covered. Based on these factors, the business’ exposure to loss must be evaluated and the current controls it uses to prevent or discourage dishonest actions from taking place must be thoroughly reviewed.

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COVERAGES

There are two general categories of coverage and types of losses. The first involves crimes that employees commit. Fidelity is the traditional term for this crime coverage. Employee theft is the current term that the Insurance Services Office (ISO) uses. The second involves crimes committed other than by employee theft. The traditional terms for these coverages are Money and Securities Coverage, 3–D Coverage, Open Stock Burglary, and other miscellaneous titles. ISO now refers to them by insuring agreement and uses descriptive titles to identify the coverage. Some examples are:

There are similarities in the categories with respect to the ultimate loss and payments. However, the controls needed for each are very different and underwriting efforts should recognize the differences.

EMPLOYEE THEFT

Employees who steal from their employer betray the trust their employer places in them. As a result, exposure analysis involves evaluating each employee’s trust level. Trust level usually means the amount of company assets that a given individual controls. Individuals usually break down into two different groups. One handles money. The other handles inventory. Either can cause serious financial damage to the company but different controls are needed for each.

Types of Employees

Underwriting and rating employee theft begins with accurately determining proper employee classifications. A higher premium charge is required for employees who have greater access to company assets. Risks that have fewer employees with access to company assets are better underwriting risks and qualify for lower premiums.

ISO determines that the following are ratable employees:

Officers and employees who handle or have access to money, securities, and other property are charged higher premiums. The chances of a loss taking place and the premium charged are lower if the named insured limits the number of these employees.

 

Example: Quicker Restaurant had a total of 100 employees. The wait staff handled bill payments in addition to their regular duties. Each had easy access to the kitchen and the restaurant’s inventory. All employees were considered ratable employees. An unexpected inventory loss caused Quicker’s owner to make changes. He hired a cashier and the wait staff no longer handled bill payments. He placed the kitchen inventory under lock and key and under the kitchen manager’s control. Only nine kitchen staff employees handled inventory. The number of ratable employees dropped from 100 to 15, including the officers. These changes reduced both the theft exposure and the premium.

 

The type of business operation must be evaluated after the employees are classified correctly.

Class of Business

The highest-rated ISO employee theft classification is Automated Teller Providers. Other classes with high rates include Currency Exchanges, Safe Depository Companies, Commodity Brokers, Pawnshops, and Mutual Fund Brokers. Each of these classes handles highly attractive property that consists of money and/or highly negotiable securities. After this group come gemstone, jewelry, and silverware manufacturers. These businesses handle high-value items that are also difficult to identify if stolen.

Other classifications with high rates include commodities with high monetary value in the marketplace. Name-brand athletic shoes, cigarettes, alcohol, firearms, designer fashions, and meat are all examples of big-ticket items that are attractive to the general public. These commodities are easily sold or disposed of on the black market. In addition, electronic commerce and online transactions increase their value because the marketplace is global and sellers can move goods anonymously.

Controls

It is impossible to eliminate employee theft. However, it can be mitigated by use of controls. Controls can also assist in capturing the parties responsible for a loss. Many employees admit that they steal from their employer because they think they can get away with it. This mindset suggests two types of controls. The first is to limit the opportunities for theft. The second is to have an audit system in place that quickly identifies any wrongdoing. There are a number of suggested control techniques that a business can employ.

1. New hires

New employees who handle cash, securities, or inventory must complete an application and provide references. A background check should verify the references and other information before the named insured hires the employee.

 

Example: A new cashier was caught after she stole $10,000 during her first month of employment. Her employer was very surprised when informed that she had past theft convictions and was scheduled to stand trial for a recent theft from a previous employer.

 

2. Separation of duties

Job duties should be separated among different employees. This means the person who makes deposits to an account should not make payments on that account or reconcile its statements. A different person should handle each function. The person who orders inventory should not sign for receiving the shipments or pay the statements for them. Pure job or duty separation may not be possible, perhaps because of a small staff. In those cases, overlapping duties can be helpful. This means that employees assist one another and regularly exchange jobs. This enables unusual transactions or incidents to be noticed sooner.

 

Example: Paul was the best bookkeeper on staff. Over the years he took on many jobs that others did not want and he never taught anyone else many of the functions that he performed. Paul suffered a heart attack and the temporary accounting help brought in to do his work quickly informed Paul’s employer that his diligence had cost the employer more than $400,000 in misappropriated funds over those years.

 

3. Check handling

All checks should be countersigned (signature by two or more authorized persons). The person who countersigns should not be involved in reconciling or preparing checks. A threshold amount over which all checks must be countersigned should be established in cases where countersigning all checks is not practical. Checks for less than the threshold amount need only one signature.

Payroll checks should receive the same careful treatment. Employment records should be verified before signing to ensure that the employees actually exist, are at work, and are not fictitious. Mechanical devices used to sign checks should be secured when not in use and only a few select and authorized employees should have access to them.

There should also be procedures to handle incoming checks. They should immediately be stamped “for deposit only” and then be recorded as received.

 

Example: Naylor Manufacturing had high employee turnover. Patricia prepared and distributed payroll checks. On one occasion, she “inadvertently forgot” to notice that an individual was no longer employed and issued a paycheck to him anyway. Patricia kept the check, set up a bank account for the now fictitious individual, and continued to “forget” to stop paying him.

 

4. Inventory control

There should be manual or computer inventory records to keep track of inventory movement. Only a few select individuals should be authorized to order items. Prior approval of suppliers by someone other than the person who places the orders should be in place. This can prevent collusion and eliminate payments to fictitious suppliers. Prior approval of customers that pay by credit should also be required so that orders are not shipped to fictitious customers or locations and payments cannot be collected. "Inventory shrinkage” can be a major problem without proper monitoring and effective safeguards. One important control is to perform regular physical inventories. Using surveillance cameras, checking the contents of employees’ packages, and restricting access and entry into warehouse areas are all useful ways to minimize inventory shrinkage.

5. Outside audits

Regardless of the number, extent, and effectiveness of internal controls, someone inside the company has ultimate control. The only way that person can be held accountable is through an independent outside audit. A Certified Public Accountant (CPA) who is totally independent of the company should conduct the audit at least annually. As the Enron scandal showed, accounting firms that have a vested interest in the company they audit continuing in business are less likely to be objective with their findings. Objectivity is even more difficult when the CPA has a relationship with the financial officer of the business that he or she audits. There must be at least an “arm’s-length” business relationship between the CPA and the business being audited. Otherwise, problems can be easily overlooked.

THEFT, ROBBERY AND BURGLARY BY OTHER THAN EMPLOYEES

It is impossible to prevent all criminal acts. However, the named insured should make arrangements and provisions to make criminal activities more difficult to commit. It is also possible to make criminals aware of the fact that it will be difficult to profit from the crime.

Barriers

A good first barrier to crime is a good lock. The better the lock, the better the barrier, as long as the door is strong enough. However, key management is essential. The named insured should provide keys to only certain people and on a limited basis. All keys should be numbered and assigned. That way, the key can be retrieved and accounted for when the employee who was issued a key leaves the company.

The next barrier is windows. They should be fixed (not designed to be opened). If they can be opened, they should be closed and locked during non-business hours. Tempered and/or bulletproof glass should be considered for businesses with merchandise or stock that is attractive, highly valued, and susceptible to burglary or theft.

Fences and/or walls erected around the perimeter of the location or premises are also effective barriers. They should be high enough and properly configured to discourage climbing and not be erected near trees. A secured gate manned by company or outside service providers personnel can reduce or prevent unauthorized entry. Razor wire can be attached at the top of the fence or wall to discourage unauthorized attempts at entry. Guard dogs on the grounds can also be effective deterrents.

Alarms

Alarms do not prevent entry. However, they do notify the proper authorities of such entry so that police, guards, or authorities can intervene and try to stop the criminal activity. Alarms can also be used to eliminate the element of surprise at an entrance so that action can be taken inside the premises to properly safeguard valuables. Alarms reduce the premises’ attractiveness as a target for theft, at least for unskilled criminals. A number of alarm systems are available. Each has different degrees of effectiveness. The expense of each is based on the level of protection needed and the extent of the protection the alarm system provides.

Silent alarms are useful for situations that involve cashiers and tellers. They notify the police that a criminal act is taking place without alerting the criminal. This prevents the possibility of panic and/or harm to the employees and customers.

Location

The business’ location and hours of operation have a relationship to holdup incidents. Holdups are much more likely if the business’ operating hours are different than those of other businesses in the area, if it is located near an access road (such as an interstate or state highway) or if only one employee works on a given shift. Businesses located in high crime areas must take more precautions than businesses located in other areas. Local law enforcement authorities keep detailed crime statistics and this information is available to the business.

Money handling

The amount of cash kept on hand should be kept to a minimum, regardless of the type of business. Checks should immediately be stamped “for deposit only,” and credit card receipts should be stored separately from cash. Cash drawers should be regularly emptied of large bills, checks, and credit card receipts. This is to minimize the loss if there is a holdup. Items removed from the drawers should be deposited or placed in a safe, vault, or other secure receptacle. Bank deposits should be made at least daily or more frequently, depending on the amount of cash on hand.

Off Premises

Underwriting off premises crime coverage focuses on who can take items off premises, why they are taken off premises, and the length of time they are kept off premises. A messenger is the person who takes items off premises. A guard may accompany the messenger but messengers are usually not accompanied. Taking cash and checks to the bank for deposit is the usual reason they are off premises.

It is important that messengers vary their routine. This could mean that they make regular deposits during the day and take different routes to the bank.

Businesses that have large amounts of cash and checks often use armored car services.