What Is a Fidelity Bond?
A fidelity bond is a form of business insurance that offers an employer protection against losses that are caused by its employees' fraudulent or dishonest actions. Also known as an "honesty bond," this form of insurance can protect against monetary or physical losses. In Australia, a fidelity bond is called "employee dishonesty insurance," and in the U.K. it's called "fidelity guarantee insurance."
- Fidelity bonds are insurance policies that protect policyholder companies from wrongful acts committed by employees.
- Fidelity bonds are not tradable securities.
- This form of insurance is considered a component of a company's risk management strategy.
Click Play to Learn About Fidelity Bonds
Understanding Fidelity Bonds
If a company has employees who commit fraudulent acts, the company itself may be exposed to legal or financial penalty in addition to the individual employee or employees who committed the act. As a result, companies are at risk of being exposed to such penalties, especially firms with a large number of employees.
Fidelity bonds cover firms for such damages. Although they are called "bonds," fidelity bonds are actually a form of insurance policy. They are typically designated as either first-party or third-party:
- First-party fidelity bonds are policies protecting businesses from wrongful acts committed by employees.
- Third-party fidelity bonds protect companies from similar acts by individuals employed on a contract basis.
A fidelity bond should not be confused with a regular bond. It is an insurance policy that is neither tradable nor can accrue interest.
Fidelity bonds are most often held by insurance companies, banks, and brokerage firms, which are specifically required to carry protection proportional to their net capital. Among the possible forms of loss a fidelity bond covers include fraudulent trading, theft, and forgery.
Why Fidelity Bonds Are Used
Fidelity bonds can be considered part of a business’s approach to enterprise risk management. These insurance policies function as a sort of protection should the company suffer losses caused by fraudulent or criminal employee actions taken against the company or its clientele.
This can include cash thefts from the business as well as if the employee steals from a customer of the company. Acts of forgery by an employee that affect the business may also be covered by this type of policy. Robbery and burglary of the company safe, destruction of company property, and the illicit transfer of funds are covered by fidelity bonds, too.
Types of Fidelity Bonds
Fidelity bonds are broken down into various types, each of which cover specific things. The most common forms of fidelity bond are:
- Business services bonds: These products, also called business bonds or janitorial service bonds, are generally the most common type of fidelity bond. Their job is to protect clients when employees visit their premises. Should, for example, a company send an employee to a customer's home and that member of staff steal a computer, the bond would reimburse the client for the loss.
- Employee dishonesty bonds: These bonds protect companies and their clients in the event that an employee misuses Social Security numbers, credit card numbers, or other financial or personal data.
- ERISA bonds: The Employee Retirement Income Security Act (ERISA) of 1974 demands trustees of pension plans have fidelity bond coverage equal to at least 10% of the total plan’s assets. This rule was put in place to protect plan beneficiaries from theft or other inappropriate actions orchestrated by those responsible for managing 401(k)s and other pension plans.
Another type of fidelity bond is used by certain states such as Alaska, Michigan, and Texas to encourage employers to provide job opportunities to applicants who have backgrounds that make them high-risk, potentially untrustworthy workers. With these fidelity bonds, the employer would be reimbursed should the employee behave dishonestly.
How Does a Fidelity Bond Work?
Fidelity bonds are insurance products that offer employers protection against losses caused by employees' fraudulent or dishonest actions. Should an event covered by the policy transpire, the company would file a claim and get reimbursed according to what it agreed with the insurer.
What Are Examples of Fidelity Bonds?
The most common type of fidelity bond is the so-called business services bond, which is designed to protect against losses when an employee is on a customer’s premises. For example, if a window repair worker is sent to a home that was damaged by a storm and steals jewelry from the residence, the company may have exposure concerning their employee’s actions. Likewise, if a dog sitter were to use their access to a client’s home to steal money, or if a home health provider took clothes or a laptop from a client, a fidelity bond tailored for such circumstances could provide the company with the coverage it needs.
What Are Two Main Types of Fidelity Bonds?
Two popular types of fidelity bonds are business services bonds, which are specifically designed to protect clients when employees enter their home or place of business, and employee dishonesty bonds, which protect companies from financial loss should an employee or group of employees engage in fraudulent activities. Another common type of fidelity bond is the ERISA bond, which protects retirement-plan beneficiaries should trustees steal from them.
The Bottom Line
Fidelity bonds are something many businesses need, either out of choice or because their state or municipality demands it. Sadly, not everybody is honest and it’s often worth paying the premium for peace of mind and to reassure customers.