Increased store traffic, the shift in management's attention to keeping stock available and the barrage of seasonal employees create an environment ripe for crimes of opportunity such as employee theft. According to the Centre for Retail Research, U.S. retailers' losses from employee theft last year were in excess of $18.4 billion.

What can retailers do to combat this increased risk during the holiday season and to minimize losses?  Retailers usually focus their efforts on reviewing and updating their security policies and ensuring that their employees are properly trained and aware that the company will prosecute any employee theft.  However, retailers should not stop there.  Retailers can protect themselves from potentially exorbitant losses with proper fidelity insurance.  While insurance may not be the first concern for a company when dealing with employee theft, retailers must assess the coverage that is in place for potential insurance claims in order to maximize profits during the holiday season.

Most large retailers have fidelity policies in place, yet each year, many sophisticated companies leave millions of dollars of fidelity insurance assets untapped.  Most of these insurance assets remained untapped because the retailer was unaware it had coverage for the loss, did not understand the impact of certain provisions in the policies or failed to properly file a claim or abide by other conditions in the policies.

In this alert we address (i) the types of losses that are covered under fidelity policies, (ii) provisions in fidelity policies that regularly impact retailers' ability to recover losses, and (iii) simple steps retailers can take to maximize insurance recoveries after an employee theft.

What Losses Are Covered Under Fidelity Policies?

Fidelity insurance policies cover loss of money, securities or inventory resulting from crime against the company.  Basic fidelity insurance coverage protects against employee dishonesty, theft, disappearance and destruction, embezzlement, forgery or alteration, robbery, safe burglary, computer fraud, counterfeit money orders and currency, credit card forgery, and other criminal acts.  Liabilities covered by fidelity insurance usually fall into two main categories:  (1) employee dishonesty coverage, which pays for losses caused by dishonest acts of employees, such as embezzlement, forgery or alteration, fraud and theft; and (2) money and securities coverage, which pays for money and securities the company loses through burglary, robbery, theft, disappearance and destruction.  Fidelity policies also may include broad coverage grants for investigation costs or specific endorsements granting coverage for these costs.  Investigating losses and substantiating fidelity claims can be expensive, so it is wise to understand what, if any, investigation cost coverage you have and to consider speaking with your broker to purchase such coverage if necessary.

Provisions in Fidelity Policies Every Retailer Should Understand

With the holiday season beginning, now is the time to review the policy provisions that often make the difference between a covered claim and a non-covered claim for retailers, namely, who is an employee under the policy, what triggers a "discovery" of loss, and what circumstances may trigger a cancellation clause, eliminating coverage for a given employee.  These are common areas of confusion and regularly form the basis for disputes when retailers file fidelity claims.

Who Is an Employee?

Fidelity policies cover losses for employee dishonesty, but the definition of "employee" varies substantially between policies.  Some policies contain broad definitions that include salaried and hourly employees, directors and officers, consultants, check processors, and temporary and seasonal workers, including employees provided by employment contractors or temp agencies.  Most fidelity policies' definition of "employee," however, is much narrower and may cover only salaried employees that the company compensated, directly controlled and had direct authority to hire and fire.  A retailer should review the definition in its own fidelity policy and ensure that the policy captures all employees it wants covered, paying specific attention to how seasonal and temporary workers are treated.  If a policy does not cover seasonal and temporary workers or any other individual necessary for operations, a policyholder can, prior to the discovery of a loss, talk to its broker and add an endorsement to broaden the definition of employee.  Often the increase in the premium for these endorsements is minimal.

How Is the Policy Triggered?

Most fidelity policies are triggered by the "discovery" of a loss.  When a loss is actually "discovered" is often a vigorously contested issue.  This can impact which policy must respond to the loss as well as the time the policyholder's obligation to provide notice to its insurance company arises.  Some policies deem discovery to have taken place on the date the retailer became aware of facts that would lead a reasonable person to assume a loss had occurred.  Other policies deem discovery to have taken place on the date the retailer learned that an employee committed a "dishonest act."  Who within the company needs to be made aware of the loss before the policy is triggered also varies among policies.  Under some fidelity policies, discovery is only deemed to have taken place once the loss is reported to certain individuals that work for the retailer, i.e., risk managers or officers and directors.  Under other policies, however, the language is less specific, and some policies have provisions that could be interpreted as being triggered when anyone within the company other than the thief discovers the loss.  Retailers should review the language in their fidelity policy and ensure that they understand what triggers their policy.  They also should ensure that they have proper procedures in place for losses to be reported both within the company and to the insurer.

Cancellation Clauses

The typical "cancellation" or "termination" clause in a fidelity policy provides that coverage for an employee is terminated as soon as the retailer learns of any dishonest or fraudulent act committed by the employee, whether the act was committed while in the employment of the insured or otherwise and regardless of whether the type of dishonesty is covered by the insurance.  Retailers need to take heed of this provision when hiring employees, when reprimanding employees and when learning of any dishonest or fraudulent act.  For example, if a retailer conducts a background check prior to hiring and discovers that the potential employee passed bad checks 10 years ago but hires the employee anyway, the retailer may very well not be covered if that particular employee ends up stealing from the company.  Similarly, if a longtime employee makes a minor mistake that could be deemed a dishonest act, i.e., not paying for a lunch under the honor system in the employee lunch room, and the company merely issues a reprimand based on years of service, again it is possible that losses caused by that particular employee will no longer be covered under the company's fidelity coverage.  If the same employee later conspires to mastermind a theft ring that depletes the company's inventory, the company may not have coverage available.  Retailers should also understand that a dishonest act that occurs outside of work and unrelated to the employment may also void coverage.  Perhaps a retailer learns that an employee has been cited for failure to pay child support and that his or her wages are being garnished.  This is considered a dishonest act in some jurisdictions.  Simply put, what a retailer knows about its employees may cause it to lose coverage.  Retailers need to understand the parameters of the cancellation clauses in their fidelity policies. When hiring or keeping employees that have committed dishonest or fraudulent acts, no matter how small, a retailer should notify its insurance company and ask whether the insurer would be willing to continue to cover the employee through an endorsement.  If the insurance company refuses, the retailer should carefully consider whether it is willing to take the risk or whether it should terminate the employee.

How Retailers Can Maximize Their Fidelity Coverage Following the
Discovery of Employee Theft

Once you determine that an employee theft has occurred, it is essential to follow four simple steps to maximize your coverage. 

First, immediately notify your fidelity carrier in accordance with the procedure and deadlines in the policy.  Notice requirements vary among policies; some policies require notice in as little as 30 days after the discovery of a loss, and in some jurisdictions, failure to abide by notice provisions may bar all coverage.  While the consequences of late notice vary based on the jurisdiction and the policy language, this is a coverage dispute that, with foresight, policyholders can and should avoid. 

Second, review the investigation cost coverage under your policy and tailor your investigation to obtain the full benefit of your insurance assets.  Even if your fidelity policy does not explicitly provide coverage for investigation costs, some costs may be recovered under a standard "recovery clause" found in most fidelity policies, assuming your investigation is tailored properly (i.e., you tailor your investigation to obtain recovery and determine the scope and extent of the loss). 

Third, take the time to comply fully with the proof of loss provisions. Fidelity policies usually contain strict proof of loss provisions that require a policyholder to swear under oath and provide details and documentation of the loss within a specific period of time, often within 120 days.  In some jurisdictions, untimely filing of the proof of loss can result in a bar of all coverage.  Policyholders need to carefully track proof of loss deadlines in their policies.  The proof of loss is a critical part of the claim procedure.  A policyholder should present a detailed comprehensive proof of loss that provides details and documentation of the loss, including a chronological narrative on how the theft occurred and the policyholder should be prepared to identify why the loss is covered under the applicable policy language. Doing so can save the policyholder time and also help the policyholder avoid unnecessary litigation on covered claims.

Fourth, reach out to experienced coverage counsel for large or complicated losses.  Experienced coverage counsel can assist you in reviewing your rights under the insurance policy, navigating the policy traps and exclusions, tailoring your investigation plan, and filing your proof of loss in a way that maximizes recovery and minimizes the risk of litigation.

If you take the time to understand your fidelity coverage and reach out to experienced coverage counsel when needed, you can maximize your insurance assets to minimize the dissipation of your seasonal profits through employee theft.

© 2011 Perkins Coie LLP